Earlier today, Moody’s came out and warned that it would downgrade the US credit rating unless Congress and the President got together on a plan to meaningfully reduce debt to GDP.
In the comment, Moody’s says:
Budget negotiations during the 2013 Congressional legislative session will likely determine the direction of the US government’s Aaa rating and negative outlook, says Moody’s Investors Service in the report “Update of the Outlook for the US Government Debt Rating.”
If those negotiations lead to specific policies that produce a stabilisation and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable, says Moody’s.
This is a completely irresponsible and economically silly statement from Moody’s for two reasons.
The main one is that the biggest threat to the economy is the upcoming fiscal cliff, whereby on January 1 of next year, a series of tax hikes and spending cuts will come into force which, if left unchecked, could easily send the economy back into recession. This is a fragile recovery in a world where are partners have been slowing precipitously.
Furthermore, a “debt deal” won’t even cut debt-to-GDP as Moody’s or Congress is imagining.
one of our favourite charts in the world is this one from Richard Koo, which shows that during its great recession, any attempt to cut spending actually saw borrowing RISE.
So not only does this warning from Moody’s come at a terrible time, it’s asking Congress to do something impossible, which is reduce debt-to-GDP by focusing on debt-to-GDP rather than focusing on growth.
Our advice to everyone is to ignore Moody’s.
All kinds of folks warned that if S&P cut our credit rating, then our rates would rise. They didn’t, and a Moody’s cut wouldn’t affect our borrowing costs either.
US rates are a function of inflation, growth, and the desire for safe assets.
An arbitrary letter from a ratings agency doesn’t matter, but what’s scary is that people might listen to it and act on it.
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