S&P just downgraded its outlook on its U.S. credit rating to negative, in what could be the beginning of a ratings agency assault on the U.S. sovereign’s status.
Many will argue this is deserved. The U.S. government has been running significant deficits, racking up debts, and dilly-dallying around getting its economic house in order.
But Richard Koo of Nomura has written before that ratings agencies don’t understand how government debt functions in a deleveraging cycle, or a balance sheet recession.
From Richard Koo:
What Japanese market participants understand that Western rating agencies do not is that fiscal deficits generated during a balance sheet recession are the result of economic weakness triggered by private-sector deleveraging, and that the private savings needed to finance those deficits are by definition made available at the same time.
In other words, such conditions lead to a substantial surplus of savings in the private sector. What makes an economy under such conditions fundamentally different from an ordinary economy (i.e., one that is not in a balance sheet recession) is that those savings are plentiful enough to finance the government’s deficits.
Corporate savings (and personal savings to a lesser extent) have boomed since the recession, and it’s that excess cash the U.S. government can continue to make use of while the country is deleveraging to keep the economy from shrinking.
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The S&P may have just kicked off the beginning of a U.S. debt downgrade round that will put pressure on the government to cut spending when the economy is weak. We’ve already seen how that’s working out for the UK.