So S&P has changed the outlook for US credit from “stable” to “negative”. Some commentators seem to have confused this with a ratings downgrade, which it isn’t–the US AAA rating is still very much intact.
Rather, Standard & Poor’s are saying that the probability of a downgrade in the future has gone up. I think the WSJ sums it up pretty well:
The S&P analysis didn’t offer any new insight into the nation’s fiscal plight or partisan differences about how to solve it, but served as a reminder that investors may not always be as patient as they have been about U.S. deficits.
The U.S. debt now stands at $14.2 trillion and is expected to balloon in part because of rising costs for health care, retirement and other so-called entitlement programs, and the interest costs on existing debt. S&P said that even if a short-term deal is reached to contain deficits, any agreement could later be undone by politicians.
Administration officials, who were first alerted to the report on Friday, questioned its conclusions but said it validated their efforts to broker a bipartisan deal to address the debt.
Fundamentally, what both sides seem to have trouble grasping is that the important thing is not to solve all our problems right now, but to convince markets that we have the will and the fortitude to solve them at some point in the future. Right now markets are willing to cut us a lot of slack because they figure that we’ll get it together eventually–just as we’ve always done before. The problems start not when our debts become totally unsustainable and congressmen start getting into fistfights on the House floor–but when markets stop believing that we’ll find some way to solve our budget problems short of inflation or default.
And “trouble” consists not of some massive capital flight, but of rising interest rates.
This is why I am so steadfastly unconvinced by people who point to our low interest rates as evidence that the market thinks it’s safe to borrow. When higher real interest rates come, they will not be a timely signal of problems ahead unless we change course–they will be the problem. The term structure of US debt is pretty short, with an average maturity of under five years, and Republicans are complaining that we’ve been issuing too much short-term debt lately. If interest rates climb significantly, our interest expense will start putting a lot of pressure on an already weak fiscal position. Arguing that we’re fine because interest rates are low is like arguing that the Titanic must be safe because it hasn’t run into an iceberg yet.
Of course, this warning applies equally to the people who think that demagoguing the debt ceiling is a fine way to force Congress to fix things (on their terms). Shutting down the government, or mucking around with the debt ceiling, doesn’t help avert a crisis: it is the crisis. Or rather, it risks triggering precisely the crisis of confidence that we want to avoid. If interest rates go up too sharply, our interest rate expense will widen the gap between revenue and spending. To my mind, this makes both large tax hikes, and sizable spending cuts, more likely, not less so. Unless you’re the sort of ideologue who would happily spend more money on interest as long as it means higher taxes or less spending, this is madness.
The US debt problems are large, and they will be painful to solve. But they are not intractably large or painful. It is our bitter, partisan politics–and our own willingness to compromise, or even face reality–that is putting us at the most risk.
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