Streetwise Professor

August 7, 2011

It Doesn’t Take a Rating Agency to Tell Which Way the Debt Grows

Filed under: Economics,Financial crisis,Politics — The Professor @ 4:36 pm

After the close of the markets on Friday, S&P downgraded US long term debt from AAA to AA+.

This is news, but shouldn’t be a surprise.  The rating agencies are like the cop who draws the chalk line around the murder victim’s body.  They just validate the obvious.

No, the arithmetic tells all.  When the government spends roughly 25 percent of GDP, is currently generating revenue at less than 15 percent of GDP, and historically has had receipts no more than 20 percent of GDP, the debt will grow at between 5 and 10 percent of GDP per annum.  The debt is already at high levels, both historically, and relative to levels that have sparked fiscal crises in other countries.  The official debt, moreover, is only a fraction of the government’s commitments.  Add it all up and the blind should be able to see the writing on the wall.  It reads “fiscal crackup coming to a country very near you.”

The administration and its acolytes have two stock responses.  The first is to screech that S&P made a “math error.”  As John Taylor notes, it’s not a math error: it’s a disagreement about assumptions.  The administration claims S&P should have assumed that discretionary spending would grow at the rate of inflation.  You know, because all the king’s horsemen and all the king’s men have pinky sworn on it.  They passed a bill and everything.  In this scenario, due to real GDP growth, spending would fall as a fraction of GDP.

S&P assumed that discretionary spending would rise at 5 percent, roughly the rate of nominal GDP growth (real growth plus inflation).  In this scenario, discretionary spending as a fraction of GDP would remain constant.  Given the historical record, this may in fact be conservative.  But under this assumption, the increase in debt over 10 years totals $2 trillion more than the administration claims.

The administration and its pilot fish have also huffed that S&P’s analysis is “political.”  Uhm, isn’t sovereign risk all about politics?  If not, please tell me what the hell it is about.

The second response is purely political–and Orwellian.  It is to repeat ad nauseum the Big Lie that this is the Tea Party downgrade, attributable lock, stock, and barrel to the failure of the Tea Party caucus in Congress to even countenance taxes as a part of any debt ceiling deal.

Like all Big Lies, this one is based on a kernel of truth: S&P did explicitly mention the unwillingness of the Republicans to include tax increases as a part of any deal as one of the justifications for its decision.

But pinning the blame on the Tea Party is fundamentally dishonest because if its adherents had its way on spending and taxes, S&P would probably give the US a AAAA rating.  Indeed, the singlemost important thing driving the Tea Party is concern bordering on obsession that the country is headed into the fiscal abyss.  The Tea Party caucus’s objection to all the proposed debt ceiling deals was–and is–that the deals did not confront this existential problem in a serious way.   They thought that something has to be done now, and the looming debt ceiling would give them the leverage to make such a confrontation possible.  I think their tactics were counterproductive because they did not take into account the objective correlation of forces (to use the old Soviet military phrase).  But they were–and are–the only sizable group that is taking seriously the underlying structural problems that led to the downgrade.

Ask yourself this: if Obama had gotten his original wish, and the debt ceiling had been raised “cleanly”–no deals on spending or taxes–would S&P have downgraded the US?  I can’t see how it could have been otherwise.  If anything, the Tea Party rebellion made a deal with a higher likelihood of slower deficit growth possible.  Under any reasonably plausible counterfactual, it is highly likely that the objective factor that drove the S&P decision–i.e., debt growth–would have been higher without the Tea Party than with it, because the ancien regime would have just gone on with business as usual.  Which means that the downgrade cannot be credibly laid at the feet of the Tea Party.

The reason the divide between the Tea Party and the ancien regime is so wide is that the two factions have fundamentally different views of the problem, based on fundamentally different views of the proper scope and size of government.  The Tea Party doesn’t consider raising taxes to be a constructive part of any effort to address the problem because its members believe that spending is the problem, not the way the spending is financed.  They believe that the government is too big, it spends to much, it spends badly, and that raising taxes just extends, but only for a little while, the life of Destructive Leviathan–whom they would rather starve than feed.

In contrast, the ancien regime–which is dominated by the left, but which includes much of the Republican Political Class as well–doesn’t believe that the government is too big.  Many of them–especially in this administration and the progressives in Congress–think if anything the government is too small.  From that perspective, the only issue is how to fund Constructive Leviathan, which makes taxes the beginning and end of the conversation.  From this perspective, the Tea Party is completely unreasonable in its refusal to raise taxes, and hence responsible for the downgrade.

That’s the divide, and it’s an unbridgeable one.  That should be the issue on which the 2012 election is fought.  If that election produces a new correlation of forces that moves policy closer to the Tea Party ideal of less spending, entitlement reform, and tax reform, there is a very good chance that the US will be upgraded.  If, in contrast, it merely perpetuates the ancien regime–where continued stalemate would constitute perpetuation–we’ve only taken the first step on the Downgrade Trail.  And if Obama prevails, the rest of the trip is more likely to be a sprint than a stroll.

And I cannot close without reminding you all of Timmy! the Treasury Secretary’s unqualified assertion, repeated often, that a downgrade would not occur.  “No risk,” sayeth Timmy!  Asked a second time, Timmy! repeateth: “No risk.”

Another fail.

But be there gladness in your hearts, peasants, for Timmy! will stay through the 2012 election.  For nothing succeeds with this administration like failure.

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  1. “The reason the divide between the Tea Party and the ancien regime is so wide is that the two factions have fundamentally different views of the problem, based on fundamentally different views of the proper scope and size of government.” If only you would apply this same logic to foreign policy. But alas, at SWP the ‘ancient regime’ stops at the water’s edge. Or at not very far outside the Beltway, which excludes the Pentagon’s massive budget. Professor, do you really think this country needs 10 carrier battle groups anymore (even if only four can operate at the same time?) Do we need military bases in 120 countries, including those around Russia? Do you want to pull out of Afghanistan because us relying on the Pakistanis (some of whom clearly want to kill us) and relying on the Russians for our logistical lifeline is just hateful to you?

    It’s easy just to throw stones. Harder to stake out real positions and fight for them like Ron Paul, back when they were far less popular than now.

    Comment by Mr. X — August 7, 2011 @ 6:33 pm

  2. Bottom line: how long are we going to able to fight mini-Cold Wars with China and Russia while trying to borrow money from them (though it would appear most of the borrowing has ceased and we’re in printing mode now)

    Comment by Mr. X — August 7, 2011 @ 6:36 pm

  3. @Mr. X. I am an apostate libertarian when it comes to international/military affairs primarily b/c there is a difference between life in a civil society and life in a state of nature–which is what international relations is. Re carrier battle groups specifically–the realities of deployment and the need for surge capacity mean that you need 2N+ battle groups to have N operational at any point in time.

    Re Afghanistan–no, I want to pull out because it is futile and does not contribute to our national security in ay way commensurate with its cost.

    And last time I checked, (a) I stake out real positions–you just disagree with them; and (b) if what I do is throw stones, then that’s what Ron Paul does–it’s just that you agree with his. And I have been advocating unpopular positions for a long time too. Just not as long as Ron Paul b/c he’s a helluva lot older than I am.

    The ProfessorComment by The Professor — August 7, 2011 @ 7:26 pm

  4. Wonderful analysis.

    Comment by Jeff — August 8, 2011 @ 6:26 am

  5. Politics is a potent cocktail of tequila and mushrooms when analysis is required. It is great for warping reality, but it’s a terrible companion for getting something sensible done.

    You’re correct that the Tea Party’s staunch insistence on radically lower spending is a critical element of resolving a spending crisis. Said in so few words, it almost sounds ridiculously obvious. Yet, I find very little evidence that many within the Tea Party, such as it is, actually understand that this is what they are advocating. What I have read is that they are doing things like, “Standing against Obama,” or, “Holding the Democrats accountable,” and other square-jawed varieties of that meme, that make you feel proud without being quite sure why.

    I watched the arm-folded defiance of the Democrats as they yelled about the Republicans’ willingness to cut social programs while making sure their rich friends didn’t have to pay higher taxes. Those dastardly Republicans, how dare they!

    And I watched the non Tea Party Republican establishment run in little circles and pee themselves because they couldn’t figure out how to get others to support their agenda, in part because they’d left their agenda in their other pants.

    The net result of the last couple of months of wrangling was a last-second “deal” that did nothing more than increase our debt in exchange for two promises:

    1) That we will totally be spending less in the future, for sure, and even though we’ve made and broken this same promise for decades like a helpless crack addict, this latest fix is not enabling us.

    2) That we will be re-visiting this issue in a few months with the same 535 incompetent, spoiled children in charge, so that we can take on the issue of correcting the gross mismanagement of our national budget for real this time.

    Having secured these two bizarre promises, legislators of all stripes have taken to the airwaves to curse and whine and point fingers. It’s all THEIR fault, they cry, pointing at everybody but themselves. And the strong message that they convey is not an effective post-mortem, but rather the public declaration, “I’ve learned absolutely NOTHING from this painful experience! I’m just as clueless as when it began, and I can’t wait to screw it up next time, too!”

    I am puzzled and surprised that you, too, seem to be engaging in the partisan poo-throwing. This isn’t “Obama’s fault,” and it isn’t a “Tea Party Downgrade.” It’s not the Democrats or Republicans who are responsible for heaving up this embarrassing hairball of a legislative failure. It’s a combined, dedicated effort on the part of ALL participants to think dogmatically rather than pragmatically. It was a strong, unified consensus that the one thing to emphatically reject was a practical financial analysis and solution.

    This isn’t about politics at all. Well… I guess what I really mean is, “the solution to our national financial crisis isn’t found in politics.” But the hideous incompetence that buried the solution was one hundred percent about politics. And having said that, there lies our salvation or damnation. Do we choose more partisan wrangling and ride that to our doom? Yeah, I guess we do.

    Thanks for reading, if you made it this far. /tips hat and wanders off

    Comment by DisenchantedFish — August 8, 2011 @ 8:05 am

  6. Dems are pointing fingers, Repubs are pointing fingers, yet the people know its the entire beltway culture that is to blame. After 80 years of socialism, we have begun to run out of other people’s money. The beltway culture refuses to accept that their time has passed and they are beginning to twist and turn as they begin their inevitable decline. The only question is whether they will give up their power willingly and restore sanity to the overall size and scope of government, or whether they will go kicking and screaming and leave such a debt that the nation will suffer for generations. So far, it looks like they aren’t going to give up readily.

    Comment by Charles — August 8, 2011 @ 8:44 am

  7. Good posts Professor and Fish.

    Politics has become the process of convincing people reality is something other than it is. At some point though reality asserts itself much to the regret of all.

    In this case with all the congratulations after “The Deal” I am reminded of Slim Pickens riding the bomb down in Dr Strangelove. I guess Strangelove is Soros but so many are now playing the role of Pickens that it is hard to single one out.

    All human systems are flawed over the long term and need periodic collapse and renewal. This one will be a bear of a collapse.

    Comment by pahoben — August 8, 2011 @ 8:57 am

  8. “At some point though reality asserts itself much to the regret of all.”

    Speak for yourself. You see, in a depression, assets return to their rightful owners.

    ” This one will be a bear of a collapse.”

    Indeed. :-))

    Comment by a — August 8, 2011 @ 9:23 am

  9. a,
    Hmm…yes I agree that “all” was too strong but I have to ask in the current situation who are “the rightful owners”. Are you referring to the 91% top bracket tax rates that came out of the Roosevelt presidency? Or even the executive Order that raised the tax to 100% on salaries above $25,000/yr. How ironic considering his family made so much money from off the books opium trade in China.

    On the other hand are you referring to the oligarchs and government mafiosa that obtained ownership of assets during the depression associated with the collapse of the USSR.

    Comment by pahoben — August 8, 2011 @ 7:26 pm

  10. […] […]

    Pingback by Anonymous — August 8, 2011 @ 7:34 pm

  11. How often I hear “wealth redistribtion” used to describe increasing individual tax rates. It is not wealth redistribution, it leaves real wealth fully intact while only penalizing current income. Penalizing current income inhibits the accumulation of wealth and thus is a further burden on the middle class.

    Comment by pahoben — August 8, 2011 @ 7:41 pm

  12. […] didn’t really need to sharpen it’s […]

    Pingback by Deer In the Headlights Breakfast Links | Points and Figures — August 9, 2011 @ 1:51 am

  13. “a,
    Hmm…yes I agree that “all” was too strong but I have to ask in the current situation who are “the rightful owners?”

    Why, the “Haves” and the “Have-mores”

    Comment by a — August 9, 2011 @ 2:42 am

  14. And go wash your mouth out with bleach for mentioning that traitor Roosevelt! (spits)

    Comment by a — August 9, 2011 @ 2:45 am

  15. It took the coffee stains right off my teeth 🙂

    Comment by pahoben — August 9, 2011 @ 11:53 am

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