- Does No One Care?”
by Liam Halligan
by Liam Halligan
“So let me get this straight. The Standard and Poor's rating agency last week took the historic step of putting the US government's AAA credit rating on "negative watch". There is now, according to S&P, "at least a one in three chance" that American debt will be downgraded from its top-notch status over the next two years - which would be a first in modern times.
A New York Times/CBS News opinion poll has also suggested the US public is now more economically pessimistic than at any time since President Barack Obama's first two months in office in early 2009 - when the country was still caught in the "Great Recession". Amid renewed talk of a "jobless recovery", the number of Americans who think the economy has deteriorated spiked by 13 percentage points over the past month. Congress, meanwhile, is locked in a bitter dispute over the federal government's ability to make ends meet.
These are the stark realities facing the world's largest economy. They are set, furthermore, against Europe's sovereign debt turmoil, Japan's nuclear crisis and ongoing violence in the Middle East. Yet despite all this bad news, this veritable litany of woe, the Dow Jones Industrial Average ended last week at a three-year high. US equities are now at levels not seen since mid-2008 - before the credit crunch really took hold. On top of that, despite S&P's announcement, the price of Treasuries kept rising, as their yield - the cost the US government must pay to borrow - fell to its lowest level in a month. Has the world gone mad?
With a federal deficit close to 10pc of GDP, it is clear the US needs some very significant fiscal tightening. Total debts matter even more than annual deficits and on that score America is almost uniquely "in the hole" - with liabilities, including Medicare, Medicaid and social security obligations, amounting to around $75,000bn (£45,000bn), or a stunning five times annual GDP.
It is a testament to the delusion - and plain dishonesty - which surrounds America's fiscal debate that this figure is not more widely cited. Almost all US politicians and pundits spout the official line that sovereign debts are 59pc of national income, rather than 500pc. But, then again, their UK equivalents maintain that our national debt is 76pc of GDP - again, a fraction of the genuine total.
Earlier this month, Republican Congressman Paul Ryan published a fiscal consolidation strategy document which demonstrated, rather cogently, that the US simply cannot afford its ongoing "entitlement program". Among the very first attempts by a Capitol Hill insider seriously to address America's staggering debts, the Ryan plan is one reason why fiscal consolidation is now set to become the core issue of the 2012 Presidential election campaign.
Another reason is this latest move by S&P. The ratings agency's move was clearly a big moment - but a political moment, having little to do with finance. S&P didn't tell the markets anything they didn't already know about America's fiscal position. US Treasuries are, by a considerable margin, the world's most closely-watched asset class.
Markets reacted the way they did, though, due to the widely-adopted assumption that the danger of a genuine downgrade will galvanise America's deeply partisan law-makers into action, provoking the requisite banging of political heads. So some kind of deal on budget consolidation now, apparently, looks one step nearer - supposedly making Treasuries more attractive. Equities rallied, meanwhile, in part because of relatively strong earnings chalked up by the likes of Apple and General Electric. But there was also a feeling that if fiscal consolidation really is now in the works, the US Federal Reserve is more likely to go easy on the monetary side - further delaying the moment when it finally raises interest rates above 0.25pc, the level at which they've languished since December 2008.
Many have commented that the most remarkable aspect of S&P's announcement is that it didn't come earlier. After all, America's public finances have been spiralling out of control for several years. Even more remarkable, though, at least to my mind, was the extent to which S&P's move appeared to be choreographed between the ratings agency - supposedly an ultra-independent body - and the US government.
This crucial announcement was made on Monday April 18. Congress was away for Easter recess, with members scattered across America and beyond. As a result, there were no protesting speeches in the Senate or House of Representatives and no resulting press conferences. The date that S&P picked, however it picked it, was very kind to the White House.
The S&P report itself was also extremely benign. There was no mention that the Obama administration has increased federal spending by more than 30pc in two years, while almost allowing the government to "shut down" by not agreeing to minuscule spending cuts. In addition, Tim Geithner, US Treasury Secretary, appeared to know about the announcement in advance. Last Sunday, the day before publication, he made himself very available to the broadcast media, touring the TV studies to give multiple interviews on the bold steps being taken by the Obama administration to "tackle the deficit". This allowed the government to, as spin doctors say, "get ahead of the news".
Once the announcement was made, Geithner merely shrugged it off. His official response was that there is "no chance" of S&P's negative outlook turning into an actual downgrade. The rational reaction to such a statement is that "there was no chance of the Titanic sinking either". The more realistic response, perhaps, is to realise that there really is "no chance" of a major US ratings agency gainsaying the White House any time soon.
One reason is that said agencies could yet be fingered by the authorities as the major culprits in the "sub-prime crisis" - and until that danger has passed, they'll do as they're told. The government could, after all, regulate them into non-existence. As the celebrated American comedian Lily Tomlin once uttered: "No matter how cynical you become, it's never enough to keep up."
While the Ryan plan and S&P's announcement means America's fiscal debate is now centre stage, investors should remember that neither event guarantees anything remotely resembling meaningful fiscal retrenchment. And, again, I'm afraid S&P's missive presents it as an apologist for, rather than a critic of, US fiscal largesse. "The US dollar is the world's most used currency, providing America with unique external flexibility," the report purrs. "Recent depreciation of the currency has not materially affected this position, and we do not expect this to change in the medium term."
This looks suspiciously to me like a ratings agency providing almost an endorsement of quantitative easing - the Fed's $2,300bn programme of "virtual" money printing. I may be wrong, and Lily Tomlin too, but with QE set to end in June, and Fed boss Ben Bernanke hosting a historic press conference this coming week, part of a new regime of "transparency", the US government is desperate for reasons to justify why the printing presses can be kept running up to the Presidential election and beyond.
There's been a lot of talk that S&P's bold move last week was a harbinger of renewed fiscal discipline, not just in the US, but across the Western world. The ratings agency, we're told, "is doing its job" and "holding politicians to account". I would like to think that's true, but I just don't. The gold market doesn't either. The yellow metal, the ultimate hedge against inflation and dollar debasement, hit yet another all-time high last week.”
Liam Halligan is chief economist at Prosperity Capital Management