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The debt ceiling ratings downgrade

Here’s what I said in April well before this debt ceiling issue reached a critical stage:

A sovereign nation that issues debt in its own fiat currency cannot default involuntarily. Again, this is the Ecuador risk factor, defaulting for purely political reasons, not because of the inability to pay. It is not clear whether there will be a risk premium associated with this risk, increasing the yield of Treasury bonds, as the showdown draws near…

For now, the ratings agencies are relatively sanguine about this dust-up.  But, the risk of default is real – and that doesn’t sound like the hallmarks of a AAA-rated country, more like the hallmarks of a banana republic.

Fast-forward to today and Reuters is now reporting that Moody’s put U.S. ratings on review for downgrade. S&P says the damage is done and they may downgrade the US even if a deal is done. So, now we see that, in fact, the debt ceiling debate has done damage to the credibility of the US. Business leaders get that. These “job creators” take issue with the position of people like the ambitious Eric Cantor who is using this issue for his own political agenda. I should also point out that bond guru Bill Gross is going against his financial interest (underweight Treasuries) and speaking out on this issue. He wrote the following in a Washington Post Op-Ed:

Pimco owns very few Treasury securities, and its clients would theoretically benefit if yields rose on an under-owned asset class that was technically in default. But default would still be a huge negative for the U.S. and global financial markets, introducing fear and unnecessary volatility into the economy and global trade. The market situation might resemble what happened after Lehman Brothers collapsed in 2008…

If our government doesn’t give a damn about the greenback dollar and its solvency, why should we expect others to protect its status as a reserve currency — a privilege that, by the way, lowers our interest expenses by an estimated $30 billion annually?

The answer to our modern-day Hamlet’s question then, is that there should be no question at all. The debt ceiling must be raised and not be held hostage by budget negotiations. Don’t mess with the debt ceiling, Washington. Bond and currency vigilantes will make you pay.

Legitimately, President Obama has to take the blame for much of this because he should have seen the Republicans’ strategy from the outset. In that April post, I wrote:

  • My understanding is that the legislation begins in the House of Representatives. Republican Speaker of the House John Boehner does not want brinkmanship on this issue because he fears the repercussions of a default. But he is under pressure from colleagues to make a tougher deal, just as he was in the government shutdown fight last week.
  • Other House Republicans want to push this issue. Since the Republicans control the house, the right tactical move for them is to attach spending cuts and other debt reduction measures as riders to the main bill. This way, the bill would pass the House and then be voted on in the Senate

The debt ceiling is not a political football. This is just cynical politics. Don’t think for a second any of these people are committed to deficit reduction. Neither the President, nor the Republicans are. At the beginning of this process, the President should have said something like this:

“Look, there is a time and place to negotiate budget issues. This is not it. I will only accept a debt ceiling bill that raises the debt ceiling and that has nothing else attached to it. My veto as President says this is non-negotiable. If you try and pull these partisan political games, I will go to the American people and tell them simply “I cannot guarantee that those checks go out on August 3rd if we haven’t resolved this issue”. They will understand then brinksmanship on the debt ceiling is cynical and reckless.

That said, I will commit to negotiate on longer-term deficit issues in a separate process during the upcoming budget negotiations.”

The Republicans would have acquiesced and voters would have been impressed by the President’s principled stance. As I said two years ago, it’s about knowing when to be an asshole and when to negotiate. Mark Halperin may be correct that the President is being a ‘dick’. But I say Obama is right to show conviction on this issue. Somehow, he continues to believe he can negotiate in good faith with people like Eric Cantor when it is clear that all they want is to tear him down.

Nevertheless, I also agree with Mitch McConnell, that “the president will have the bully pulpit to blame Republicans for all this disruption.” And if the US defaults, the Republicans will have handed Obama the White House and the Democrats gains in Congress on a platter.

If Cantor doesn’t fold his hand, it will be a political disaster for him and his party and economic disaster for the global economy.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

11 Comments

  1. David Lazarus says:

    If the ratings agencies do downgrade US debt then I would have a lot more questions about the ratings of Switzerland and Japan. I have less concerns about Japan because of the high savings, even though I suspect that the banks still might have lots of non performing loans outstanding. Switzerland I suspect has still some problems within its big banks with a lot of toxic debt hidden somewhere. The smaller banks are not so much of a problem. The US is far more credit worthy than any other country. The ratings agency are only justified in a review if the debt limit is not increased and until then it is speculation.

  2. Benedict@Large says:

    This entire thing is happening SOLELY because they are not properly understanding the accounting involved. The fact is that the net liability position of the federal government is the same before and after it borrows. What they are missing is the initial liability incurred by creating the dollar which is subsequently borrowed. Once this is added in (as accounting rules would require), it can be seen that the borrowing transaction is simply a debt swap, and not a net change in liabilities.

    The price of government bonds should not drop (though perhaps there will be a spike). If they do however, BUY!!!!

  3. Percy says:

    Your remarks, especially concerning Mr. Cantor, show that you do not understand the temper of the Amercian times. We’ve had it with this crap. We are not going deeper in debt. We are not accepting higher taxes in any form. It’s that simple. Let the cards fall where they may.

  4. nmtdoc says:

    Interesting remark Percy. I suggest you educate yourself regarding the way the modern monetary system works. Bill Mitchell has an excellent blog on this topic. The US government is a monopoly issuer of the only currency which legally extinguishes our tax liabilities. We are not on a gold standard, nor are we on a currency peg. This has profound implications regarding the budget, taxes, and public policy. The blog is very well written, the logic impeccable. Please spend a few months there. Though not easy reading, I think you will find it rewarding.

  5. Bernard says:

    the ideological ground and the political gamesmanship is all that matters here. No Taxes and getting Obama, maybe get both with one strike. otherwise, keep at it. no Taxes no matter what.

    Obama vs. Political Ideology. an interesting show

  6. Will H says:

    something missing here is that Obama isn’t credible when it comes to promising budget cuts. His recent 2012 budget increased spending, effectively doubling our debt levels during his term. Why, after reading through his budget, would any republican give in to increasing the debt ceiling without budget cuts? obama made this political when he submitted his joke of a budget

  7. Harry Thompson says:

    What are the debt ratings of countries considered banana republics, compared with Chairman NObama`s 3rd world banana republic, aka, the USA?