THE recent decision by Standard & Poor’s to publicly put the credit rating of America’s debt on notice of a possible downgrade from the unimpeachable “triple A” status caused only a brief ripple in equity markets.
The rationale for the move was stated as being that America has far greater budget deficits than countries with similar debt ratings.
Standard & Poor’s was not just flagging the estimated deficit of over $1.5 trillion (or 11% of GDP) in the current fiscal year, but also the fact that there is no “clear path” to dealing with the problem as the debt burden becomes ever greater.
The USA now has $14.3 trillion in total debt, already equivalent to 97% of GDP by the end of March this year.
Why have investors been so sanguine about the move?
Stock markets only declined for a fleeting moment, while bond prices (which one would have thought should have been most disturbed by the news) are actually higher today than when the move was announced.
The simplest explanation is that the facts of the matter amounted to a statement of the obvious that was already fully accounted for in investors’ minds.
A more subtle explanation may be that this move is actually a sign that at last some momentum is building to tackle the difficult financial problems that face America over the coming decade.
Viewed dispassionately, the evidence abounds that Standard & Poor’s action is only part of a process of America taking their situation more seriously. The rise of the “tea party”, a loose affiliation of right wing politicians with little in common aside from a commitment to cutting the size of the deficit (or government itself, depending upon who is asked), is its most obvious manifestation.
This phenomenon has made the state of the nations’ finances a key issue for the 2012 Presidential election.
In reality, America’s debate on the sustainability of its finances is one that mirrored in the rest of the developed world.
Eye-catching figures put the true size of the Government Debt burden (if future unfunded commitments are included) at close to $50 trillion – a figure which suggests the debt to GDP ratio will rise to over 300% if spending is left unchecked.
That then, is the nub of the problem. America and Europe are facing the bill for the social contracts written between electorate and government when the maths of the situation were very different.
Pensioners were not supposed to live much beyond 70 and the medical treatments were never envisioned to be available for such a broad array of ailments (both fatal and inconvenient) – certainly not at such a high cost.
The track record of America is that once a problem is identified, they do not flinch from grasping the nettle.
My own view is that this will be the case again, which will ultimately be good for stock markets and for the US Dollar.
In the short term, however, the politics of claiming the high ground that will enable the lead to be taken in the shaping of solutions will dominate.
As a result, investors will need to be braced for congressional brinkmanship and bluster such as the threatened holding-up of an increase in the deficit ceiling which must occur this month.
John Haynes,
Head of Research,
Rensburg Sheppards
