Use access key #2 to skip to page content.

Ignore the Raters

Recs

24

April 19, 2011 – Comments (24)

There are serious problems that America has to deal with (Massive unemployment, Reforming our healthcare system [either streamlining it from the top down, or breaking it apart], Determining the right size of government [will this crisis lead to a growth or shrinking of our government?]). And having a lively and sometimes heated debate about these issues is necessary and productive.

... However it is productive only insofar as the arguments remain factual.

And those that use fear mongering about a potential US Federal Government default are either a) Being highly disingenous and trying to stir up a lot of emotion and misconceptions in comparing the US to Greece, or b) show that they have no idea how our monetary system actually works.

The US Government, as sovereign issuer of its own currency, can never be financially constrained to default on its debt. Never. Neither can Japan, Australia, Great Britian, etc. This is completely different than the Eurozone countries, which are currency users of the Euro, not issuers. Which is why comparing the US, Japan, etc. to either Greece, Portugal, Spain, Germany, etc. displays a complete lack of understanding about the how our currency systems are fundamentally different.

What should the Credit Default Swap rates on US Government debt be?  ..... 0.000%

So when we debate about the role of government and what monetary and fiscal stances should be taken, we must consider:

Is massive inflation a risk? Yes

Is hyperinflation a risk? Yes (although I would argue not likely based on current macro conditions).

Is US Federal Government default a risk? NO.

We have to move past these fictitious economic concerns so that we can debate the points that actually matter, disabused of the false notion that we are somehow Greece and that the bond vigilantes will no longer support the US Government. That is how it works for Greece and any other EU country. That is not how it works for the US and Japan.

-------------------------------------------------------

Ignore the Raters
By L. Randall Wray

http://www.nytimes.com/roomfordebate/2011/04/18/is-anyone-listening-to-the-standard-poors/ignore-the-raters

L. Randall Wray is a professor of economics at the University of Missouri-Kansas City and a senior scholar at the Levy Economics Institute of Bard College. He is the author of“Understanding Modern Money,” and blogs at New Economic Perspectives.

In what appears to be an attempt to influence the political debate in Washington over federal government deficits, Standards & Poor’s rating firm downgraded U.S. debt to negative from stable. Yes, the raters who blessed virtually every toxic waste subprime security they saw with AAA ratings now see problems with sovereign government debt.

The best thing to do is to ignore the raters — as markets usually do when sovereign debt gets downgraded — but this time stock indexes fell, probably because of the uncertain prospects concerning government budgeting. After all, we barely avoided a government shutdown earlier this month, and with S.&P. joining the fray who knows whether the government will continue to pay its bills?

Mind you, this has nothing to do with economics, government solvency or involuntary default. A sovereign government can always make payments as they come due by crediting bank accounts — something recognized by Chairman Ben Bernanke when he said the Fed spends by marking up the size of the reserve accounts of banks.

Similarly Chairman Alan Greenspan said that Social Security can never go broke because government can meet all its obligations by “creating money.”

Instead, sovereign government spending is constrained by budgeting procedure and by Congressionally imposed debt limits. In other words, by self-imposed constraints rather than by market constraints.

Government needs to be concerned about pressures on inflation and the exchange rate should its spending become excessive. And it should avoid “crowding out” private initiative by moving too many resources to our public sector. However, with high unemployment and idle plant and equipment, no one can reasonably argue that these dangers are imminent.

Strangely enough, the ratings agencies recognized long ago that sovereign currency-issuing governments do not really face solvency constraints. A decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from the government. The raters back-tracked and said they were not rating ability to pay, but rather the prospects for inflation and currency depreciation. After 10 more years of running deficits, Japan’s debt-to-gross-domestic-product ratio is 200 percent, it borrows at nearly zero interest rates, it makes every payment that comes due, its yen remains strong and deflation reigns.

While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of U.S. sovereign debt will have a similar impact here: zip.

24 Comments – Post Your Own

#1) On April 19, 2011 at 9:37 AM, JaysRage (89.22) wrote:

It's not a question of whether the country is going to default or not.   It's a question of the value of the bonds that the U.S. is selling.  If the only way that the country can pay its debt is by deflating the currency, the owner of that debt instrument has received a diluted product that actually loses money.    Thus, it's a crappy investment and not worthy of the top rating. 

Report this comment
#2) On April 19, 2011 at 10:01 AM, PeteysTired (< 20) wrote:

 JaysRage 

I think Treasuries are a joke.  I mean for the public they can certainly can buy them if they want, but they are not really used to fund the gov't.  The Fed Reserve is really who funds the gov't along with other central banks.  

Why doesn't the Federal Reserve do what they do for their member banks and 'add' money when the US gov'ts account is short?

I agree Binve, the US will never go broke, but they sure can wreak havoc on the rest of us :(

Report this comment
#3) On April 19, 2011 at 10:23 AM, kdakota630 (29.62) wrote:

I posted a Schiff video blog about this subject last night with basically the same conclusion.

Report this comment
#4) On April 19, 2011 at 10:47 AM, ajm101 (32.03) wrote:

Right, I think Ritholtz does a great job on the subject here: http://www.nytimes.com/roomfordebate/2011/04/18/is-anyone-listening-to-the-standard-poors/no-real-risk-of-default

Report this comment
#5) On April 19, 2011 at 10:50 AM, binve (< 20) wrote:

JaysRage ,

>>It's not a question of whether the country is going to default or not. 

100% disagreed. There is so much fear-mongering right now, that so many people (including those in Congress) think that is a possibility for the US Gov. This is not a trivial point to make.

You can then ask if bonds are a good investment. Will they keep up with inflation? Those are perfectly legitamite and very important questions to ask, as an investor and a currency user of US Dollars.

But all this fear-mongering regarding the default of the Government is much more dangerous than simply being idiotic.

PeteysTired ,

Agree, there are all kinds of ways where havoc can ensue :(. (Default not being one of them).

kdakota630 ,

Right on, I will check it out!..

Report this comment
#6) On April 19, 2011 at 10:51 AM, binve (< 20) wrote:

ajm101 ,

Thanks ajm! Agreed...

Report this comment
#7) On April 19, 2011 at 11:02 AM, mtf00l (44.84) wrote:

As has been pointed out in other blogs on this site "the people can't be trusted to make the right decisions" so it is imperative to miss inform as many as possible and hope the majority rules.

Report this comment
#8) On April 19, 2011 at 11:29 AM, outoffocus (22.91) wrote:

As much as I respect your monetary analysis I have a hard time believing that the US's debt binge has no consequences.  Yes the US can print its own money, but the resources that money buys and the taxes they collect steal from REAL productivity.  So they can print themselves into infinity.  At what expense? Basically impoverishing their citizens through a constantly debased currency.

 

Report this comment
#9) On April 19, 2011 at 11:35 AM, binve (< 20) wrote:

outoffocus,

You are misreading what I am writing.

There are consequences. And we should debate those consequences (at what point does spending become highly inflationary, will all this spending result in a larger government, and do we want that?, etc.) from sounding reasoning.

The point of this post is to say that one of the ramifications of this spending is the possibility of default, is not sound reasoning and is a completely wrong point to make...

Report this comment
#10) On April 19, 2011 at 11:40 AM, eldemonio (98.85) wrote:

binve,

I'd like to begin by mentioning that Racer 5 IPA from Bear Republic is a must have.

While I agree that our situation is very different from those poor EU bastards, I don't agree that defaulting is not possible. 

I wish I had your optimism that our leaders won't CHOOSE to default.  Let's face it, at some point, these jokers could choose to stop printing money and not pay our debts. 

This scenario is most probable under the watch of the Donald - that guy in one slimey son of a gun.

Thanks for the post.

Report this comment
#11) On April 19, 2011 at 11:46 AM, binve (< 20) wrote:

eldemonio,

Excellent! I have also been drinking recently a lot of Odell IPA (awesome!), Modus Hoperandi (it's pretty good, but I love the name :) ) and Caldera IPA from Oregon (yum!!)

>>I wish I had your optimism that our leaders won't CHOOSE to default.  Let's face it, at some point, these jokers could choose to stop printing money and not pay our debts. 

100% agree. However, we need to make the point that that is a political choice, *not* a financial constraint.

>>This scenario is most probable under the watch of the Donald - that guy in one slimey son of a gun.

No kidding man.

Thanks!..

Report this comment
#12) On April 19, 2011 at 12:26 PM, awallejr (83.78) wrote:

Binve you are absolutely right.  It is an impossibility for the US to ever default since all they have to do is print more money.  Of course this has consequences, as you suggest (inflation being the obvious one), but default is simply not one of them.

Report this comment
#13) On April 19, 2011 at 12:33 PM, binve (< 20) wrote:

awallejr,

Thanks, agreed..

Report this comment
#14) On April 19, 2011 at 1:04 PM, ajm101 (32.03) wrote:

Sweetwater 420 is good in the Southeast... IPAs are tricky, my advice:  always go with the local, but microbrews don't generally enjoy a particular advantage here like they do in other styles.  Granted, I'm more of a fan of the piney/citrusy finishing/dry hopping flavors more than the big alpha-acid ones (exception to this is 21 amendment's 'brew free or die' ipa).  Rogue, Sierra Nevada, Stone, and Dogfish Head always seem to do solid jobs there.

Report this comment
#15) On April 19, 2011 at 1:14 PM, binve (< 20) wrote:

ajm,

Agreed. Dogfish Head 60 min is my all-time fave IPA (just for drinking in general). Sometimes I have a desire for the 90-min when I want something heavier. I have had the 120-min only once, it is was delight in a bottle :) I have tried probably 2 dozen beers out of the Dogfish catalog and found only a couple that I don't like of theirs. They are my favorite brewery because of how adventurous they are.

eldemonio turned me on to Stone about 2 years ago. Their Ruination IPA is magical if you are in the mood for an intense hop blast (and I usually am :) ). 

But I agree with your take, I am a big fan of the citrusy hops too (Cascade hops are my favorites, but especially when blended with a little bit of Mt. Hood and Willamette hops too). 

Sierra Nevada makes a 'Hop Torpedo' that I am quite fond of.

If you can find it (It is not an IPA and it is a seasonal brew), Odell makes a spring/summer ale called St. Lupulin which is lively and golden. It looks like a lager, but tastes bright and hoppy like a good ale should. Lots of hop character, not too assertive. It is literally sunshine in a bottle :)

Report this comment
#16) On April 19, 2011 at 1:32 PM, leohaas (33.49) wrote:

Excellent post!

But I am not so sure I fully agree with you. I can come up with at least two scenarios (one likely, one not likely at all--although some gloom-and-doomers seem to point in that direction) where the US will default.

My 'likely' scenario: Let's assume that the debt ceiling is not raised when we hit it over the next month or so. Now our Government will not be able to pay everyone it ows money.  Whom will they not pay? Receivers of subsidies, like welfare recipients and agri-businesses? Our military? Government contractors? Or perhaps the holders of our debt? Somehow, it would not surprise me if it were the latter. After all, why would you pay on existing debt if you are barred from taking on new debt?

My 'unlikely' scenario: the "printing" of money leads to hyperinflation, wage increases fail to keep up with price increases, everybody ends up in the poor house, food riots break out, civilization as we know it ceases to exist, our Government collapse. Who will pay off our existing debt in that situation?

Report this comment
#17) On April 19, 2011 at 1:43 PM, binve (< 20) wrote:

leohaas,

Thanks.

>> Let's assume that the debt ceiling is not raised when we hit it over the next month or so. Now our Government will not be able to pay everyone it ows money.

Like I said above in comment #11, we need to make the point that that is a political choice, *not* a financial constraint. We can make the raising of the debt ceiling this political spectacle at there might be some standoff that fails to raise the ceiling.

It is like saying you can't run because you tied your shoelaces together. You can run, but you have placed an artifical constraint on yourself that prevents you from doing so. So saying you can't run is disingenous.

Same thing with the debt ceiling. The US Government can issue bonds and always has the ability to service the interest because of the fact that it is monopoly issuer of its own fiat currency. We can put a cap on the spending as a constraint, but saying that we can't afford to service the interest is disingenous

>>My 'unlikely' scenario: the "printing" of money leads to hyperinflation, wage increases fail to keep up with price increases, everybody ends up in the poor house, food riots break out, civilization as we know it ceases to exist, our Government collapse. Who will pay off our existing debt in that situation?

Agreed. But we are in the middle of a balance sheet recession right now, and so massive inflation is not a likely outcome until employment really starts picking up (employment is a resource, just like commodities, and the fact is we have serious underutilization of resources in this country right now). However, it is worth pointing out that hyperinflation is different than massive inflation: http://pragcap.com/hyperinflation-its-more-than-just-a-monetary-phenomenon.

So I agree it is a risk, I agree that it is not a likely risk in the foreseeable future.

, ..

Report this comment
#18) On April 19, 2011 at 3:13 PM, Borbality (46.29) wrote:

Good discussion. I agree it is a political decision, but nevertheless a possibility to not raise the debt ceiling.

 I think what is most likely is that republicans will go down to the wire to try to wring out whatever concessions they can from the democrats. The republicans know the debt ceiling will be raised but they can still make a big show of it.

 Also staying on topic, my favorite IPA has to be the sierra nevada HOPTIMUM I had on tap a month or two ago. Man that thing was out of this world. Almost like citrus. 

Report this comment
#19) On April 19, 2011 at 3:52 PM, binve (< 20) wrote:

Borbality,

I agree, there will be a show, but I can't imagine that they will turn a political argument into an actual default on US bonds. Talk about cutting off your nose to spite your face.

>> Also staying on topic, my favorite IPA has to be the sierra nevada HOPTIMUM I had on tap a month or two ago. Man that thing was out of this world. Almost like citrus.

Sounds great, I will keep an eye out!..

Report this comment
#20) On April 19, 2011 at 4:19 PM, eldemonio (98.85) wrote:

binve,

I'm so sorry about turning your blog post into a beer drinkers paradise.

Back to your original topic of ratings.  Check out this link:

http://www.ratebeer.com/beerstyles/india-pale-ale-ipa/17/

Although not in the top rated list - The Avatar Jasmine IPA from Elysian Brewing shouldn't be missed! 

Report this comment
#21) On April 19, 2011 at 4:39 PM, binve (< 20) wrote:

Awesome man, thanks for the link! And I have seen that Jasmine IPA before, but I have not tried it yet. I know what I am going to pick up next! :) Thanks man.

Report this comment
#22) On April 19, 2011 at 6:11 PM, davejh23 (< 20) wrote:

I think many misunderstood the point of your post because of the title.  There's been a lot of attention recently on the debt ceiling debate and the S&P outlook change.  The "rater's" outlook change doesn't appear to be based on the debt ceiling debate and the possibility of default.  It's based on the fact that we don't have our fiscal house in order...as other's have mentioned, we don't need to default for our debt to be a lousy investment...given the uncertainty, do US bonds deserve a top rating?  No. 

Now, watching the administration's/congress' bringing up default as the immediate consequence of not raising the debt ceiling, you're correct.  It's simple fear-mongering.  Nobody involved in the debate cares one bit about the future of this country...it's all a spectacle.  The debate will continue and they'll reach a "compromise" in the last hour...and if they don't?...well, the rest of the world already knows that we're monetizing the debt...why not just throw the whole debt ceiling formality out the window?

Report this comment
#23) On April 19, 2011 at 11:42 PM, tekennedy (71.16) wrote:

Good discussion on gov't debt etc. but +1 rec for the beer discussion.  You've named a good half dozen of my favorite beers.  I'd like to add Stone's Levitation and Brookline Blast (a double IPA) to the list of great hoppy beers.

Report this comment
#24) On April 20, 2011 at 10:55 AM, binve (< 20) wrote:

davejh23 ,

>>given the uncertainty, do US bonds deserve a top rating?  No.

That is not quite right. Bonds get downgraded based on credit risk (the potential for default). Junk bonds have a high default rate, AAA have a very low default rate. Why would the bonds of a soverign currency issuer who can always create the money to service the interest payments ever be downgraded? The answer is they shouldn't.

That is competely independent of whether or not as an investor you think that government bonds are a good investment. Will the interest keep pace with inflation? Are there better assets to invest in at this point in the cycle? Those are the investment questions you need to answer.

Default risk is not a fiananical constraint on US bonds. It may be a political choice, but there is no financial reason for a default to ever occur.

tekennedy,

Thanks! I have never tried Brookline Blast, but a different double IPA that I really like is from Breckenridge brewery 417 double IPA. Good stuff!..

Report this comment

Featured Broker Partners


Advertisement