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U.S. Credit Rating, Automation can’t Curb DC’s Spending

Personal_Finance / Government Spending Nov 30, 2011 - 03:22 AM GMT

By: Dr_Jeff_Lewis


As Washington DC frets the automatic cuts coming from a failure of the super-committee, the American public is watching their wealth vanish.  This disappearing act of wealth occurs on two fronts, first by the continuous spending and inflating in Washington, and secondly by a loss of confidence, which has sent the stock market plummeting in recent days.

It appears certain that the automatic cuts that were supposed to come into play after a failure in action by the super-committee might not be so automatic.  Senator John McCain is leading a Republican charge to save cuts from the military.  Democratic leaders are rallying their Congressional members to save cuts to social programs.

Nothing was lost

In truth, the headline figures made public as part of a $1.2 trillion deficit reduction were hardly true cuts.  Congress calculates future cuts to the CBO baseline, a model of future spending.  To cut only $1.2 trillion from 10 years of the CBO baseline is to tell the American people that Congress will spend more; it just won’t increase spending as much.  Military expenditures, for example, would still grow by $100 billion over ten years, even as Congress calls such changes “cuts” to the budget.

The real focus for investors shouldn’t be the suggested cuts to the budget.  With or without an additional $1.2 trillion in spending, the US deficit will continue to grow with virtually zero upper bound.  The real concern, for investors, taxpayers, and citizens of the United States, is that any action to thwart cuts to government spending could result in another round of downgrades on US debt issues.

S&P’s Early Move

Standard & Poors was belittled, even investigated, for downgrading the United States from triple-A to double-A status.  The ratings agency uses a forward model which judges the statistical potential for default, not the current financial standing of a business or nation itself.  In downgrading the United States, S&P told the markets that the United States has a higher potential for default, mostly due to political infighting in Washington DC.

Now that Washington has indicated it will not tolerate any amount of cuts to the budget, not even cuts to future spending growth, other ratings agencies could follow the S&P to downgrade American debt issues.  This weekend, a Moody’s economist noted that a downgrade from their firm is unlikely, saying ““You know, it’s all relative to expectations and investor expectations with regard to the committee I think are — have been and are still very, very low.” 

However, the agencies remain on the watch.   Ratings agencies warned that a failure today would not result in an immediate downgrade, as Congress has until the 2013 budget decision to enact spending cuts.  If Congress fails to act, then the next step, one year from today, would be new cuts to the United States’ standing in the credit markets.

Investors who are forward thinkers know that such a downgrade would rattle the markets.  For Wall Street, one downgrade was a source of entertainment; two downgrades would be confirmation of the new reality.  A second downgrade of American debt could send yields higher, government expenditures upward and deficits larger.  Investors should remind themselves that Greece and Italy were broke to begin with, but it was rocketing government debt yields that finally broke the camel’s back.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

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