Fitch Threatens Downgrade Waves Wet Noodle at US

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Here we go again….

As the Obama administration is quietly working towards a “Grand Bargain”, which is the current branding for “let’s put the middle class on the austerity rack just when the economy looks depression prone”, rating agency Fitch does its part by lobbing in a “the US needs to get its fiscal house in order” message.

Readers may recall we went through this drama at the end of last summer. S&P huffed and puffed about a downgrade and the financial media obligingly went into a complete panic. Yet what happened when S&P pulled the trigger? As we predicted, pretty much nothing. In fact, US Treasury yields have continued to fall. Yet the Wall Street Journal shamelessly misreports what happened:

A potential downgrade could send shockwaves through financial markets, similar to how S&P jolted markets last summer when it stripped the U.S. of its top credit rating.

No, sports fans. The market upset was BEFORE the downgrade. And it also happened to coincide with an acute episode of stress in Europe, making it hard to parse out how much of the stock market reaction was due to concerns over Europe v. downgrade fearmongering. The downgrade was a non-event. Treasuries rallied, which is the exact opposite of what the overwhelming majority of commentators said would happen. This was worse than a Y2K scare (at least there was real remediation prior to Y2K; this by contrast, was simply overhyped).

It isn’t hard to understand why, that is, if you are interested in understanding. A country that issues its own currency can always pays its debts. It may choose not to, as Russia chose not to in 1998, stunning investors because it had a very low government debt to GDP ratio (my recollection is below 20%) and investors were blindsided by its move. The US does have political constraints, in that fiscal actions are subject to Congressional approval and the US government has financed itself by issuing bonds, rather than by simply having the Federal Reserve “print”. And as was discussed at considerable length around the time the US last looked like it might bump up against the debt ceiling, there are ways operationally to get around that, but the Obama administration has chosen to lash itself to the mast and refused to consider them.

The risk that a country that issues its own currency does run when it overdoes deficit spending is inflation. Not only are we not at risk of inflation, but we are in a situation where government deficit spending is warranted. On the lack of inflation risk, note that government bond yields have continued to fall since the S&P downgrade. Investors are clearly worried about deflation; in deflation, the place to be is cash and in government and other high-qualty bonds. The TIPS yield curve has gone negative, signaling that investors expect the downturn to worsen. Recall, conversely, that when we had the 1970s stagflation, we had massive deficit spending in the 1960s and early 1970s when the economy was already growing smartly, PLUS labor had strong bargaining power which meant that when costs rose, workers could get wage increases, which then led companies to raise the prices of their products (this is called “cost-push” inflation). And we also had the oil price shock.

By contrast, instead of robust growth, we have both consumers and businesses reducing debt levels. When the private sector is net saving, government needs to accommodate the saving by running a deficit. The only way the private sector and government sector can save at the same time is when a country runs a trade surplus, and that’s not where the US is. If the government tries saving when the private sector is saving too (and you don’t have the trade surplus to square the circle), GDP and wages contract, as Greece, Ireland, Latvia, Spain, and Portugal are demonstrating.

Now deficit hawks might argue that the S&P downgrade didn’t have the impact it should have because investors still could rely on Moody’s and Fitch and treat US government debt as AAA. They contend that once two agencies have downgraded the US to AA, many investors required to hold AAA assets would be forced to sell.

That’s less of a risk that it seems. The media reported on the eve of the downgrade that a lot of fund managers were getting opinions of counsel to cover them in case that took place. And one of the biggest uses of Treasuries is as collateral for derivatives positions. Counterparties want a very safe and highly liquid asset, and Treasuries will remain the best game in town, no matter what ratings agencies, who don’t exactly have stellar track records, say about the matter. The very worst you might see is some short-term price moves, as particularly concerned investors sell while others pick up the bonds as artificially cheap.

Jane Hamsher argued that the S&P was threatening the US government as a way of warding off reforms. That sounds like a stretch until you look at the evidence. And the ratings agencies have another motivation: having lost credibility for missing the boat repeatedly in the runup to the crisis, acting aggressive on the Treasury front garners them favorable headlines from a press that has been conditioned to take budget scare-mongering more seriously than it ought to. But the reality, as with US mortgage bonds, is that the ratings agencies are not covering themselves with glory on this one.

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  1. abelenkpe

    “The reason to be concerned about budget deficits isn’t bankru….”

    Is there supposed to be more?

    1. F. Beard


      A platinum coin worth trillions both mocks the gold standard advocates and advances the cause of pure fiat at the same time.

      Good show!

  2. F. Beard

    Bill Mitchell calls borrowing by a monetarily sovereign nation “corporate welfare”:

    ‘The US government issues its own currency and, in intrinsic terms, never needs to fund its own spending in US dollars. The issuing of public debt is an entirely voluntary act by the US government and provides the bond markets with “corporate welfare”. Just imagine what the uproar would be from the bond markets and investment banks if the US government announced it was cutting off this source of corporate welfare.

    It happened in 2001 in Australia when the Australian government had virtually caused the official bond markets to dry up when it used the surpluses it was running to run down outstanding debt. The Sydney Futures Exchange led the charge and demanded that the Government continue issuing debt, which gave the game way – if debt-issuance was to fund net government spending (deficits) then why would they be issuing debt when they were running surpluses?

    Answer: it was patently obvious that the outstanding debt was private wealth and its risk-free nature allowed the private investment institutions to price other risky assets and maintain a safe haven when uncertainty rose (by holding bonds).’ from http://bilbo.economicoutlook.n… [emphasis added]

    Let’s tell these fleas who think they are the dog where to get off? And if pensioners need welfare then let’s up their social security benefits as needed.

  3. Brooklin Bridge

    Over at Vast Left-Wing Conspiracy, there’s an Obama ’12 slogan thread,

    so far,

    Evil minus one.

    Vote for Obama because fuck you!


    Hey f**king retard, you in?

    1. Harold

      Vote for Obama, and he’ll see what he can do about keeping you off the kill list.

    2. Johnny Clamboat

      “Vote for Obama because fuck you!”

      I like that one. It captures the only logical explanation for most State action: “Fuck you, that’s why!”

  4. Johnny Clamboat

    Looking at debt and demographics alone, it’s farcical that the US has anyone willing to stamp an AAA rating on its prospects.

    The sooner this house of cards collapses, the better off the citizens of this great nation will be.

    1. Jim

      I don’t get it. How can this “house of cards” collapse. The US issues the US dollar, and all of its debt is in US dollars. What am I missing?

      Inflation risk, yes, which may lead to an uptick in interest rates, provided that nominal GDP begins to grow at 6%+. But credit risk, how?

      Also, if President Obama does agree to a “Grand Bargain” he will lose by a minimum of 7% points.

      1. EconCCX

        Because the US issues only the coins. The rest of the money is issued as overdraft money by private banks. For each dollar created, someone — government, individual or business — must pledge to pay back more than one. It’s a thieving system of money that goes back to when governments owed unpayable war debts, denominated in gold, to private banks.

        You’ll find this system among Central Banks all over the world. A governmental entity issues the coins: positive money. An “independent” private entity issues the notes. Promissory notes. Promises to pay in coins for whoever prefers them. Promises which are themselves legal tender. Money as debt, with supposedly sovereign governments mere bit players in its issuance.

        1. Andrew

          I suppose bearers felt better when they promised to pay the bearer 1 dollar in gold they didn’t have. Nowadays they are promising to pay the bearer 1 dollar in fiat money….which can be anything they want it to be.

      2. rps

        I read “Grand Bargain” and I think Flee Market…Is it me or Obama’s cognitive dissonance?

  5. Jim Haygood

    With gross U.S. debt-to-GDP now crossing 100% in a strong uptrend — and with no credible plan to EVER end the deepening structural deficit — rating downgrades seem entirely appropriate. Chart:

    ‘Sell the rumor, buy the news’ is a classic trading rule. Expecting yields to pop on downgrade news is for frayed-collar journos, who usually can be faded for an easy profit.

    1. Yves Smith Post author


      You’ve been had. Great Britain had debt to GDP well over 200% during its peak growth period, the 1800s.

      And the US accounting is wrong. The US NET debt (net of the Treasury receipts held by Social Security, hence NOT owed to third parties) to GDP is ~ 70%%. The CBO has been informed of its wee issue. It confirms that the analysis is correct but won’t change what it puts out. So much for the vaunted independence of the CBO.

      Details here:

      1. Jim Haygood

        ‘Great Britain had debt to GDP well over 200% during its peak growth period, the 1800s.’

        Indeed it did. That constitutes one, utterly unique example of a dangerously high debt ratio which didn’t lead to default. On the other hand, Rogoff and Reinhart detail dozens of sovereign defaults in the past two centuries, at much lower debt ratios.

        ‘Peak growth period’ explains a lot about Britain’s narrow escape from default in the early days of the Industrial Revolution. That’s a long way from we’re at now.

        Ferguson and Johnson are quite disingenuous in calling Reinhart and Rogoff’s 90% of GDP threshold a ‘magic number.’ R&R discuss the fact that dominant economies can tolerate higher levels, whereas serial defaulters may get in trouble with debt at only 50% of GDP. Ferguson and Johnson essentially base their argument on U.S. uniqueness, which leaves one with no analytical framework at all.

        The fact remains that U.S. debt-to-GDP, whether one uses net or gross debt, is in a STRONG uptrend. Its credit ratings will decline accordingly, as one would expect.

        1. Yves Smith Post author

          You’ve been doubly had. That R&R analysis is bunk. But it gets repeated everywhere because it suits the story the ideologues want to tell.

          1. Mixed gold standard countries with fiat currencies. Most of the data points are gold standard, hence irrelevant to the US.

          2. Asserts causality (debt => lower growth). That has been debunked. In the overwhelming majority of the cases, it’s either “financial crisis => high debt + low growth” or “low growth => rising debt levels”.

        2. F. Beard

          If the debt of a monetary sovereign is ITSELF a form of money but (worse) one that pays interest then it follows that monetary sovereigns should not borrow at all from an inflation view point since it is worse than pure money printing*.

          *Due to the interest created. Of course the issue is confused by the fascist banking system that is allowed to create (endogenous) money and thus create price inflation by itself. Sovereign borrowing is a bribe to the banks not to do so since it (supposedly) ties up their reserves.

        3. Andrew

          I like it when the deficit hawks claim Japan’s debt to GDP ratio of 230% is only allowable because the Japanese are such good savers and noble exporters of high moral standing. Such virtuous attributes surely must justify the exception that proves the rule ….. Right?

          In reality because the Japanese private sector has such a strong desire to save the endogenous outcome of the budget is a large deficit, despite the Japanese running a trade surplus. No faux moral judgements required…..just simple accounting and correct interpretation of sectoral balances.

  6. alex

    “Fitch Waves Wet Noodle at US”

    Let ’em. Does anyone care what these clowns say about US Treasuries? Notice the sky high interest the US has to pay because of the S&P downgrade.

    Obligatory reminder: these are the same geniuses that rated CDO trash as AAA. And they no longer even pretend that ABQXZ (or whatever rating) means the same thing for commercial and government securities.

  7. F. Beard

    The risk that a country that issues its own currency does run when it overdoes deficit spending is inflation. Yves Smith

    Banks are also a potential source of price inflation since they create “endogenous money” so it follows that if banks were forbidden to do so (or otherwise limited by, say, removing all their government privileges) that the risk of price inflation via government deficits would be (greatly?) reduced.

  8. Hypnotized By Welch

    Changing the subject slightly – what does the Bernanke say and what does it mean for the slave/proles job prospects, housing and pocket money?

  9. Ed

    “As the Obama administration is quietly working towards a “Grade Bargain””

    I think the Obama administration is calling this a “Grand Bargain” and I think we should given them this one and use the term as well.

    And I think the US debt burden is fine as long as massive amounts of coal, oil, or some similar energy source are discovered in the U.S;, or US companies take over and plunder India or someplace of similar size and wealth; or corner the heroin market; or are able to use slaves to produce a highly desirable export commodity. And maybe something similar wlll turn up. Otherwise the rating agencies could actually be behind the curve again.

    1. Andrew

      Rating agency reports are just commisioned marketing material for their sponsors. Trading desks will be placing counter bets against the mug punters reaction to the news. They would have observed the herds reaction to the last piece of S&P market churning advertising material.

      1. Andrew

        My bad, that was a reply for Nat below.

        BTW. Note the timing coincides with a uptick in Euro crises news cycle market churn……hoping to shake out a few weak hearts.

  10. Nathanael

    Why is Fitch rating US debt? It’s no good at rating sovereign debt.

    This just reduces the credibility of Fitch.

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