By Marshall Auerback
America’s Triple AAA credit rating could be at risk should its nascent economic revival not develop into a full-blown recovery, Moody’s Investor Service (NYSE:MCO) warned Thursday. The credit ratings agency cautioned that if the US were to grow at slower pace than expected, the largest economy in the world’s already-extended finances could be over-stretched, in turn damaging its AAA credit rating.
Dis-credited ratings agencies
Sound familiar? The so-called “Big Three” ratings agencies have been making claims like this for years: in Japan, the UK and, now, the United States. It is worth recalling that these are the same organizations which, as recently as 2007, were conferring Triple AAA ratings on subprime mortgage paper. Did that work out well for you?
The real news here is that anybody takes anything these discredited rating agencies say seriously. As my colleague, Randy Wray, has already suggested, the top three ratings agencies — Moody’s, Fitch, and S&P — should all be ignored. In fact, Wray is right to suggest that we should prohibit regulated and protected institutions from using any ratings by this group. Their history of failure makes my beloved Toronto Maple Leafs seem like a veritable hockey dynasty in comparison.
Moody’s war on governments freely deploying fiscal policy is nothing new: In November 1998, the day after the Japanese government announced a large-scale fiscal stimulus to its ailing economy, Moody’s Investors Service began the first of a series of downgradings of the Japanese government’s yen-denominated bonds by taking the Aaa (triple A) rating away. The next major Moody’s downgrade occurred on September 8, 2000.
Then, in December 2001, Moody’s further downgraded the Japan Governments yen-denominated bond rating to Aa3 from Aa2. On May 31, 2002, Moody’s Investors Service cut Japan’s long-term credit rating by a further two grades to A2, or below that given to Botswana, Chile and Hungary.
Why Japan doesn’t bounce checks
What was the long term impact of these downgrades? Well, since that time, Japan’s debt/GDP has gone over 200%, and all with a zero or near-zero interest rate policy for over a decade, and 10-year Japanese Government Bonds (JGBs) were continually issued in any size the Japanese government wanted, at the lowest rates in the world.
This, despite the country’s dire economic circumstances: Last year, not only did Japan’s economy fall in percentage terms by three times that of the U.S.; it fell in percentage terms in a year by more than the U.S. economy fell from cyclical peak to cyclical trough in all of its recessions and depressions over the last two hundred years with the exception of 1837-1841, 1929-1933, and perhaps the panic of 1907. Japan’s business expansion in this past decade was driven almost entirely by the growth in exports and an increase in business fixed investment which was itself driven for the most part by the growth in exports. If one looks at the peak to trough decline in Japanese GDP over the last year or so, almost three quarters of it was due to the collapse in exports.
And yet despite these dire economic circumstances, the Japanese government has yet to bounce a check. The country’s central bank has the ABILITY to clear any Ministry of Finance check for ANY size, simply by adding a credit balance to the member bank account in question. Yes, the BOJ could be UNWILLING to clear ANY check, but that is an entirely different matter than being UNABLE to credit an account. Operationally, concepts of the BOJ not having “sufficient funds” to credit member accounts are functionally inapplicable.
Sadly, not even all Japanese policy makers appear to understand this. BOJ board member Seiji Nakamura sounded much like the ratings agencies themselves when he spoke of the need for the US, the UK, and Japan to get their debts down to a “sustainable level” (a level which, curiously, is never defined, because there is no modern economics textbook which offers clear explanations of what constitutes a “sustainable” public debt position). Unfortunately, Nakamura continued in this vein, insisting that Japan’s reliance on fiscal stimulus to spur an expansion without having a strategy to cut public debt would only exacerbate the government’s fiscal situation, and place the country in the same position as Greece, Spain and Portugal.
He’s wrong. The position of Japan, like the US, is very different, because both can operationally issue unlimited quantities of debt in their own national currencies. By contrast, as we have argued before, the relationship of member countries in the Euro zone to the European Central Bank (ECB) is more similar to that of the national treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; nor does Greece, Spain, or any euro zone nation. In this kind of circumstance, taxes really do ‘finance’ state spending and states really do have to borrow (sell bonds to the markets) in order to spend in excess of tax receipts because they are users of a currency, not its creator. Eventually, one hopes that even the Germans will begin to appreciate this point, as they persistently frustrate any rational response to mitigate the possibility of a major national insolvency within the EMU.
But they are not there yet. Purchasers today of Greek, Spanish or Portuguese bonds do worry about the creditworthiness of these nations much as we might also fret about California’s ultimate solvency. That solvency fear is now spreading across the Euro zone and creating contagion effects in all of the world’s capital markets right now.
What about the United States? Well, according to Steven Hess, Moody’s lead analyst for the United States ,”The Aaa rating of the U.S. is not guarantee…So if they don’t get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy.” This assessment is made without any mention of what the net spending would be achieving or what the non-government sector might be doing by way of debt-retrenchment and saving. It also assumes that the surpluses in the coming years are attainable, which seems unlikely if the US is bullied into cutting back expenditures, as Moody’s advocates.
We also have no idea how Moody’s defines “sustainable” levels of debt. Even if the US sought to identify a debt threshold in the way in which the European Monetary Union has done, this threshold would tell us nothing at all about fiscal discipline. Imagine an economy faced with a sequence of aggregate demand failures due to private sector pessimism. Without any change in fiscal parameters, the government would see its deficit increasing and because it voluntarily ties net spending to debt-issuance, the former will also rise. You can easily construct circumstances where the debt/GDP ratio could skyrocket without any discretionary change in fiscal policy at all, as Bill Mitchell and Joan Muysken describe in their book, Growth and Cohesion in the European Union.
The running-out-of-money myth
Unlike Moody’s, we think it is absurd to say that the government is going to ‘run out of money’ as our President has repeated. It is not dependent on China or anyone else. There is no operational limit to how much government can spend, when it wants to spend. This includes making interest payments and Social Security and Medicare and Medicaid payments. It includes all government payments made in dollars to anyone.
And if Moody’s (or any other ratings agency) genuinely thinks that government debt is intrinsically evil and that surpluses should be the stated goal of US government policy (in order to safeguard America’s Triple AAA rating) then it must spell out the full consequences of this policy choice. The ratings agencies appear incapable or (at the very least) unwilling to explain the essential sectoral relationships that link the government, private and external sectors. They seem to think that you can have everything - a budget surplus and high private saving and debt reduction. You cannot as a matter of plain accounting logic unless you suddenly start net exporting in great volumes, (which has not happened to the US in its post W.W. II history), or if the domestic private sector is either choosing to deleverage or use leverage less than in the past, that means it will take large and increasing fiscal deficits, or small and decreasing trade deficits, or some combination of the two, in order to achieve trend real GDP growth paths. Otherwise, the result is stagnation or in the extreme, debt deflation. That will not do much to enhance America’s credit rating.
So if the political preference is for the government to deficit spend less, (as Moody’s implicitly advocates), what other sector is ready and willing to reduce its net saving position? The reduction in fiscal deficits cannot occur without an offsetting reduction in domestic private or foreign net saving (the latter being the inverse of the trade deficit). If the answer is that no other sector is willing or able to reduce its net saving, then income growth in the economy will have to adjust downward. Which means higher unemployment, lower growth and more social misery.
That is where the perverse logic of the ratings agencies take us, which people ought to remember the next time yet another one of these silly debt downgrade scare stories makes the front pages of the financial press.