Seeking Alpha
Recommended for you:
Bonds, dividend investing, ETF investing, long only
Profile| Send Message|
( followers)  

It’s been a hot summer, and it’s been even hotter in Washington, D.C., where Democrats and Republicans have been burning down the House with a pitched battle over the debt ceiling, the cap that Congress puts on the national debt.

Usually it’s a mundane bit of legislative business barely worthy of C-Span. Congress hikes spending, and then authorizes an increase in the debt ceiling to pay for it. It’s happened 78 times since 1960. But this year it will likely cause the US’s prized AAA credit rating to go up in smoke.

Newly elected Tea Party Republican Congressmen have held fast to their campaign promises to cut spending. They have demanded spending cuts at least equal to the roughly $2 trillion that the debt ceiling will have to be increased to from its current $14.3 trillion to cover rising expenditures.

If that doesn’t happen by August 2, President Obama and many others have warned the government won’t be able to meet all its obligations, including interest payments on the debt, military pay, Social Security checks, what have you. If we can’t, it could mean a default by the US government, just like Argentina and Mexico did in days of yore.

Speaker of the House John Boehner and other Republican leaders also have said that default is not an option. But as a polarized Washington seems incapable of reaching a compromise, the ratings agencies have stepped in with more and more dire warnings.

Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings all have warned that failure to raise the debt ceiling would trigger a downgrade of US government debt. S&P in particular has raised the stakes, and quite publicly. The kind of short-term fix so popular in Washington — like the ones that are being bandied about as I write this — that raises the debt ceiling for six months or so, with maybe $1 trillion or so in spending cuts, may forestall a technical default, but still may result in a downgrade, S&P officials have said.

I’ll save who I think is primarily responsible for this mess for my political blog, but I will say this: You can kiss the AAA rating of US Treasury debt goodbye.

If a miracle happens, we may be able to forestall it for a while. But without a huge turnaround in Washington’s broken political culture, I don’t think this Congress and president will enact the dramatic changes S&P has strongly suggested are necessary for us to stay in the elite club of AAA-rated sovereigns.

They include Australia, Austria, Canada, Denmark, Finland, France, Germany, the Netherlands, Norway, Singapore, Sweden, Switzerland, and the United Kingdom.

The philosophical and political differences between Democrats and Republicans are so sharp that no long-term agreement on spending and revenues seems possible. They live in two parallel universes, with two completely different visions of what problems face the country. And if they can’t strike a compromise with the Sword of Damocles of default hanging over their heads, when are they going to do it? In 2012, when they may face primary challenges and well-financed general election opponents?

This may sound like a digression, but it’s actually at the heart of S&P’s warnings.

“There is at least a one-in-two likelihood that we could lower the long-term rating on the US within the next 90 days,” S&P wrote on July 14, when it put US debt on CreditWatch with negative implications. “Despite months of negotiations, the two sides remain at odds on fundamental fiscal policy issues. Consequently, we believe there is an increasing risk of a substantial policy stalemate enduring beyond any near-term agreement to raise the debt ceiling."

In fact, it warned that it

may lower the long-term rating on the US by one or more notches into the "AA" category in the next three months, if we conclude that Congress and the administration have not achieved a credible solution to the rising US government debt burden and are not likely to achieve one in the foreseeable future.

An inability to reach an agreement now could indicate that an agreement will not be reached for several more years. We view an inability to timely agree and credibly implement medium-term fiscal consolidation policy as inconsistent with a "AAA" sovereign rating.

S&P even spelled out what it thought would be necessary to maintain the AAA rating:

If Congress and the administration reach an agreement of about $4 trillion, and if we conclude that such an agreement would be enacted and maintained throughout the decade, we could, other things unchanged, affirm the "AAA" long-term rating on the US.

In this remarkable report, the agency laid out several possible scenarios for losing and regaining the AAA rating, which I won’t go into but you can read at www.standardandpoors.com.

Neither Moody’s nor S&P would provide officials for me to interview for this column, and S&P issued a statement that said:

Standard & Poor’s has chosen not to comment on the many and varying proposals that have arisen in the current debate. Any statement to the contrary is inaccurate.

Maybe so, but it you draw a road map, do you really need to fill in the name of every one-horse town along the way?

In fact, a top S&P official appeared to be easing the pain of a downgrade in advance. In a video interview on S&P’s website, executive managing director Paul Coughlin said, “That’s not the end of the world. Lots of countries would give their right arm for a AA+ rating.” That would put us right up there with Belgium and New Zealand. With AA, we’d be in the class of Bermuda and Qatar.

Losing the AAA would probably hurt the economy through higher borrowing costs for the government, corporations, and consumers, especially those who have adjustable-rate debt, and we’d likely see a stock market decline. (My colleague Jim Jubak spelled out what a default would look like here.) But most of all it would be a terrible blow to our national pride and prestige, capping a decade of decline from the commanding heights we bestrode at the start of the millennium.

It gives me no joy but considerable sadness to reluctantly agree with Barry Knapp, head US-equity strategist at Barclays Capital, that a downgrading of the US’s credit rating is inevitable.

As the great Bob Dylan wrote, you don’t need a weatherman to know which way the wind blows. So long, AAA, it’s been good to know you.

Source: Deal or No Deal, Our AAA Rating Is Toast