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Budgets and Ratings

Governments are increasingly being forced by markets to become more responsible. Thus, S&P’s downgrading of U.S. debt from AAA to AA+ is more a reflection of market reality than a key event. The efforts by the U.S. and European governments to reduce budget deficits, an inherently political decision that reflects conflicting values on how much to cut spending and how much to raise taxes, not to mention which spending categories and which taxes, is a highly contentious battle, of course. Each side is fighting for what it believes. Compromise is desirable. And it is very likely that the political process will produce compromise, which is inherent to politics, even if the process is not pretty to watch.
 
I do not see the S&P rating downgrade of the U.S. as a significant event, unless you were sleeping for the last several years and, especially, over the last several weeks. Everyone in Washington understands that the budget deficit is unmanageably large. They differ over how to reduce it. It will surely take a while to accomplish this goal, but the effort has begun. Expect periodic negotiations to go right to any artificial deadlines that are set. Expect the talks to be punctuated by fear mongering. Alarmists will have a field day. 
 
Both sides are complaining about the budget deal reached in the U.S. With both sides complaining, it is entirely possible the deal was enough of a compromise that it is a good start. More needs to be done and the politicians did put some structure into place to force them to do more. It is certainly too soon to reach a strongly negative view of what has been accomplished to date.
 
The European Central Bank effectively reversed its stupid decision to hike overnight interest rates a month ago by agreeing to buy Spanish and Italian debt, since both governments are committing themselves to reduce their budget deficits. Regaining control over large deficits will not be accomplished overnight in Europe, any more than it is possible in the U.S. But, they have also begun the process.
 
Global growth will be slowed by the effort to reduce deficits, as governments spend less and tax more, which will not make the task any easier. However, monetary policy will remain very accommodative to try to offset some of this.