Too much US government spending, too little savings and political indecisiveness compose the gist of the August credit rating downgrade of the United States by acclaimed credit rating agency Standard & Poor (S&P).
From a triple-A rating that indicated the country’s extremely strong capacity to meet financial commitments, S&P has given the US, the world’s largest economy, an AA+ rating, which indicates only a very good capacity to meet financial commitments. On top of this, S&P has also given it a negative outlook, meaning that the US would be unable to regain its AAA rating in the short term.
The downgrade was, according to the statement by S&P, reflective of the agency’s opinion on the agreement for financial consolidation measures between administration and Congress, referring to the raising of the national debt ceiling and the supposed improvement of the country’s capacity to pay back its debts and meet its obligations.
Demystifying the debt ceiling
The debt ceiling is a reflection of the United States’ capacity to pay for what the federal government spends, and the US Congress’ approval of said expenditures. The measure is more a matter of ratification of said expenditures and permission to pay for its financial obligations rather than being a control or limit on what the government may choose to obligate itself to.
Such obligations include social security and medical healthcare benefits for its citizens, government salaries, debt interests and similar public institutional functions. Failure to raise the debt ceiling would lead to the failure of the US federal government to pay its obligations and sovereign debt, which may lead to the loss of millions of jobs, the failure of businesses and terrible, lasting consequences for the US economy.
As of July 31, the US has conditionally raised its debt ceiling by $1.5 trillion if a budget plan could be agreed upon by the Congress to cut government expenditures of $900 billion spread over ten years. A budget plan had been agreed upon by both Republican and Democratic representatives, and the debt ceiling was hence raised.
S&P points out that the political ‘brinkmanship’ of such a move, with reference to the dynamic between both political parties in agreeing to the budget plan as well as the urgent necessity to avoid default (or the failure to meet its financial obligations), compromised the scope of the budget plan passed by Congress.
The agency said that the budget plan highlighted a low effectiveness, stability and predictability with regard to US policy formulation. University Fellow and Economics Professor Dr. Tereso Tullao clarifies that such predictability, stability and effectiveness is made doubtful due to the fact that such suggested policy which won was initiated and won by the opposition party, the Republicans.
“One way of limiting debt is limiting government expenditures, and another way is raising taxes,” says Tullao. “The Tea Party [Republicans] wants to limit expenditures, whereas the Democrats want to increase taxes.” In this case, the Tea Party won, and the Democrats had nothing left but to criticize the downgrade.
Another reason for S&P’s decision to continue with the financial downgrade was that the agency’s downgrade report had overstated the US’ federal deficit by $2 trillion, a big factor in deciding economic stability but nonetheless an accounting admitted by the agency. Despite this, S&P maintained its AA+ rating with negative outlook, affirming the political instability of the US as a sufficient factor regardless of the federal deficit.
Backlash for a shrinking economy
S&P has promptly been investigated by the US federal government, claiming that the downgrade had political motivations, although arguments stand saying that the investigation is simply a reaction to the downgrade. Other credit rating agencies such as Moody’s and Fitch Ratings retained a similar triple-A rating for the United States, although Moody’s predicted a negative outlook as early as June this year.
Paul Krugman, Nobel prize economist and columnist for the New York times, states that S&P, along with other credit rating agencies Moody’s and Fitch Ratings, may merit less authority than they seem to deserve, given that misleading investment grade ratings were partial cause of the subprime mortgage crisis which led to the global economic recession of 2007.
The subprime mortgage crisis was caused by investor reliance on credit ratings of government and private financial money-lending institutions in the United States, many of which were at the highest tier investment grades, even though said institutions did not have sufficient financial capacity with which to pay off debts as is similar to the case of the US federal government now.
According to a letter by the US Department of Treasury, up to around 40 percent of government spending by the US federal government has been from borrowed money as of May 2011, a fact that has greatly increased with the approval of the debt ceiling increase. The increase prompted an uprecedented $238 billion increase in US national debt, representing 60 percent of the debt ceiling and surpassing 100 percent of US gross domestic product.
Tullao cites that financial instruments such as government bonds and treasury bills issued by the government would then mean paying higher interest rates. “For ordinary citizens, it becomes part of the perception that there might be a recession,” he adds.
“Interest rates will go up when you borrow. There is a tendency for firms and consumers to consume less, to invest less and thus it becomes a self-fulfilling prophecy that there will be lower aggregate demand, and with this, people will spend less. It will be costly to buy services and to buy goods. The economy will shrink.”
With an economy still reeling from the setback of a financial recession and high unemployment, foreign markets have had mixed reactions. Although global stock markets plunged after the downgrade, as the United States is a strong partner for both developed and developing economies, certain countries downplayed the recession.
Finance Sec. Cesar Purisima, for instance, stated in a press release that the Philippines would have no need to fear with regards to being affected by the credit rating downgrade. “[We are] in a much better position now,” says Purisima, referring to the recent growth forecasts for the Philippines.
Rating agencies, banks and financial institutions such as the International Monetary Fund have maintained an average 3-5 percent growth forecast for the Philippines despite the US credit downgrade, with minor slashes in original estimates due to the poor forecasts for developed countries including not only the United States but also debt-stricken European countries.
