Marshall Auerback offered up a brutal dismantling of rating agencies’ negative outlooks on sovereign debt issuers like Japan, the U.K., and the U.S.
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 warned yesterday…
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…
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.
If there’s one thing that Auerback and his fellow neo-chartalists stand out on, it’s this: rating agencies, policymakers, economists, pundits, and many, many others think and speak about debt, deficits, and money as if the world still operated on some type of commodity standard. It does not. Smaller economies may be forced by circumstance to be on hard currency standards, at least operationally, and that is somewhat analogous to a commodity standard. But there is no compelling reason why any issuer of the world’s major currencies (ex-ECB ) should ever miss a debt payment. It’s preposterous.
And yet people actually buy protection against default on U.S. treasury debt via credit default swaps (CDS)! That’s a financial snake oil that comes with potentially significant economic costs. Here’s why:
- Holders of Treasury debt are giving away money to the counter parties selling CDS protection.*
- If it were possible for the U.S. government to default, what counter party could possibly cover its obligations? Diligence schmiligence?
- Leverage, insufficient regulation, and herding behavior have actually made the long CDS trade a winner at times over the past several years.
- That means a greater amount of capital becomes (mis)allocated to people who have done nothing to improve overall economic well-being.
- Those winners will suffer delusions of genius, which almost guarantees they’ll make bad decisions in the future.
- If those bad decisions are levered highly enough, their errors will have systemic implications.
- Add opportunity costs to the risk of systemic damage and the net long term social costs of such behavior are almost certainly negative.
* It might not seem like much — at 50 basis points it costs $50,000 to “insure” $10MM of Treasury debt — but if we assume, for example, that a pension fund is on the long side of the swap, it’s giving away the equivalent of one or two pensioners’ incomes. And while it might look like a good move as long as speculation in Treasury CDS continues to run, the real economic value is ZERO, for the reasons outlined by Auerback.