Sell! ... No, buy! ... No, sell!
Some readers may have taken note of Standard & Poor’s Friday downgrade of the long-term debt ratings of France, Italy and Spain as well as assorted minor European countries such as Austria, Cyprus, Malta, Slovenia and the Slovak Republic. To some, that development may seem distant and irrelevant to Virginia as legislators struggle to assemble their own two-year budget. Yes, it is distant, but it is hardly irrelevant. It means that Boomergeddon is closer than even I had imagined.
In my book (buy it here!!) I published what I called the “Milestones to Mayhem,” which listed sign posts on the United States journey to fiscal perdition. I felt quite certain we would pass them all, although the dates I attached to them were conjectural.
2011: Slower-than-expected economic growth. Check.
2013: Failure to cut discretionary spending. Two years out, and we haven’t cut anything. Check.
And so it goes: a U.S. currency crisis by 2017; the Social Security Disability Insurance crisis in 2018, which Washington has utterly failed to address; the next recession in 2018; and spreading fears of sovereign default in 2019.
In the short run, I noted, Europe’s sovereign debt crisis helps the United States because scaredy cat investors park their money in U.S. Treasuries, which seem safe by comparison. But that’s hardly a vote of confidence, I stressed. “It means that investors regard them as less unsafe than Greek, Spanish and Italian government bonds. In the long run, a default by Greece would cast a shadow across all sovereign debt, including our own.”
Then I explained the practical consequences of debt downgrades:
Declining confidence in sovereign debt will feed upon itself. As nations’ credit ratings are downgraded, investors will command higher risk premiums. According to one 1996 analysis, the loss of an AAA rating jacks up interest rates by 60 basis points (or 0.6%). Further declines to a Baa1 rating are worth another 60 basis points. Further deterioration leads to commensurately higher risk premiums: 2.5% for a Ba1 rating, 4.5% for a B1 rating, and 7.5% for a Caa rating. In a vicious cycle, higher interest rates force governments to spend more money on interest payments, which inflates deficits and scares investors even more. It is a very quick slide down the B-level ratings to the very bottom.
Once the dominoes start toppling, the contagion of fear will spread rapidly. Investors, I suggested, next would start shying away from the debt of U.S. states and even start demanding risk premiums from the federal government itself. With a national debt now exceeding $15 trillion, every one percentage point increase in average interest rates paid will jack up the U.S. deficit by $150 billion.
Here’s the takeaway: In my Milestones to Mayhem, I speculated that Europe would muddle through another business cycle before fears of sovereign default became rampant. I was too optimistic. Those fears are spreading already. Boomergeddon is running ahead of schedule.
