by James A. Bacon
So, Standard and Poor’s has downgraded the credit rating of the United States from AAA to AA+. There’s no immediate cause for alarm. AA+ is still a high, investment-grade rating and the interest rate differential between the two is miniscule. Interest rates will not go shooting up because of this. The economy will not tank (not for this reason, at least).
But S&P’s downgrade is symptomatic of fundamental problems that we do need to take very seriously. Here’s what S&P has to say:
The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policy making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
So, what comes next? When “Boomergeddon” was published one year ago, I guesstimated that the United States would default on its debt within 15 to 20 years. The very idea seemed ludicrous to some. As it turns out, I was not nearly pessimistic enough. In Chapter 4, I listed a series of “milestones to mayhem” by which we could judge how fast the U.S. was heading to Boomergeddon. “The U.S. won’t go broke all at once,” I wrote. “It will be a long, slow, painful process marked by a thousand steps. We will have years of warning with many milestones to mark our progress. The precise order and timing of these markers is unknowable. But we will pass most of them on our journey to perdition.”
2011: Slower-than-expected growth. One of the most important assumptions embedded in the 10-year budget forecasts is the rate of economic growth. If the economy grows slower than anticipated, tax revenues will fall short of projections and deficits will be worse. When I was writing, the Obama team was projecting 3.8% growth in 2011. I was skeptical. I was right and the Obamanoids were wrong. The first half growth rate has been less than 1%.
2013: Failure to cut discretionary spending. The debt-ceiling deal won’t actually bring about cuts in discretionary spending — only a cap on spending, which the Congressional Budget Office expects will save $71 billion in the 2012 and 2013 budgets compared to the “baseline.” Over 10 years, the projected “savings” — spending increases that don’t take place — will amount to $756 billion.
That’s it? That’s about one-tenth of what we need to cut — not even taking into account the slowing economy. If you consider slower economic growth in combination with the trivial budget cuts, the U.S. will continue to lose ground over the next two years.
2017: Medicare Part A. crisis. The trust fund for Medicare Part A, which pays for hospitalization, was projected to run dry in 2017. In the past year, the short-term financial situation for Medicare Part A has deteriorated, with revenues falling short of previous projections. The Obama administration maintains that cost controls embedded in Obamacare will extend the life of the trust fund to 2024. Let’s just say I’m skeptical. Come 2017, we’ll see who’s right.
2017: Currency crisis. At some point in the next few years, the value of the dollar will tank, driving up interest rates. The main thing propping up the dollar right now is the weakness of the euro. The situation is highly volatile, hence difficult to predict. But my timeline allows six years for things to spin out of control.
2018: The next recession. Obama’s 10-year forecast does not envision the possibility of a recession. If one does occur, revenues will decline and expenses will soar relative to projections. When I wrote “Boomergeddon,” I figured a recession was inevitable by 2018. It may well come sooner… Some say next year.
2019: Spreading fears of sovereign default. I figured the European Union would be able to muddle through its sovereign default issues with Greece, Ireland, Portugal, Spain and Italy for several more years before the whole euro experiment collapsed. At this point in time, it looks like I was optimistic. Collapse could come as soon as next year. When it does, watch out. Sovereign debt contagion will spread to other welfare-state democracies, including the U.S., driving up interest rates.
2020: State defaults. I calculated that California and other stressed-out states might muddle through another business cycle before their state finances collapsed. I’m still thinking that California might make it. But the state is still dysfunctional, and the next recession will be devastating. When big states start defaulting on their debt, investors will demand a higher interest-rate premium on T-bills.
2022: U.S. credit downgrade. Boy, did I get this wrong. I thought it would take a lot longer before U.S. debt was downgraded. Our slippery slope is a lot steeper than I’d figured.
2024: Intensifying capital scarcity: By the 2020s, I wrote, “two gale-force winds will be driving interest rates higher. First, sovereign credit risk will spill over to the financial sector. … Second, as the global financial system shifts from a capital glut to capital scarcity, interest rates will begin a long secular upturn that will last years if not decades.” (Read the book for an explanation why.) Higher interest rates will accentuate the U.S. debt burden while also slowing U.S. economic growth.
2025: Draw-down of Social Security trust fund. In 2025, Social Security is projected to stop generating a surplus and start drawing down its trust fund, meaning that the Treasury will have to start borrowing money in the open market to repay the debt it owes Social Security. The Obama administration insists that the situation has not deteriorated in the last year. Slow economic growth and prolonged unemployment will change that appraisal in a hurry.
2026: Attack of the hedge funds. The bond vigilantes eventually will start doing to the U.S. what they’ve been doing to Greece and other “peripheral” European Union nations.
2027: Failed auctions. In the final phase, investors will totally lose faith in the ability of the U.S. to repay its debt and refuse to buy any more. The only buyer left will be the Federal Reserve. Either the U.S. will default on its debt directly, or it will do so indirectly by allowing the Fed to inject massive liquidity into the money supply, sparking hyper-inflation.
As Adam Smith said about the massive debts that England accumulated during the American Revolutionary War, “there is a lot of ruin in a nation.” England pulled through that crisis, and then it survived the Napoleonic wars that followed. Will America pull through the crisis of its unaffordable welfare state? Not the way we’re going. Without a dramatic change in course, we could well see Boomergeddon by 2020.
