On the one hand, everyone has been in a panic now over America’s impending fiscal collapse, after the Standard and Poor’s rating agency last week took the historic step of putting the U.S. government’s AAA credit rating on “negative watch”.
The latest NY Times/CBS News opinion poll has also suggested that the U.S. public is now more economically pessimistic than at any time since President Barack Obama’s first two months in office in early 2009 – when the country was in the “Great Recession”.
But on the other hand, the reality is that America does not face an immediate debt crisis. Just take a look at the simplest indicator, the day that Standard & Poor’s raised its now famous warnings about America’s debt, markets decided to lower America’s borrowing costs and the dollar rose against its principal alternative, the euro.
More over, the Dow Jones Industrial Average ended last week at a three-year high. U.S. equities are now at levels not seen since mid-2008. On top of that, despite S&P’s announcement, the price of Treasuries kept rising, as their yield – the cost the US government must pay to borrow – fell to its lowest level in a month.
Last week, the International Monetary Fund (IMF) also issued a report on global growth that confirms that the U.S. is likely to be the fastest-growing of the world’s advanced economies. In fact, the real problem for America may well be that it does not face a short-term crisis.
And this short-term good news means White House isn’t really acting as if it faces a crisis. Over the last few years, everyone has been worrying about America’s debt, and despite all that public worrying, markets keep lowering the rates at which we can borrow money.
One of the most remarkable aspect of Standard and Poor’s announcement is that it didn’t come earlier. After all, America’s public finances have been spiralling out of control for several years. This crucial announcement was made on Monday, April 18, when Congress was away for Easter recess, with members scattered across America and beyond.
As a result, there were no protesting speeches in the Senate or House of Representatives and no resulting press conferences. The date that S&P picked was very ‘kind’ to the White House. The S&P report itself was also extremely ‘kind.’
There was no mention that the White House administration has increased federal spending by more than 30 percent in two years, while almost allowing the government to “shut down” by not agreeing to minuscule spending cuts.
In recent weeks, Paul Ryan, the Republican chairman of the House Budget Committee, and President Obama outlined plans to shrink budget deficits. Even if they were far from sharing common ground, the proposals generated a sense of progress, says Nick Kalivas, vice president of financial research at MF Global Ltd.
He also said that the threat of a downgrade may push congressional Republicans and the Obama administration to reach an agreement on tackling the country’s long-term debts. Cutting spending and raising taxes would lead the government to sell fewer Treasuries. A drop in supply probably would push up Treasury prices.
The warning could also prod Washington to make even deeper spending cuts more quickly than officials would otherwise. Economists warn that slashing too deeply, just like raising taxes too high, could threaten the economic recovery. That could actually help the bond market too.
When the economy slows, investors tend to take fewer risks and favor more-stable investments such as bonds. During the financial crisis, for instance, Treasuries trounced other investments.
The Federal Reserve probably would also postpone raising short-term interest rates because the threat of inflation would diminish. All these would add to the appeal of Treasuries. As a result, what’s bad for the economy is often good for Treasury bonds. [via LA Times, CNN and The Telegraph (UK)]