Last week was a bad one for Wall Street. The DOW got pummeled by over 500 points, Standard and Poor’s downgraded the rating on US treasuries, and now no one is quite sure what will happen. Now this is only the tip of the iceberg that many of us have been talking about for almost a year now, but I highly doubt most people even seem to understand the implications involved. Not being satisfied with third hand reports, I downloaded Standard and Poor’s report, and began to see just how messed up things really are.
First of all, the report often makes three assumptions to prevent further downgrading of debt. The first is that the bush tax cuts are removed (or rather allowed to lapse) in 2013. The second is that government spending slows down even more then the new so called budget deal. The third is that the fed raises interest rates. Unfortunately the main body of the report focuses on these things happening to bring forward a ‘best case scenario’. Unfortunately, neither can happen at this point.
To start with, congress didn’t have the backbone to cut spending before. Sure they slowed down the amount of spending taking a savings off of the proposed deal, but it was not nearly enough to meet the bond rating agencies wishes. This happened for two reasons. The first was that the immediate effect of a meaningful cut in deficit spending would mean that many people would not get the government hand outs they were promised – something no one wants to do on a good day – let alone so close to an election. The second was an equal method of political suicide – decreasing tax cuts to increase revenue enough to meet the promised expenditures. This will not change in the future either, so S&P’s idea that it is possible is naïve at best.
As to raising the interest rate, the SP report is very skewed within itself. It states that a plus would be to have the fed incur a loose money policy in a time of monetary tightening (their words not mine). This is foolish because by enacting another round of QEx, the easy money allowed to maintain what the SP sees as a good monetary policy during tight times, will mean an insane amount of money being injected into the bank balance books – on top of the QE2 which has still yet to take full effect as the bankers keep raking it in. Contrary to popular belief, the banks are not only tying up more money than all of the private corporations combined, but and even worse is that government has even more money tied up in promised payouts. This is something Standard and Poor’s did not address in their report.
What I take issue with the most is Standard and Poor’s inferences. It takes into account the slower than expected GDP growth and the increased debt burden. However instead of urging the government to reign in its spending, it encourages it, and follows through with a hint that we need to raise taxes. This is their biggest mistake of all.
What the SP either is forgetting or deliberately leaving out, is that many of our economic woes are from taxes – both corporate and private alike. If these taxes where ever raised to meet government expenditures, then the rate would be far higher than it is now – almost double; and that still would not cover everything. In addition, many businesses have moved their bases of operations overseas just to make it affordable to operate. Should taxes be raised yet again, then even more will go overseas – this creating an even bigger drop in job loss. Less jobs here is less tax revenue, thus making the idea of raising taxes undoable right out of the gate.
However damaging this news is to our bond holders (especially in the future when it gets downgraded again, which will happens as democrats will promise more spending as republicans sign off on it without allowing taxes to go up), it is still pretty petty compared to the much larger issues that will be adding fuel to this fire.
You see as government is able to fund less and less through bond sales, it will need money to cover the difference. QE1 and 2 have already aided in this effort, but still fell drastically short. In addition, the money has not gone to any productive source, but rather into government and big bank balance sheets so that they can keep the toxic assets on their books in an effort to maintain their high prices. This of course is very foolish, and has already allowed money to leak into the private sector allowing the prices to rise across the board. Once QE2 begins to finish piddling out over the next 3-4 months, QE3 will be enacted, and it will be game over by mid 2012 as hyperinflation sets in when the money finishes trickling in with no production to back it.
Now all this could have been avoided. The so called ‘small government’ tea partiers at any time could have dug their heels in and put their money where their mouth is – but as I noted in November of last year, that was not going to happen; nor did it. Driving this mess is a slew of big government supporters who to this day still refuse to even admit to any of this. Sure you have Krugman and a few others use the same nonsensical arguments over and over in support of big government that fail to take all factors into account from start to finish (though Tom Woods of Robert Murphy are far better at rebutting them then I am), but no real sound reasoning in support of big government.
So here are the problems that the nation faces right now, and they are not going away. Sadly enough, they will be getting exponentially worse until government spends itself into a quicksand of debt that there is no escaping from. On the flip side it needs to be noted that the US treasuries would have been downgraded regardless of what our govt did. All raising the debt ceiling did was make the matter worse by increasing expenditures.
Sources:
http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3DUS_Downgraded_AA%2B.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243942957443&blobheadervalue3=UTF-8
http://www.treasurydirect.gov/RI/OFBills and http://www.treasurydirect.gov/RI/OFNtebnd – note the interest rates on the bonds – would you buy those for your personal portfolio? Also, by clicking on the links you can find the exact details on the bonds sold/redeemed of that type.
http://www.federalreserve.gov/monetarypolicy/files/monthlyclbsreport201107.pdf – note then increase of buys the FED made on US treasuries over the last year using new monies placed on to the books.
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