US Sovereign Downgrade by S&P: Buffo!

On the evening of Friday, August 5, 2011, Standard and Poor’s, in an act of Bravura, downgraded United States Sovereign Debt rating to a AA+ from a AAA while reaffirming its A-1+ rating on US short term, notwithstanding their $2-trillion math-error! Bravura?  More Buffonata! than Bravura! This move had to some extent been discounted by global markets. Suffice to note the past week’s session drops in all major bourses. Those drops may also pre-empt the impending confusion and instability that will characterize the upcoming weeks' sessions on most security markets, especially from Asian and European markets which, opening after watching the announcement, should experience a tumble, but not a crumble.  

Todate, Moody’s and Fitch Rating have shown caution in this regard reserving their assessments for later.

The analysis by Mark Zandi of Moody's on fiscal sustainability,  tax reform and responsible compromise demonstrates the type of level headedness that is required by Credit Rating Agencies when they approach new paradigmatic scenarios, because de facto, the current US Debt situation invites paradigmatic shifts in methodology and optics.

Sovereign Balance Sheet is not a Corporate Balance Sheet. There are overwhelming incidences of political discretion that can neither be reduced to a quantitative measure nor can they be appreciated as stand-alone components for a measurement standard. The deficit cannot be isolated from the trade-off matrices that configure the US relationship to its broader sphere of influence within the domestic and  global political and economic network.   

Apart from a global audience whose appetite was partially satisfied by the Washington deal, the winners of the Washington tug-of-war will be investors. The basic premise that some investors will be precluded from future purchases is unrealistic. Most institutional players have portfolio criteria that permits purchases on any security rated a AAA to peers by at least one or two of the Big Three. Flight from US Treasuries is also very unlikely because there is no other safer investment haven in the world than the United States.

On the downgrade, markets will bid up the AA+ US Treasuries; many investors will pull out of equity markets leading to their decline resulting from the failure of corporate equities to compete with rising sovereign debt.  The US Dollar could appreciate for a time, as timely capital inflows into the US on purchases of US sovereigns dominate foreign exchange markets. At one point, given all things equal, markets will reach a state of equilibrium: the USD should subsequently  fall into a lethargy . How far down must the Dollar fall before the J-curve comes into play is anyone’s guess. US manufacturers are no longer very competitive on global markets. Marshall-Lerner conditions may no longer prevail in an orthodox manner- what previously worked and set precedents may no longer apply to current conditions.  Ultimately, a drop in the currency increases the existing deficits and dissembles interest for the de-facto guarantor of most of the world’s assets. Moreover,  core expenditures cuts may dramatically affect a large number of sectorial players in energy, financials, defense, health and transportation as well as state, municipalities and para-government agencies.

By 2012, unless deemed progress is made on the deficit front, markets may be confronted by another adverse assessment of the US Debt situation that could trigger another downward spiral and so on.

So returning to rational predicaments.
When is the Big Sell-Off.
How much has already been Shorted.
What is the option to a Big Sell-Off.

As with any rational and conceivable counterfactual scenario, the market must review the effects of the day-after.

Firstly, if a AA+ still attracts investors, then the S & P  Grid is substantively superfluous, because it does not deter investors, it merely panders a price peg.

Secondly, if it really considers US Sovereign Debt as relatively compromised in relation to other options (what similar options are there?), then S&P should be integrally considering a reassessment, if not a downgrade, of every major holder of US securities: reassessing the actuarial liability of every pension fund, the unit value of every mutual and the stability of every Bank in the world carrying US Treasuries especially the those of the UK, Canada and the Caribbeans, as well as the holdings of the Governments of China, Japan and Taiwan, since the integrity and liquidity of their respective financials are now compromised.

Thirdly, trading partners' current accounts may find themselves as compromised by the US deficit reduction plan as US domestic players. They, and their own nationals, may indeed have to envisage a weaker investment profile than anticipated in face of such a contagion as their own economic growth falters and begins staggering.   

Finally, the effect of contagion within the American political and administrative system is even more immediate. Municipal, state and other domestic secured borrowers will not only find their investments more expensive to finance, they may actually find themselves excluded from markets. The impact of the above is extremely onerous on regions and communities attempting to recover. It is even more onerous on the American people as households will be forced to pay more for their debt. What appeared as an enterprising improvement in household wealth in the last quarters may quite rapidly deteriorate into ephemera.

There appears to be no end to the downward spiral. The downgrade weakens the Dollar, and eventually adversely skews expectations on Dollar Assets, further defeating the Dollar Stability Paradigm. Why would anyone hold Dollar assets under such conditions.  It is somewhat irrational to advance a rational argument that impels an irrational decision. Theoretically, the world should dump dollars; but no coordinated action has been exercised yet. Is the premise false or are the components of the dilemma flawed. Probably a combination of both. As to the premise that the downgrade weakens the Dollar and the Stability Paradigm is weakened, there is some truth, but there is no  real dilemma since there is no credible option to the dollar, except for the esoteric: Gold, and that should experience an early surge next week, or short date moves to the Swiss Franc or Yen. If one buys into the Gold Niche, then the predicament is: should we not revert back to the Gold Standard.

Perhaps, the real issue is that no one cares about the one S & P evaluation in the case of US Debt because 'safe haven' should be given more value than the nature or size of the deficit. Or perhaps, as reality sets in, investors will realize that the US will continue refinancing its interest payments at a higher cost indefinitely, and the principal is far enough out that it will not affect their immediate results, and in turn will be itself refinanced. So enough for intergenerational considerations!Circuit theory  and modern monetary theory can certainly clarify the situation at hand and suggest reasonable solutions. We are de jure dealing with a perpetual money printing process.

As bond yields rise, equity markets sell-off,  and since interested liquidity is not abundant these days, the market promotes its own volatility, prefers the selloff to being hostage to an uncertain future 12 months down the line-the US debt-limit problem will resurface in 2012. One hears the snickers of a community of free-loaders and free-riders. In the end, one witnesses a run to les paradis artificiels of gold and similar glitters. Metals follow course and a manufacturing sector that had tolerated an adverse and unexplainable peak in prices, experiences once again a surge in commodity prices, a drop in demand -the combination of which dampens their recovery. Layoffs follow. Companies close and household wealth plummets. We are in the third phase of the Great Recession, or Phase One of the Great Collapse. For workers and their families, it is inconceivable that this happen in and to the United States.  

Did S&P cynically engage in a Marketing bravado of 'I was First' or 'We blew it last time, and we got hammered by the US Government-it's our turn now!!! '

If so, then it's ironic that Nemesis should be invoked in this farcical manner. Showmanship is not publicly responsible. To be sure, what the Rating Agency contends is that it is simply acting in accordance with its professional responsibility, intending Hayek and claiming unintended consequences  with respect to the outcomes in performing its mission.But markets have short memory spans; they were ready to crucify S&P a few years ago for negligence; now they'll take the free ride they offer.

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Debt-Limit Impasse and US Credit Rating: Nonsense per Beckett


The high probability that a political stalemate between a trying President Obama and a headless GOP would unleash an economic nightmare in the global financial system was unprecedented in American politics. To observe this staging with its original cast, from showmanship through the intrigues of gamesmanship only to end in a display of outright irresponsible brinkmanship was more like unraveling Kahn's absurd than thinking the unthinkable.  There was nothing tolerable being rehearsed on the stage in Washington.

For some, the Republican House had little to lose: they may have shattered the image once and for all of an already tarnished and staggering President Obama, if not out of the White House, most probably out of some future Majority. There is now, in hindsight, a conversation within the GOP depicting the emergence of a ‘Republican moment’ that will define the party and establish its future credentials. For others,  this supposedly tactical moment may have sealed the coffin to the GOP's own demise for the upcoming election.

Yet, the debt-limit impasse between a Presidential vision and the GOP counterproposal  led most pundits to rethink public ethos and try to figure out which of the parties was more irresponsible: President Obama in failing to appreciate the tactical whims of a political adversary  or the Republicans failing to appreciate the gravity of the demise bearing on the American economy , and the unwarranted burden of malaise and suffering being wrought on seniors, children, the sparsely employed and the unemployed.

The actors lost themselves in their mimes. Both parties-the White House and the House have forgotten the nature of their primary obligations.

Who stands to lose?

There are over 14M unemployed in the land, disposable personal income has decreased since 2007 with the exception of the 2009 anomaly, household wealth although rising, is slowing down, is also largely mitigated by a rise in values of financial assets that could as easily reverse their course and plummet family balance sheets overnight, and finally poverty thresholds are being surpassed daily with over 45.8M, or about 15%, of Americans on food stamps. To further taint this cautionary tale, there is no clearing in that bleak vision that signals an abetting storm; quite to the contrary, a piebald horizon of weak data and weakening indicators omens more the fury of a squall than a desired calm.

One daresay that the world was witnessing a burlesque rendition of Waiting for Godot. Certainly, Samuel Beckett could not have construed better and original script for a more consequential tragicomedy in two acts, than the Washingtonians did with such a routine episode of American Domestic Politics as the Debt-Limit debate. Note Beckett's Vladimir underscoring Washington's lack of public accountability

"Let us not waste our time in idle discourse! (Pause. Vehemently.) Let us do something, while we have the chance! It is not every day that we are needed. But at this place, at this moment of time, all mankind is us, whether we like it or not. Let us make the most of it, before it is too late!"

and with the same breath, note again Vladimir underscoring Washington's lack of political responsibility

"But that is not the question. Why are we here, that is the question. And we are blessed in this, that we happen to know the answer. Yes, in this immense confusion one thing alone is clear. We are waiting for God [ot to come]"

Classic Drama, with all the classical elements, written for Washington!

Yet, Beckett's characters in waiting resonate within the absurd; Washington's characters await generational inspirations for having lacked the day's resolve- again Vladimir

"To-morrow, when I wake, or think I do, what shall I say of to-day?"

It seems that, if anything is to be recognized, it is that the debt-limit dateline should have been a moot issue; the grotesque impact will and could come from the evaluation of US Treasuries by the Credit Rating Agencies, in particular the Big Three,whose own records during the last three years have been less than commendable. The same process that lacked discernment with  an infinitely less complex file back in 2007 will now determine the demise of a AAA sovereign. If the fate of future generations rests with the hubris of a community of analysts whose only consequent is a pricing label - that influences the cost of capital that should be ultimately tagged to the sovereign’s Treasury, then we are inviting a systemic disarray.

Yet, the US is still the most secure investment haven in the world and the latter feature will not be justly embedded in the credit rating evaluation.

The embarrassment cannot be undermined; the economic and financial costs to the US Government and the American people must not be underestimated.  The Rating Agencies should defer their assessments in order to fine-tune their methodologies, to refine their presumptions of what constitutes default risk, and to review the values that constitute and embed appropriate fiscal and monetary management of public finances in the 21st century.