Some Thoughts on the US Downgrade
S&P’s downgrade of the US government’s credit rating is all over the news. Will that be the straw that pushes the US into Round 2 of the recession? And if the US situation worsens, will it take down most of the world with it? Who can say? So I’ll just stick to some other aspects linked to the downgrade.
Even as S&P downgraded the US rating, the US treasury officials pointed out a $2 trillion error in S&P's math. S&P has acknowledged the error. So how reliable is the downgrade assessment then? (I don’t know how big an error that is with respect to the US, my only reference is that $2 trillion is the size of India’s GDP!). Secondly, the other rating agencies haven’t downgraded the US… yet. Then again, all these rating agencies were assigning high ratings to all the crap that the investment banks sold before 2008. So how much trust should one put on anything they say? Or are the rating agencies now in the “boy who cried wolf” situation? Maybe it’s a case of nobody believing them even when they speak the truth.
I remember reading a couple of my brother’s finance books a few years back and noticing how American government debt was always referred to as the equivalent of risk-free return. Now, with the S&P downgrade, maybe some of those text books have to be edited! And since pretty much all of risk v/s returns portfolio theory is built around the idea of US debt being the risk-free standard, wonder what’s going to be the new risk-free equivalent in those text books?
Then there’s the impact this downgrade on the Keynesian theory that the government-should-spend-its-way-out-of-a-recession. Now I realize that the Keynesian idea has a fatal flaw: theory v/s reality mismatch. Keynes never considered the possibility that a government could run out of money before the economy recovered! Kind of ironical given that he once said “The markets can remain irrational longer than you can stay solvent” (He was talking about individuals, not governments).
Finally, this is also why I don’t agree with the way many who treat economics as a science. I don’t mean that in a contemptuous way, just in a it’s-a-fact kind of way. Like take US banking boss, Ben Bernanke (equivalent of the RBI governor): the guy was well read on the Depression, and yet couldn’t (or at least hasn’t till date) charter the way out of the recession despite all his learnings from all those studies. Why? Because there are too many variables, plus too many new variables that didn’t exist in 1929. If you can’t repeat an experiment and isolate the variables, how is it a science?
Even as S&P downgraded the US rating, the US treasury officials pointed out a $2 trillion error in S&P's math. S&P has acknowledged the error. So how reliable is the downgrade assessment then? (I don’t know how big an error that is with respect to the US, my only reference is that $2 trillion is the size of India’s GDP!). Secondly, the other rating agencies haven’t downgraded the US… yet. Then again, all these rating agencies were assigning high ratings to all the crap that the investment banks sold before 2008. So how much trust should one put on anything they say? Or are the rating agencies now in the “boy who cried wolf” situation? Maybe it’s a case of nobody believing them even when they speak the truth.
I remember reading a couple of my brother’s finance books a few years back and noticing how American government debt was always referred to as the equivalent of risk-free return. Now, with the S&P downgrade, maybe some of those text books have to be edited! And since pretty much all of risk v/s returns portfolio theory is built around the idea of US debt being the risk-free standard, wonder what’s going to be the new risk-free equivalent in those text books?
Then there’s the impact this downgrade on the Keynesian theory that the government-should-spend-its-way-out-of-a-recession. Now I realize that the Keynesian idea has a fatal flaw: theory v/s reality mismatch. Keynes never considered the possibility that a government could run out of money before the economy recovered! Kind of ironical given that he once said “The markets can remain irrational longer than you can stay solvent” (He was talking about individuals, not governments).
Finally, this is also why I don’t agree with the way many who treat economics as a science. I don’t mean that in a contemptuous way, just in a it’s-a-fact kind of way. Like take US banking boss, Ben Bernanke (equivalent of the RBI governor): the guy was well read on the Depression, and yet couldn’t (or at least hasn’t till date) charter the way out of the recession despite all his learnings from all those studies. Why? Because there are too many variables, plus too many new variables that didn’t exist in 1929. If you can’t repeat an experiment and isolate the variables, how is it a science?
Apart from discussing figures and debating errors of evaluation or discounting the validity of the bases of evaluation, there is something else I noticed. Let the figures be wrong and let the lowering of the rating be erroneous. Let the US reign supreme for now. But, for the first time in several decades, some opinions are getting more clearly formed against wholesome trust in the US economy; it is that which crystallizes into ratings - whether people wish to pay heed or ignore it.
ReplyDeleteThere was a time when most US organizations were not into the mode of manipulation of the accounts, falsification etc. not at any scam level for sure. Not very far in the past, the US corporations were going about business with a clear identification of the market potential and planning needs. But, during the recent fear of recession (and some actual recession or slackening of economy, even if not alarming)the wrong deeds as well as mindless and headlong ways were talked about, based on facts.
Trust and optimism are one thing. It may not be right to lose confidence hastily. Nevertheless a basic question remains: Economics may not be an exact science but will that stand guarantee for any nation, USA and any other, from falling from its supremacy? Can there be total faith that USA will be continue to be on top of the world a decade from now. Should US go on and on borrowed wealth of other nations when it is supposed to be the richest? I continue to think foolishly of course that it is the developing nations that need borrowing! But they say good economics implies never buy anything except on loan! Is there really no limit to this non-sense? I am more or less convinced that the USS has overdone it.