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S&P Downgrade Will Have Little Effect On Interest Rates or Obama's Policies

The Standard & Poor’s downgrade of U.S. government debt can only have lasting economic consequences if it significantly affects the interest rates U.S. government pays or political machinations in Washington.

Global investors have little alternative but to continue to do business in dollars and store wealth in Treasuries. The bonds denominated in other reserve currencies—the yen and euro—are simply unavailable in suitable quantities.

Japanese institutions hold most of Japan’s privately-held sovereign debt—simply put the Japanese have too high a savings rate, and their government borrows from them, through banks and funds, to finance deficits that keep its economy going. As the long term prospects are for the yen to rise against the dollar, global investors are holding about all the yen-denominated sovereign debt they can get their hands on.

The euro zone has no central government that can levy taxes, spend significant sums, and issue bonds. Instead, investors must purchase euro-denominated debt issued by the member states.

The largest issuer of euro bonds is Italy, and it is doubtful that investors would swap U.S. Treasuries for Rome’s paper. Even if more German and French sovereign bonds were available, the future of the euro is so much in doubt—and likely to stay in doubt for many years—that the long term stability of even the strongest euro-zone economies is uncertain.

U.S. bonds are subject to the risk of unanticipated inflation if the U.S. government keeps printing too many bonds and greenbacks but that risk pales in comparison to the risk that the euro-zone will disintegrate and seriously impair the German and French economies.

The fact is that Washington prints the world’s currency, and will likely do so for a very long time to come.

China, the biggest purchaser of U.S. debt, likes to carp about U.S. fiscal affairs but will keep on buying dollars to maintain an undervalued yuan and convert those into Treasuries. Otherwise, Beijing must finally let the yuan rise significantly against the dollar, and that would end China’s export boom and bubble economy.

Longer term, all the debt Uncle Sam is piling up is bad for the United States but the problem won’t be resolved anytime soon.

The administration treated the S&P downgrade like it does all other bad economic news—it sought to blame others, circumstances and the messenger. The Tea Party, bad luck like the Japanese earthquake and the competence of the S&P staff—who used CBO numbers to assess the future of the U.S. debt burden—were all cited by the president’s surrogates in interviews and the Sunday talk show circuit.

Communications in the White House are such a closed loop that the administration does not even recognize help when it gets it from critics. The S&P report gave the president ammunition to push for higher taxes—ill-advised as that might be.

The S&P report pointed to political dysfunction in Washington, fingered Republican reluctance to raise taxes and cited skyrocketing health care costs. It did not single out Democrats resistance to cutting Medicaid and Medicare, and this despite that fact that spending is more of a problem for our country than taxes. Simply put, spending is up $1.1 trillion over the last four years, when only $200 billion was needed to cover inflation, whereas reinstituting the Bush tax cuts for all brackets would raise revenues by only $300 billion.

The report went on at some length about how different taxation scenarios would affect the situation. It said little about what curbing U.S. health care spending to German levels—also a private system—would do to future U.S. debt, or even adopting Congressman Paul Ryan’s reforms would effect.

After a temporary disruption in stock and bond markets, this report is likely to little affect what the U.S. government, companies or consumers pay for debt.

At the time of the downgrade, the stock market was in an adjustment owing to concerns about the economy. Neither those nor the deficit worries will abate until the president offers the country a plan to get the economy going—other than blaming others, hoping for a favorable turn of events or criticizing those that keep score on the economy and government’s performance.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former chief economist at the U.S. International Trade Commission. Follow him on Twitter @pmorici1

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.