USA credit downgrade bad for Obama; is it bad for you?

Standard & Poor's credit downgrade is a bigger deal in Washington than on Main Street. But don't count on Washington not to share the pain.

NATCHITOCHES, La., August 6, 2011 — Standard & Poor’s downgrade of U.S. government debt, from AAA to AA+, might be a lot of things: mistaken, a wake-up call, Wall Street’s attempt to reassert its dominance over the government in the financial world, a political critique, overdue.

It’s not a disaster. Yet.

The immediate impact is political. The Obama Administration is taking pains to dismiss the importance of the downgrade. Obama’s team has denounced S&P’s calculations as flawed, while reminding anyone who will listen that the ratings agencies did a poor job evaluating credit risks in the run-up to the 2008 financial meltdown. Their position is that this isn’t fair, and it isn’t their fault.

Congressional Democrats will see the downgrade as proof that Congress should raise taxes. The GOP will see it as proof that they should cut more spending. The upshot is that each side will feel justified in doing what it’s already doing, only more so.

Congress responds to the S&P credit downgrade.

Congress responds to the S&P credit downgrade.

All else equal, the downgrade makes it more expensive for the government to take on debt. All else is never equal. Your credit score helps determine the interest rates you pay. When it falls, your rates go up. But the rates you pay also depend on whether interest rates in general are going up or down, whether you’re borrowing on a credit card or on a home equity line of credit, whether you have a better or worse relationship with your banker.

America’s downgraded credit rating doesn’t change any facts on the ground. Lenders have known for years about America’s mounting debts and recessionary woes. They have well-defined views of America’s long-term fiscal viability. S&P only put a label on what everyone already knew: America is no paragon of fiscal probity, and it’s on a road to financial ruin.

In that way our new AA+ rating is very different from your credit score. You’re an unknown quantity to most lenders. For that matter so is New Zealand. America is not.

The U.S. government has considerable power to influence the interest rates it must pay. All else equal, it would have to pay billions more in interest every year because of the downgrade, but being a game-maker, it may not have to.

Whether it pays more depends on what it does next. And so does whether that AA+ drops to AA or lower. So while this isn’t a disaster, it’s very interesting, and not in a good way.

If Congress doesn’t take decisive steps to restore confidence in the political side of our economy, America will be burdened with higher interest rates. If the U.S. Treasury has to pay higher interest rates, so will we all.

All other interest rates in the U.S. are affected by Treasury rates. If they rise, businesses will pay more for credit and you’ll pay more for goods. Your home town will pay more for schools and hospitals, and you’ll pay more in local taxes. You’ll also pay more for personal credit. This will be a tax, and not the sort of tax that Grover Norquist and his tax-pledge minions can stop.

Congress can pledge not to pass tax increases, but if it fails to heed this AA+ warning shot, prices and interest rates will rise. By focusing on federal taxes, Congress could very easily make consumer costs rise and standard of living decline. Our real tax burden can rise even if every member of Congress drinks Norquist’s Koolaid.

The Norquist brigade is absolutely correct to say that our fiscal policies have been reckless. Government has spent too much and taken on too many obligations. It’s also correct to argue that raising taxes in a recession is a bad idea. Economic growth will be far more important to raising tax collections that higher taxes will be.

Where they are wrong is to make taxes a fetish. They risk turning the U.S. government into a cargo cult, expecting that if they arrange the deck chairs just so, wealth will pour out of the sky. No one who signs their pledge can even vote to repeal abominations like the ethanol subsidy. They would lock distortions into the economy for ever and ever.

The downgrade of U.S. debt will have a positive impact if it shocks Washington into taking fiscal policy seriously. If Washington is beyond shock, then we’ll finally have the tax increase that no one wants. And this one won’t do much to close the debt.

James Picht is the Senior Editor for Communities Politics and teaches economics at the Louisiana Scholars’ College in Natchitoches, La., where he went to take a break from working in Moscow and Washington. But he fell in love with the town and with the French professor, so there he stayed. Now he teaches, annoys his children, and makes jalapeno lemonade and chili-chocolate cupcakes. He knows his taxes are too high; he’s not sure about yours. He tweets and has a badly neglected blog at pichtblog.blogspot.com.


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Jim Picht

James Picht is the Senior Editor for Communities Politics and teaches economics and Russian at the Louisiana Scholars' College in Natchitoches, La. After earning his doctorate in economics, he spent several years working in Moscow and the new independent states of the former Soviet Union for the U.S. government, the Asian Development Bank, and as a private contractor. He returned to Ukraine recently to teach principles of constitutional law and criminal procedure at several Ukrainian law schools for a USAID legal development project. He has been writing at the Communities since 2009.

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