U.S. Government Merits a Junk Credit Rating: Laurence Kotlikoffby
Politicians and investors say Standard & Poor’s made a mistake when it cut the U.S.’s credit rating from AAA to AA+. I agree. I wonder why S&P didn’t take it all the way down to CCC.
The country’s political leaders, from President Barack Obama on down, are alternately decrying S&P’s hubris and blaming their opponents. Big investors who hold lots of Treasuries are also on S&P’s case. Warren Buffett said the downgrade “doesn’t make sense,” that Treasuries are still AAA in Omaha, Nebraska, and that S&P should rate U.S. debt AAAA. If AA+ means very low credit risk and AAA means no credit risk, I guess AAAA would signify negative credit risk.
My question, though, is why U.S. government bonds carry a rating any better than CCC, which is well into junk territory. Such a grading, according to S&P, implies the debtor is “currently vulnerable and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.”
Sounds right to me. Our economy is in horrible shape. Unemployment is stuck at more than 9 percent, real per-capita output hasn’t budged in six years, the national savings rate is zero, and domestic investment is a miserable 4 percent of national income. With 78 million baby boomers heading into retirement, we have made no provision to pay their full annual Social Security, Medicare and Medicaid benefits, which will average $40,000 in today’s dollars. We are spending more than the next 13 countries combined on defense. The U.S. is running enormous budget deficits, and our tax system is collecting the least revenue per dollar of output since World War II.
True, bad economic conditions don’t necessarily translate into bad credit. Credit risk formally refers to the likelihood of actual default -- that is, not paying debts precisely when they are owed. Even if our economy continues to falter, the government collects enough taxes to do this job for decades, provided it treats its bondholders as senior creditors and pays them before others, like Social Security beneficiaries and soldiers.
There’s another reason the U.S. can always stave off default. The Federal Reserve can simply print dollars to make bond payments. Unlike Greece -- which relies on the European Central Bank for its supply of euros -- our government controls its printing press. The Fed could even print $10.3 trillion and buy up every single Treasury bill and bond held by the public and foreigners. There would be no debt outstanding on which to default. The Chinese could no longer claim we are “addicted to debt.”
Interest and Principal
Where, the reader might ask, would the Treasury get the money to make interest and principle payments on the debt? Simple: from the Fed. The central bank would lend the Treasury the money needed to pay the interest, which the Fed would then return to the Treasury under the heading “profits of the Federal Reserve.” The principal would be rolled over as the Treasury issued the Fed new bonds to pay off old ones.
The questions multiply. If it’s possible just to print money and never default, why aren’t Treasuries rated AAAA, like Buffett suggests? And why doesn’t the Fed go ahead and crank up the printing presses? Why, for that matter, doesn’t the ECB print euros and buy up all the Greek, Italian, Spanish, Portuguese and Irish debt?
To some extent, both the Fed and the ECB have been doing this. But they have been trying hard to keep it quiet. The Fed called it Quantitative Easing II. The ECB has been buying government bonds in large quantities, and euro-area countries have arranged for the ECB to launder more bond purchases through the new European Financial Stability Facility.
S&P understands what the central banks are doing. It also knows that printing too much money to buy up debt can trigger high inflation rates, if not hyperinflation, which could force Uncle Sam and Tante Brunhilde (Sam’s European counterpart) to slow their printing presses and, at some point, formally default. The trigger could get pulled at any time. If regular folks get wind of what’s really going on, they will drop the dollar and the euro like hot potatoes, producing the inflation that Sam and Brunhilde deeply fear.
S&P knows something else: Its credit grading isn’t viewed strictly as an indicator of repayment probability. Investors think the rating indicates whether a country’s bonds are a safe investment -- that is, whether they will be paid in real, hard currency, as opposed to colored pieces of paper devalued by inflation. If S&P thinks printing money is the only way a country can service its debt and that bondholders will get paid in watered-down dollars, it will think twice about granting a AAA rating.
The real scandal here is that S&P knows that the Fed and ECB have been printing money like crazy to buy up debts, both private and public. It also knows that given long-term fiscal commitments and likely future economic conditions, these central banks will surely need to print vastly more money, which means bondholders will end up being paid back only partially or in debased currencies. And it should know that this implies one and only one rating: CCC.
(Laurence Kotlikoff, a professor of economics at Boston University, is a Bloomberg View columnist. The opinions expressed are his own.)
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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