Standard & Poor’s is right
Standard & Poor’s didn’t downgrade America’s AAA credit today. What they did is subtler: They attached a “negative outlook” to our AAA credit. That means they upgraded the chance of a future downgrade. So if you ask the S&P’s Magic 8 Ball whether America will be triple-A in five years and then give it a shake, it now says “don’t count on it” rather than “you can rely on it” (all answers taken from this list of actual Magic 8 Ball replies).
I’ve seen some observers react to the S&P’s decision by saying that the rating agency blew the subprime crisis and thus there’s no reason we need to listen to it now. But that seems shortsighted. S&P’s concerns are perfectly reasonable. The company believes “there is a material risk that U.S. policy makers might not reach an agreement on how to address medium-and long-term budgetary challenges by 2013. If you don’t agree with that, you’re not paying enough attention. At this point, the rating agency only puts the chances of a downgrade at one in three — which strikes me as, if anything, a little low.
What’s important to understand here is that the rating agency isn’t saying that America’s debt has grown beyond what our economy can absorb. They’re saying that Democrats and Republicans don’t agree on what to do about it, that the gap is widening rather than narrowing, and that that polarization, when added to the political system’s increasing dysfunction, could conceivably delay or prevent a deal. Our deficit problems are not, in other words, problems of economics so much as problems of politics.
On that, they’re almost certainly right. Paul Ryan’s budget has invested Republicans in a deficit-reduction strategy that cuts taxes and makes sweepingly ideological changes to Medicare and Medicaid — changes that have little to do with deficit reduction, and that are deeply objectionable to Democrats. Meanwhile, we almost tumbled into a government shutdown no one wanted and now politicians are playing games with the debt ceiling. So there’s plenty of reason to worry that the two parties are (a) drifting further apart and (b) less able to compromise in general.
The upside of the S&P’s move, of course, is that it makes an eventual downgrade less likely. The more external pressure Washington has to act, and the more it fears the consequences of inaction, the more likely it is to actually do something. This “negative outlook” is the sort of thing that builds pressure. Same for PIMCO’s decision to flee the market for Treasurys. As the market sends more and more of these warning shots, it becomes likelier and likelier that Washington will actually act. S&P is an observer here, but it’s also a player, and maybe that’s for the best.