Why are the nation's CEOs banding together to bring down the deficit? According to some of our biggest banks, it's because they're afraid that "another downgrade of our nation's debt by a major rating service...could lead to significantly higher interest rates," as they wrote in a recent letter organized by the Financial Services Forum. “Higher interest payments would worsen our nation's fiscal burden and likely increase the uncertainty and instability in global financial markets.”
They join a growing chorus of corporate executives who argue that a bipartisan "grand bargain" must be the country's number one priority — not just for the sake of the government's balance sheets, but their own as well.
But are high government deficits really bad for business? Certainly, some credit ratings agencies have threatened to downgrade the U.S. if Congress fails to enact significant deficit reduction in the near future. If the upcoming budget negotiations "lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable," Moody's said in September. "If those negotiations fail to produce such policies, however, Moody's would expect to lower the rating, probably to Aa1."
Fitch Ratings says it's in the same camp. "They need to set out some kind of plan to address the deficit and debt in a sensible way. We are not looking for slash and burn; we are talking about a sensible reduction. If they can’t really put that together in the first half of 2013, there is a significant threat to the loss of the triple-A rating from Fitch,” said one Fitch executive in late August.
Going over the fiscal cliff would be one way to reduce the long-term deficit. But Moody's warns that doing so would mean that it would probably keep the outlook for the U.S. "negative" into 2014 given the cliff's big shock to the short-term economy, which businesses are also eager to avoid.
So there does seem to be reason to believe that if Washington fails to come up with a long-term deficit reduction plan, the country will face a credit downgrade. Going over the cliff might not result in a downgrade, per se, but would also dampen the country's near-term economic outlook.
However, it's not the downgrade itself that businesses are afraid of: It's what would happen afterwards. Typically, if borrowers are deemed less creditworthy, others would be less likely to lend to them unless interest rates were higher. But that's not what's happened in the recent past.
Standard & Poor's downgraded the U.S. after the debt-ceiling debacle last year, on the rationale that a destructive political climate was endangering the country's long-term economic health. Interest rates, however, actually fell after the S&P downgrade, tumbling from about 3 percent in mid-July 2011 to under 2 percent by the end of August, as the U.S. Treasurys remained a safe harbor in even more tumultuous global markets. The same political dysfunction also prevented the supercommittee from coming to an agreement a few months later, but yields remained low.
Some analysts say this is an anomaly that they don't expect to repeat itself. "Perhaps perversely, rates fell after the S&P downgrade in a flight to quality. I don't think that would happen with another downgrade by Moody's and/or Fitch," says Gus Faucher, senior macroeconomist at PNC Bank. Indeed, one factor that kept U.S. interest rates low amid the last downgrade was that Europe's financial crisis was flaring up, making U.S. securities look more attractive by comparison; if European leaders continue getting a better handle on their problems, that phenomenon could reverse as money flows back across the Atlantic.
So it's conceivable that a major deficit-reduction plan could prevent borrowing costs from getting higher for firms and businesses, as the CEOs have argued. What's less clear is why these CEOs' companies aren't borrowing and investing more right now, if borrowing costs are so critical to their business decisions.
Interest rates are at historic lows right now, yet companies are still holding back. "We're awash in money right now, so lack of capital isn't an issue," notes Faucher. That suggests that it's not simply borrowing costs — and the state of the long-term deficit — that is holding back business confidence. Rather, recent research reports suggest that it's about the fiscal cliff itself — too much austerity, not the lack thereof.
A bipartisan "grand bargain" is one way to address the fiscal cliff, but it's certainly not the only one. And private industry's own actions belie their own argument that that the long-term deficit must be reined in, above all other priorities. Why, then, would they be making this push right now? Felix Salmon and Jonathan Chait have a few ideas.