The Real Downgrading of America

Today Standard and Poors downgraded long term debt of the United States from the highest rating of AAA to AA+.  The other two major agencies have not downgraded but have warned of the possibility.

This is the first time in history that US Federal government debt has had anything other than the top rating so many people haven't really ever considered this and are unsure of the consequences.  Even financial experts aren't so sure.

Many products and pricing methods in Finance are built around the concept of what is known as the "risk free rate."  This is useful for calculating things like the "Present Value" of future cash flows.  (ie.  the opportunity cost of not having money today that you could then invest at the 'risk free rate.')  Nothing is ever truly risk free but having the highest possible credit rating is as good as you can get.

There is a knock on effect of a downgrade of US Sovereign debt.  It is a principle that the Sovereign must always have the highest credit rating in the country.  The idea behind this is very simple:  A nobleman can't be AAA while the King is AA since the King can simply choose to tax the nobleman to pay his obligations.  As a result, Apple Computer may have had more cash in their bank account than the US Treasury did for a time last week, but their credit rating still cannot be higher than the Treasury.  This knock on effect may increase borrowing costs for many US companies down the line.

The Standard and Poors downgrade statement made a particular point of saying that a deficit reduction plan had to be 'credible' and that the dysfunctional way in which the Executive and Legislative branches are interacting was a factor.  I don't think that anyone who followed the recent debate and brinksmanship around raising the debt ceiling could argue with these criticisms.

As a practical matter, this downgrade may not have any big immediate effects.  There are three major ratings agencies and the others have not yet followed suit.  (if the other dominoes fall, then the USA is on the same slippery slope as Greece)

The S&P doesn't have a mandate for social commentary but their statement still pointed us to the real historical downgrading of America:  before Congress got dysfunctional, society became dysfunctional and voted that way.

The real problem is a downgrading of the values of shared sacrifice that once existed in America.  Where people once dutifully stood in ration lines to support the effort to defeat the Axis powers, people now see shopping on credit as their patriotic duty.  In a way, one can hardly blame them.  President George W. Bush and Mayor Giuliani told them to do just that.

Every debate around the budget comes down to various interest groups basically saying one of two things:

1. Cut my taxes and raise taxes on these other people.
2. Don't cut my benefits, cut someone else's.

Both Democrats and Republicans are equally guilty of this.

The 2011 Federal Budget contained spending of $3.8 trillion dollars and revenue (taxes) of $2.2 trillion leading to a deficit of $1.6 trillion.  This means that for every one dollar collected in taxes, the government was spending one $1.72.  That is an absolutely irresponsible level of spending.

Here is my suggestion for how America can fix this problem of values and get their AAA credit rating back:

1. Raise taxes on the wealthy.
2. Raise taxes on the not wealthy.
3. Cut Democratic sacred cow social programs like Social Security, Welfare, Medicare and Unemployment Insurance.
4. Cut Republican sacred cows like National Defence, Corporate welfare subsidies, Ethanol subsidies.

In short, taxes go up for EVERYONE and benefits are cut for EVERYONE.  How can this be fair?  It's fair because when $1.72 of spending exists for every $1.00 in taxes, the entire society is living beyond its means.

Those on the right will talk of how certain social programs cost too much.  By and large, these programs benefit urban dwellers and minorities.  They will ignore any talk of ethanol subsidies which benefit rural white farmers.

The left is equally guilty of playing class warfare politics of division.  They will always say that taxes should go up for the "rich".  This is a red herring because the rich already pay higher taxes and there simply aren't enough of them earning $250,000 + to fix this fiscal imbalance.  This plays right into the attitude of "let someone else pay."  Why shouldn't the middle class pay more?  The only reason nobody says that is because the middle class is where most voters are.  

My suggested plan will fix the deficit (unlike the current plans) and probably trigger a severe recession (just as the current plan will).  Recessions are painful but they are inevitable.  They are inevitable because sustained growth creates the conditions that lead to recession.  (I don't want to write a textbook here so I won't go into that much more now.)

My suggested plan would not get a single vote in Congress.  It offends every constituency and enforces shared sacrifice.  Therefore, my plan is not aligned to the values of America right now.  What a pity.