We Must Understand Impacts of S&P Rating

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May Enquirer Article.pdf

On April 18, we received a wake-up call when Standard and Poors put the federal government’s debt on negative watch. It is a serious warning that some observers feel is a possible first step to downgrading U.S. bonds from their AAA rating. It is crucial that Americans understand what this means for our nation, our families, and our jobs. When Congress later this month debates raising the debt ceiling, all of us should pay close attention.

The concepts here are straightforward. Every time the government spends more than it receives in revenues it must borrow money to finance the resulting deficit. This borrowing, which usually occurs through the sale of government bonds, adds to our outstanding debt. In 2010, our federal deficit added $1.6 trillion to our debt which now equals $14.0 trillion. This is almost equal to the total value of all goods and services sold during the year. Both sides of the political aisle agree that this debt is unsustainable in the long term. But many of us are not aware of the current impacts of this debt.

Some experts argue that when the government borrows, it competes with the private sector for funds available for lending. As the government increases its demand for these loanable funds it will increase the interest rate, making borrowing more expensive, and will “crowd out” private investments. These private investments are essential to the health of the economy and productivity gains. A reduction in private investments leads to fewer good jobs, a less competitive economy and a decrease in our standard of living.

One way to offset this “crowding out” comes from foreign countries, especially China, who loan us money by purchasing our debt. However, this works only up to a point and recently, China has indicated that it might diversify its holdings away from U.S. government debt. If so, this reluctance will result in higher interest rates and fewer private investments in the U.S.

The Federal Reserve can try to offset the effects of this crowding out by lending the government money through the purchase of government bonds. However, the Fed’s cure may be worse than the disease because purchasing these bonds injects more money into the economy which will likely cause inflation. Increased debt and an expanded money supply also devalue, or weaken, the dollar. Today the value of the dollar relative to other currencies is lower than any time since August 2008 and only 5 percent shy of the lowest level since statisticians started to measure this in 1971. A devalued dollar means that when Americans purchase foreign products, they must give up more dollars to meet the price of those products. The sharp increase in commodity prices, such as oil, is due partly to a weakened dollar.

A country that has a decreasing currency value is less attractive to foreign investors who measure their investment’s return in their own currency. For example, if an investment earns 12 percent in a year but the value of the dollar depreciates by seven percent, the foreign investor is left with five percent. When investments in the U.S. become less attractive and even fewer investments are made, our economy suffers.

The costs of excessive debt occur now as well as the long term. The message from Standard and Poors seems to be that now is time to fix the problem. This will require some difficult decisions; prolonging short-term pain through shortcuts or political posturing will only exacerbate the pain, both locally and throughout the nation.