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Further Thoughts on S&P’s Downgrade of USA

Posted by Larry Doyle on August 8, 2011 7:44 AM |

The sun did come up here on the east coast this morning. That is a very good thing. Life does go on.

Our fiscal life goes on as well. In many respects it is little changed but in others it is very much changed and will not soon be restored. As the emotions of many inside and outside of the markets are frayed as a result of S&P’s downgrade of the USA, let us keep our heads and maintain our ‘sense on cents‘ approach.

On that note, what are three questions I see many asking and how would I respond to them?

1. If the USA just had its credit rating downgraded, then why aren’t US Treasuy rates moving immediately higher as a result?

Our interest rates are a function of many factors not just our credit rating. What other factors?

>>Primarily the pace of economic growth and the projections for future growth. The economy is perceived to be slowing and the chance of a double dip recession is increasing. I personally believe the recession we entered in late 2007 never truly ended and that the pop in the economy was predominantly a function of short term and unsustainable government stimulus. A slowing of the economy portends low rates …and the Fed will certainly continue to keep short term rates low for an extended period.

>>With the slowing in our domestic and global economy, the threat of deflation or disinflation within our real economy increases. This topic is getting little air time but it should not be discounted. The dreaded “D” —as in deflation or disinflation— will hold down our interest rates.

>>Let’s be honest, our Treasury market has been very heavily manipulated by the Federal Reserve via its quantitative easing programs. The European Central Bank is now engaging in a similar exercise trying to support the Italian and Spanish bond markets.

I do believe the biggest move in our US Treasury market over the longer term will be a steepening of the curve, that is, short term rates will remain low while longer term rates gradually move higher.

This reality will negatively impact most savers and borrowers. How so? Rates on CDs and assorted other short term investment products are tied to short term Treasury rates and will remain low. Rates on mortgages are predominantly tied to longer maturities and thus OVER TIME will move higher from where they are today.

These projections on rates are independent of another round of quantitative easing by the Federal Reserve.

2. What about Standard and Poors? Are they out of line with this downgrade?

For Tim Geithner and others within the administration and Congress to cast aspersion at Standard and Poors is a joke. The fact is S&P downgraded the outlook for the US to negative last April and then put the US on negative watch in mid-July.

The reality of an actual downgrade may have surprised some who are merely used to “the boy who cries wolf” approach in Washington but the simple fact is that “big, bad wolf” is clothed in the debt of the USA and it is both very real, very large, and very mean.

Since April, how often have Tim Geithner and his sidekicks in Treasury spoken to the crowd at S&P? If they were not speaking to them on a regular basis and comparing notes and numbers, then I believe they were negligent in performing their duties. Spare us the histrionics Tim.

3. How do we move forward in a truly meaningful fashion?

In summary, our fiscal nightmare will only be addressed with meaningful reform within our entitlement programs and our tax policy and structure. Everything else is important but will not ‘meaningfully move the needle‘.

Additionally and no less important, I firmly believe we need to exorcise the debilitating and corrosive incestuous relationships which Washington fosters with a wide array of constituencies. I believe this badly needed exorcism will only occur as a result of imposing strict term limits.

For those who have not read my immediate reactions and opinions on the market and economy to this HUUUUGE story, I am happy to provide a link to Breaking News: S&P Downgrades United States.

Questions, comments, constructive criticisms always encouraged and appreciated.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.



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