S&P's wake up call

Those who thought that raising the US debt ceiling was all that was needed to avert a downgrade had a nasty weekend surprise.

Standard & Poor's saw the vote and still cut the rating. Clearly S&P believes as do many on both sides of the aisle, that some radical change in how business is conducted in Washington is overdue.

While the President's mouthpiece on economic affairs, will-I-or-wont-I-resign Treasury Secretary Timothy Geithner, slammed the downgrade in an interview on Sunday with NBC News, market professionals like Jim Bianco of Chicago based Bianco Research cautioned that the downgrade fallout may be months from now. "People who say this move doesn't matter are assuming it stops with Friday's announcement [but] I'm saying it only began on Friday."

The rating cut by S&P of long-term U.S. debt threatens one of the fundamental underpinnings of financial analysis: that when the risks and prices of practically every major investment are considered, it is against the belief that U.S.-government paper is "risk free." That belief is now dented, although not shattered.

Betting there won't be a credit downgrade of the United States was all over the media late last week. Many commentators misread what the fight in Congress was all about and what an agreement to raise the ceiling really means to the United States Treasury's cost of borrowing.

Geoffrey Garrett's analysis of the 'debt ceiling' is typical of expert opinion (US adrift as Obama outflanked by tea party zealots The Australian 6 August). Garrett echoed common sentiment when he claimed that "America's real problem is its reinforcing economic and political crises" and that "gridlocked Washington is incapable of showing any leadership to revive it".

Wrong twice.

First, the Tea Party forced Americans to dwell on the mammoth debt; and not the debt ceiling. Second, "Washington" is not gridlocked along party lines. It is very much divided within the Democratic Party between those who think the republic needs to pursue a new economic paradigm of significantly less debt (to counter the Chinese challenge and remain a First World nation) and those who see nothing wrong with the frequent lifting of the debt ceiling.

The divide leaves most Republicans and many Democrats on one side, and significant minorities from both parties on the other side. This can be seen by how the vote was won:

What is clear is that while the Republicans, herded by House Speaker John Boehner, spoke with a loud voice (more or less), it's the Democrats who showed themselves to be very much divided.

Most pundits thought that the raising of the ceiling would help maintain the AAA rating. This was not to be. Higher interest rates will follow and the greenback will erode in value; its erosion slowed by the even worse position in which the eurozone finds itself.

While many experts prescribe more federal stimulus for an economy on life support, they forget that consumers' reluctance to spend is more a result of a dearth of jobs than it is a preference to save.

US firms are doing well (profit wise) but are not hiring much. They are doing more with less. Or at least doing no less with less. Make life easy for them and maybe there will be a lift in employment. Perhaps they should be granted some tax breaks based on the numbers they hire.

Those rallied in favour of slashing government spending believe that the republic's slide to more and more debt is much more than just a matter of economics. It's a defining imperative as to what future Americans want for themselves and their children.

Consider the facts from the United States Bureau of Economic Analysis. Government spending at all levels has risen over time, as follows:

• 27% of gross domestic product in 1960; to

• 37% of gross domestic product in 2011; and expected to touch

• 50% by 2038.

and the percentage of Americans who pay zero or negative federal income taxes has risen from:

• 19% in 1986; to

• 51% in 2008.

All of this has taken place while the total national debt swelled to 100%of GDP today from 42% in 1980.

Simply put more and more Americans are living off the sweat of someone else's brow. And that "someone else" comprises fewer and fewer people over time. This is the major issue. Also vital to address is the matter of the widening income inequality between the haves and the want-to-haves.

In the absence of unprecedented bipartisan action to tame the runaway debt and fashion a financially sustainable America, Arthur C. Brooks on 25 July in the Wall Street Journal (The Debt Ceiling and the Pursuit of Happiness) outlines two possible outcomes: the Scandinavian option and the Greek option.

In order to fund a growing social welfare state, more and more able-bodied taxpayers will have to finance a republic that allows many to enjoy the good life without paying for it. This will require higher taxes and a closing of loopholes. The Swedish model is a good guide to such a future.

The Greek option is the alternative. Under this scenario, less and less people over time will fund the welfare state, while demands on the state will rise unabated. Austerity will eventually be introduced by politicians in Washington. If that fails, then austerity will be forced on the United States by its trading partners.

One route delays Judgement Day, while the other route brings that day forward.

Most Americans are no doubt praying that their elected representatives will act on the matter of out of control debt as soon as possible. Long before S&P considers yet another downgrade.