Blame Obama and Boehner for the Downgrade

In April 2010, Treasury Secretary Timothy Geithner said there was “no chance” Treasury bills could lose their AAA rating. The fact that top government officials thought there was “no chance” something could happen surely is one reason it happened.

U.S. government bond ratings are falling — the S&P downgraded the US credit rating yesterday from AAA to AA-plus, the stock market is plummeting — such movements don’t necessarily have story lines like Hollywood movies. Herd instinct and randomness are factors. Even top economists can’t agree on exactly why the Dow headed south.

But the bond rating drop unequivocally is a direct result of the Barack Obama-John Boehner national-debt deal being as phony as a three-dollar-bill.

Stocks for their part began to fall two weeks ago, on rumors the Obama-Boehner deal would contain nothing but pandering. The drop accelerated – 6.1 percent of the 10.5 percent decline – pretty much to the hour, on Monday, when the deal became final and it was clear that reports were correct. Monday, markets learned that people at the top of the government of the United States were going to do nothing at all about the national debt, beyond acting like windbags.

America had been elaborately warned that endless borrowing to appease interest groups doesn’t work – the warnings have come from Greece, Ireland, Portugal and most of all from Japan. President Obama and congressional leaders of both parties ignored those warnings and ordered another round of champagne, agreeing to a deal that includes $2.4 trillion of fresh borrowing by 2012, paired with only $21 billion in specific cuts in the same period — about $115 spent for each $1 saved.

That Super Committee to which the debt can has been kicked? The core problem of U.S. fiscal policy is that federal taxes are too low and entitlement spending too high. Yet the Super Committee is all but forbidden to discuss Social Security reductions or tax increases. Good luck finding trillions of dollars of savings in the Fish and Wildlife Service.

Of course leading indicators are an aspect of the market drop. Growth is slow. European debt may be in worse shape than European Union leaders are letting on. On Monday, the Institute of Supply Management reported the lowest figure in a year for its influential Purchasing Managers Index. Though, the ISM also reported, “Economic activity in the manufacturing sector expanded in July for the 24th consecutive month.”

So factory orders aren’t great but aren’t awful either. Yesterday’s news of mildly positive jobs numbers cautions against pushing the panic button.

Even if indicators could be a lot better, the main piece of new information added to markets in the last two weeks has been that Washington is leaderless.

Both parties, and both the White House and Congress, are more interested in blowing smoke than in firm action. Both parties are terrified of offending any special-interest group. That’s a formula for turning the United States into Japan, as The Economist’s spooky cover suggested. And if you think the United States is in peril of turning into Japan economically, then stock prices should drop.

Some commentators believe Washington should be diving even deeper into debt, for Keynesian reasons. Since the recession began in early 2008, the United States has borrowed $5.6 trillion – nearly the entire national debt not in the dim past, but the year 2000. American is now on track to borrow another $2.4 trillion by the end of 2012.

That will mean $8 trillion of debt-based spending merely from 2008 to 2012. Stated in today’s money, the United States borrowed $3.9 trillion during World War II. If $8 trillion of debt-based spending in a short period doesn’t have the desired Keynesian impact on growth and jobs — then either Keynesianism doesn’t work, or something else is happening.

The vote here is that something else is happening. The something else is that every time the United States borrows more against the future, the future becomes less valuable. If you think the nation’s leaders are squabbling children, you save rather than spend (if a consumer) and horde cash rather than invest (if a corporation). Both behaviors are being observed.

This won’t change until clear, specific action – not windbag grandstanding – is taken against debt trends. That action must include entitlement cuts and tax increases. The political parties must stop living in a dreamworld on these topics.

Democrats have taken to calling Social Security “a program for the poor.” This is pure dreamworld. Most Social Security benefits flow to the middle class, and must be trimmed; some flow to the rich, and must be eliminated.

Republicans who live in a tax-cuts dreamworld should ask, “What would Reagan do?” The answer is that Ronald Reagan would raise taxes. Faced with ballooning deficits, Reagan backed an income tax increase in 1982 and a corporate tax increase in 1986. The nation’s books righted themselves, and 20 years of boom growth and high employment followed.

There is no path out of the current problem that does not include tax increases and entitlement cuts. On Monday, Washington’s leaders showed they are terrified of that fact. When will they find resolve?

[Cross-posted at Reuters.com]

Gregg Easterbrook

Gregg Easterbrook is a contributing editor of the Washington Monthly and the Atlantic. He's also a columnist for ESPN.com.