Is US Suing S&P Payback for Ratings Downgrade?

In run-of-the-mill stories, there are heroes and villains: I've been in this town so long that back in the city I've been taken for lost and gone and unknown for a long, long time. Today, however, we instead have two major baddies duking it out: the US government and credit rating agency Standard & Poors. It's the political economy equivalent of Aliens vs. Predator. Apparently, the US government was, like many, suckered into buying securities of dubious creditworthiness by inflated ratings slapped on them by S&P and its peers. So many years after the global financial crisis hit its peak, the United States sued S&P for misrating these securities earlier in 2013.
 
The plot is not that straightforward, though. Recall that S&P is the only major credit rating agency to have downgraded US debt from Triple-A status exactly two years ago. I argue that action was too little, too late anyway in that America's debt problems are only going to get worse due to fiscal mismanagement unmatched by any other country in absolute terms: anyone else owe $16.7 trillion?

It appears that S&P is now trying to absolve its past actions by accusing the US government of using the suit as revenge for its ratings downgrade:

Standard & Poor's Ratings Services escalated its legal battle with the U.S. Justice Department, accusing it of filing its $5 billion lawsuit against S&P in "retaliation" for the company's downgrade of America's debt in 2011. S&P's defense, made in a court filing on Tuesday, shows that the world's largest credit-rating company is digging in as it fights the Justice Department's Feb. 4 lawsuit, which accused S&P of misrepresenting its rating process in the years before the financial crisis [...]

The Justice Department "commenced this action in retaliation for [S&P's] exercise of their free speech rights with respect to the creditworthiness of the United States of America," lawyers for S&P wrote in court documents filed Tuesday in the U.S. District Court for the Central District of California. A Justice Department spokeswoman said in a statement that "the allegation is preposterous." S&P referred questions back to its Tuesday response to the U.S. lawsuit [...]

While this tactic is not unusual for those sued by the Feds, proving it is ludicrously difficult:

It isn't unusual for companies sued by the federal government to claim political payback, said some lawyers who have been following the lawsuit. S&P could eventually decide to drop the payback argument, they said, depending on what documents are unearthed during the discovery process or if the judge overseeing the lawsuit indicates that line of defense doesn't hold water [...]

[L]awyers also said that proving retaliation will be difficult for S&P. It will be an uphill battle to prove that there was direct communication between different government agencies [i.e., Treasury and Justice] and to indicate any such goal, as of the alleged retaliation by the government, the lawyers said. 

As with most half-truths, both villains are partly correct. I, of course, would state the facts of the matter thusly which casts both in a negative light: 

• The United States deserves an even bigger downgrade than what S&P made given the true extent of its future liabilities. 
• S&P provided deliberately misleading ratings since it was financially beneficial for it to do so.

In the end, that's all there is to it. The S&P conspiracy theory is too elaborate and veers too far away from coherence to be admissible. For this round, the US government villains at least have a logical case against the ratings villains. Besides, if the US government really wanted to hurt S&P, it could easily put it out of business. 

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So, Why are China, Japan, ROW Dumping Treasuries?

There is a debate going on here in the rest of the world concerning the United States. It isn't really whether American officials are trustworthy, but whether they are more of BS artists or ripoff artists. When it comes to foreign holdings of US Treasuries, it's arguably both: The United States likes to con others with "strong dollar" rhetoric as it runs unfathomable deficits and the dollar falls to some godforsaken level. There is a lie, and a large financial consequence to believing in such nonsense.

Or, is there a limit to global gullibility? Will the rest of the world continue to be held hostage to this "financial balance of terror"? As it turns out, the top two suckers--China and Japan--have actually been selling loads of dollar detritus in recent months. What's more, the rest of the world are following suit, intensifying movement away from greenback garbage:

China and Japan led an exodus from U.S. Treasuries in June after the first signals the U.S. central bank was preparing to wind back its stimulus, with data showing they accounted for almost all of a record $40.8 billion of net foreign selling of Treasuries. The sales were part of $66.9 billion of net sales by foreigners of long-term U.S. securities in June [there is a two-month lag with this data series], a fifth straight month of outflows and the largest since August 2007, U.S. Treasury Department data showed on Thursday.

China, the largest foreign creditor, reduced its Treasury holdings to $1.2758 trillion, and Japan trimmed its holdings for a third straight month to $1.0834 trillion. Combined, they accounted for about $40 billion in net Treasury outflows.

Bernanke spooking the markets by suggesting that the Fed will soon stop accumulating nearly unlimited Treasuries to lower borrowing costs is resulting in others' pre-emptive action to avoid near-term losses:

"The sell-off in Treasuries and Bernanke's tapering remarks are related," said Michael Woolfolk, global market strategist at BNY Mellon in New York. "Lightning doesn't strike in the same place twice, but Bernanke repeated his comments in June and that roiled the market."

He said the net Treasury outflow was the highest since at least 1977 when the government started compiling the data. June was the fifth straight month that foreign investors sold long-term U.S. securities, but the specific selling of long-term government bonds was the big turnaround as foreigners had bought $11.3 billion of Treasuries in May.

Are we reaching the outer limits to global gullibility in buying Treasuries? Given the aforementioned time lag in reporting the data, it will be interesting to note from forthcoming reports whether rising interest rates Stateside are driven more by Bernanke signalling the end of "money for nothing" policies or by central banks worldwide dumping Treasuries en masse.

Heaven knows, this world would be a much better place if the latter trend continues. Central bankers of the world, don't be afraid to dump those treasuries and teach America a lesson; in the end, only you will be responsible for your people suffering losses from hanging on to such worthless pieces of paper in their name.  

UPDATE: To be fair, the FT expects some bottom-fishing to buoy capital inflows into America in the next report.

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In Detroit We Glimpse America's Future

Just a city boy, born and raised in south Detroit
He took the midnight train goin' anywhere...

I have been to Detroit and it is not an experience I fondly remember. So, I do not question the motives of the protagonist in the Journey song above in leaving. Still, it was with some sadness that I heard this once-great American city declare bankruptcy only yesterday. In many respects it was the conclusion of the inevitable: years of outmigration and industrial decay had taken their toll on municipal finances. Contrast its decrepit state today with what it used to be. Despite the occasionally dodgy (non-)narrative, the documentary Detropia does a fine job of visually contrasting the city in its heyday with its present state. (PBS also has a neat photo essay on its faded grandeur.)

From a broader perspective, Detroit is also a microcosm of what ails America. Some will of course say that it's inevitable for unattractive cities to decay as these people forever on the move seek better fortunes elsewhere--such as in the non-unionized South. However, I would argue that removing yourself from Detroit only rewinds the clock by a few years from an inescapable American fate. That is, you can take the "midnight train" elsewhere, but you'll still end up in the US of A with all its woes. Let us now count the ways "Detroitification" is a portent for this country's future...

1. Decrepit infrastructure is a nationwide phenomenon - I enjoy video games featuring post-apocalyptic wasteland,and one of the best remains Fallout 3.  (With one of its expansion packs already set in Pittsburgh, perhaps Fallout 4 should be set in Detroit instead of Washington, DC.)  In real life, though, crumbling infrastructure is not isolated to Detroit but is a daily reality for most Americans. The American Society of Civil Engineers give the nation an overall mark of D+ [!], which is an unbelievably crappy mark in this age of grade inflation merited only by the most apathetic of students. The ASCE further estimates that the United States needs $3.6 trillion in infrastructure spending to maintain it in acceptable standards.

Given the current economic state of America--where economic growth is an oxymoron--it is hard to imagine massive federal or state outlays on the scale civil engineers believe is necessary. So, no matter how bad things are now, they are only likely to get worse. And, if everything everywhere is plain awful, there will not be an easy solution alike taking the "midnight train" out of Detroit when every other town looks like Dodge as the Yanks say.

2. Unfunded (and unpayable) liabilities keep mounting - One of the things which surely led Detroit to fess up to its fiscal depravity was a recent requirement for state and local governments to recognize unfunded liabilities, Depending on the assumptions you make--setting discount rates, life expectancies and so forth--local governments have a shortfall in what they owe pensioners ranging somewhere between $1 and $4 trillion. That sounds pretty dire already, but consider that the United States at the federal level has at least $61.9 trillion in unfunded liabilities by one fairly conservative estimate. Again, based on different assumptions, a former Fed governor put these at $85.6 trillion--in 2008.

Assuming no major tax increases or spending cuts are forthcoming--a most non-heroic assumption given the current state of American political paralysis--the only real cures at the federal level are effectively reneging on unfunded liabilities under some flimsy legal cover (unlike municipalities, the US government like all others cannot declare bankruptcy though) or eating away at them via inflation. Either way, the reputational damage will be huge.

It is also worth pointing out that there is this American proclivity for dumping unfunded liabilities on Uncle Sam. (As it turns out, estimates of corporate unfunded liabilities are also fairly huge.) The "GM solution" for dealing with them has of course been the government bailout, which leaves America on the hook for even more than already massive federal liabilities. Already there are suggestions that Barack Obama should fund another federal rescue a la GM for Detroit.
* * *

There will be much interest in seeing whether another federal rescue--this time of a city instead of a company--is forthcoming. Doing so would risk further bloating federal liabilities as all similarly troubled companies and municipalities resort to US government succour in the future. It will not be a pretty picture if and when the federal government is treated as a limitless dumping ground for corporate and municipal IOUs that cannot be honoured.

At present, nation-states do not have to report unfunded liabilities as corporations and now US local governments do. Still, who do they think they're fooling? Like America itself, Detroit has seen better days. The question for the rest of us is how to free ourselves of US-style misery before it drags us down to its level. Are we really as foolish as Detroit's lenders to believe that the US represents a good credit risk? Its problems are similar and differ only in terms of magnitude, where national problems are obviously far greater.

Not even RoboCop will save Detroit now...or the rest of America from "Detroitification."

UPDATE: French photographers Yves Marchand and Romain Meffre have an extensive photo collection entitled "The Ruins of Detroit."

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IMF Agrees w/Cheney: Deficits Don't Matter for US

Here we go again: for everyone else--especially the likes of Egypt, Pakistan and so forth, deficits do matter. But for the United States which (they say) has little funding its current account deficit, it's not really a problem. In essence it's the IMF approving of American deficits as per Dick Cheney's famous dictum that "deficits don't matter." To be exact, there's always the qualified economistic wording about how short-term fiscal consolidation is not required but rather stimulative policies to get the economy unstuck or suchlike. Instead, the real fiscal challenge for the United States is in the medium- to long-term when it must deal with its health care and pensions unfunded liabilities as baby boomers retire en masse:

Here is the IMF head honcho on the subject matter:

The U.S. economy would be faring much better were it not for the "self-inflicted" wound of tighter fiscal policy, the head of the International Monetary Fund said on Tuesday. "The U.S. is not doing as well as it could be, because of self-inflicted fiscal wounds. This year alone, fiscal adjustment will constitute an enormous 2.5 percent of GDP," IMF Managing Director Christine Lagarde said at the Brookings Institution.

She said the challenge was not the near-term fiscal outlook for the longer-term one, given the pressures of healthcare and Social Security spending. "The next couple of years are going to be quite positive looking. But if nothing is done about the medium and long-term horizon ... then the picture is a lot bleaker," Lagarde said. "This is the major challenge facing the U.S. economy today, and it must be met."

I am beginning to wonder when the medium- and long-term will arrive since they never seem to come when the IMF speaks about the US. It's in essence a free pass. Actually, the Yanks have a term for delaying the inevitable time and again in plain English: "kicking the can down the road."

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Tim Geithner, I Dub Thee 'Pantywaist of Globalization'

I've been meaning to make this post for four long, steenkin' years--and here it finally is. Perhaps Timmy thought he got away with stepping down soon as Treasury Secretary, but alas, I've pulled the trigger at the last moment. Anyway, this award is for continually being cowed in the China-bashing exchanges he finds himself in the middle of. In the past, I confess to poking fun at his responses to being made to perform admittedly unenviable tasks [1, 2]. How does piling on $1T in debt annually sound, for starters? My favourite, of course, being his repeated avocations of "strong dollar" policy despite continually asking China to revalue its currency. After all, wouldn't calling for the latter be a "strong yuan" policy that conversely implies a weak dollar is actually in effect?

At this point I guess we'll never know. Since moving from a strict peg to a managed float, the yuan has gained 25%. This doesn't mean that criticism has ceased, though. His soon-to-be former boss certainly kept harping on the currency issue throughout the recent US election. As it so happens, the US Senate requires the Treasury to report on the currency practices of America's trading partners. Eight opportunities have come to "do something" about China. Eight opportunities have gone to "do something" about China. As is usual during election years, Treasury delayed the release of the report scheduled for October for after the elections. And we got exactly the same thing:

The deadlines for the currency report to be issued are April 15 and Oct. 15 each year. But the Obama administration announced in October [this year] that it would delay the fall report until after meetings of finance ministers in early November. That decision also delayed the report until after the November election...

But Sen. Charles Schumer, a longtime Democratic Party critic of China's trade policies, criticized it. "This report all but admits China's currency is being manipulated but stops short of saying so explicitly," Schumer said in a statement. "It's time for the Obama administration to rip off the Band-aid and force China to play by the same rules as all other nations."

Not that the US will ever give up this issue:

Still, Treasury said the yuan remains significantly undervalued. It vowed to keep pressing Beijing to let the currency rise further to "level the playing field for American workers and businesses and support a strong, sustainable and balanced global economy."

The U.S. trade deficit with China reached $29.1 billion in September. It is running 6.8 percent ahead of last year's record pace. It has long been the largest U.S. trade gap with any one country.

Just as Susan Rice is the archetypal Ugly American, Tim Geithner is the archetypal Damp Squib in British-speak.Tim Geithner, for what will probably be the last IPE Zone post on you in your current capacity, I dub thee pantywaist of globalization.

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Foreign Private Investors Dump Treasuries in Sept

MarketWatch alerted me to the fact that foreign private investors dumped the most Treasuries ever in the month of September based on Treasury International Capital System (TICS) data:

Foreign investors were net sellers of $18.3 billion of Treasurys in September, the largest amount on record, Treasury Department data released Friday showed. Overall, foreign investors bought a net $17.9 billion of long-term U.S. securities in September, down sharply from the $78.5 billion purchased in the prior month. This includes Treasurys, mortgage-related bonds, corporate bonds and equities. According to the data, China-based investors slightly increased their holdings of U.S. Treasurys in the month. Foreigners made net purchases of $23.4 billion of U.S. equities in September, up from $6.1 billion in the prior month

The official data is here if you want to see it. Here's hoping that private foreigners get rid of more of this dollar-denominated detritus in the near-term as we head towards the fiscal cliff and the inevitable downgrades of US sovereign debt. That should teach those current account deficit lovers a thing or two.

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Bill Gross: QE1-3 Added No Savings or Investment

In case you missed it, bond investing legend Bill Gross has just provided the most damning evidence that various Fed easing efforts have been worse than useless. You'd think all of this helicopter dropping of cash would encourage more investment which in turn would generate more jobs, but capital expenditures Stateside are actually dropping like a rock even if real interest rates are well and truly negative:

It is of course expected that Americans just keep spending their brains out since they can't help it. But, to put money aside for productive expenditures? You must be joking. We're talking about modern America here, an instant gratification society that hasn't had much to be grateful for as of late. And, where there's no investment there's no savings. Much has been made of laughably puny increases in consumer savings since the events of 2007, but if you add together government, business and consumer savings, the truth is that US net national savings are scraping all-time lows in negative territory where it's been the last three years:

I'd like to ask the Drezner wannabe USA#1 cheerleaders to explain these charts. Clearly, that has-been nation isn't investing in the future because...they simply have no savings left to invest. What a joke. Obama or Romney, their next leader will certainly reap the misery sowed by essentially non-existent investment. Given a non-existent future, it may be the "rational choice."

I'll leave Bill Gross to deliver the coup de grace:

All of the money being created and freed up is elevating asset prices, but those prices are not causing corporations to invest in future production. Admittedly, the chart shows this downward spiral has been underway for decades, but financial repression and quantitative easing were supposed to be the extraordinary monetary policies that kick-started the real economy in the other direction. They have not.

Is it any surprise that, for more sensible young Americans, the "American Dream" is to leave America? Take your money and go--everyone else already did.

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Of Obama's 'Retreat Dividend' and Condi Rice

Dear readers, something most commentators missed in observing that the United States has now had four consecutive years of trillion dollar-plus deficits is that something remarkable has transpired: For the first time since 1955, US government spending has gone down--from fiscal year 2011 to 2012. Sure, moving from nearly $3.6T to 'just' $3.54T is not really an amazing feat in absolute terms--especially after considering the aforementioned deficits--but it's an improvement nonetheless.

Back during the last heyday of America during the Clinton administration, a number of commentators spoke of a 'peace dividend' emanating from the end of the Cold War that helped improve the US budget situation. Sure, there were other reasons for that nation's improved fiscal health, but cutting back on military spending played its part. And so it is that Obama has ever-so-slightly reduced government spending. However, instead of a 'peace dividend', what we have here is a 'retreat dividend' with the United States leaving behind the massive trillion-dollar-plus fiascos of Afghanistan and Iraq. %^&*ing up other parts of the world and chickening out when the opposition is too tough--and public opposition too much and bills too high--is typical Americrusader behaviour in this day and age. (Is contemporary US defence policy inspired by N.W.A.? Remind me to invest in Dre Beats if that's the case.) What even Obama's critics miss though is that there cannot be a 'peace dividend' here since we are reminded by news stories on an almost daily basis about how violent Afghanistan and Iraq remain. What a success.

This intro brings me to one of the architects of the Bush-era manoeuvrings, National Security Adviser then later Secretary of Defence Condoleezza Rice. In 2008 when I was a doctoral student at the University of Birmingham, I had the opportunity to attend a talk given by IPE stalwart Benjamin 'Jerry' Cohen at the nearby University of Warwick. At the time, he was launching his much-lauded history of our field, International Political Economy: An Intellectual History (which was in turn based on an RIPE article he published the year before). There is not much more I can about this book which is essential reading for IPE scholars or those with a general interest in the subject matter. While I regret that IPE is very much an Amerocentric and Eurocentric field, his description of it as such is accurate. At any rate, I was doubly miffed when I found out that the publisher Princeton University Press gave away copies of the book at the Warwick event since many of my colleagues came back with them. Grr!

Anyway, in the years since, I have met Professor Cohen and he is a very classy guy (and not a riffraff blogger like yours truly). It is with some shame that I now sheepishly admit to checking out this book from the library only now, but an interesting tidbit in the book concerns the encounter of Robert Keohane with a certain someone at an academic conference. Since Keohane is one of IPE's founders, he gets ample space in the book. On pp. 25-26, Cohen writes:

Another time, I witnessed him serve as a discussant for a research paper presented by a young woman just out of graduate school. Not impressed by her scholarship, Keohane tore her work to shreds, questioning her understanding of basic IR theory. I left the room thinking the young woman's career was over before it had begun. She had the memorable name of Condoleezza Rice.

Yikes! We must give props to Rice for persistence even if she 'made it big' for all the wrong reasons. Except in certain neoconservative circles, the rest of us recognize the Afghanistan and Iraq conflicts she helped oversee for what they are--unmitigated disasters. Still, it is heartening to know that an IPE guy foresaw the trouble with Ms. Rice from the get-go.

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Obama, Bernanke, Stimulus & American Brattiness

The New Yorker has an interesting new take on one of my favourite research genres, the search for the behavioural pathologies which account for terminal American decline, be it in health, income, wealth, life satisfaction or what else have you. Why should a clearly regressive society influence so much of what goes on in the rest of the world? It is not exactly news to the rest of the world that American parenting is as crappy as it gets, hence the search for solutions from more parentally enlightened societies [1, 2]. Nor is it news that American stewardship of the world economy is nearly as bad. Ultimately, these two are likely interrelated: While Bart Simpson and that Yanqui brat they caned in Singapore were all the rage in the nineties, let's just say things have gone downhill since then Stateside. In time, individual pathologies snowball into something unfathomably huge alike $1,000,000,000,000+ annual deficits whose momentum can hardly be arrested.

Recent anthropological research suggests these pathologies have their roots in households throughout the Land of the Free Loader:

Often, the [L.A.] kids had to be begged to attempt the simplest tasks; often, they still refused. In one fairly typical encounter, a father asked his eight-year-old son five times to please go take a bath or a shower. After the fifth plea went unheeded, the father picked the boy up and carried him into the bathroom. A few minutes later, the kid, still unwashed, wandered into another room to play a video game.

In another representative encounter, an eight-year-old girl sat down at the dining table. Finding that no silverware had been laid out for her, she demanded, “How am I supposed to eat?” Although the girl clearly knew where the silverware was kept, her father got up to get it for her.

In a third episode captured on tape, a boy named Ben was supposed to leave the house with his parents. But he couldn’t get his feet into his sneakers, because the laces were tied. He handed one of the shoes to his father: “Untie it!” His father suggested that he ask nicely. “Can you untie it?” Ben replied. After more back-and-forth, his father untied Ben’s sneakers. Ben put them on, then asked his father to retie them. “You tie your shoes and let’s go,’’ his father finally exploded. Ben was unfazed. “I’m just asking,’’ he said.

These vignettes are awfully similar to what you get in modern America. With the economy tanking again despite untold trillions spent to--erm...I'm not sure if these guys have achieved anything in the way of sustained progress--the proposed solutions once more involve spending massive debt-fuelled sums to silence this society of whingers. "As always, the Federal Reserve remains prepared to take action as needed to protect the U.S. financial system and economy in the event that financial stresses escalate" says the fawning brat appeaser Ben Bernanke. Meanwhile, Obama largely ignores somewhat better parenting suggestions from the Budget Supercommittee he himself convened in fear of offending the juvenile sensibilities of the American electorate.

Obama and Bernanke are perfect examples of really poor American parenting as they indulge bratty behaviour time and again. Instead of being leaders, they are led by those who don't know any better who demand instant gratification. Just throw more money at the problem and hope it goes away, nevermind that these exercises in fiscal and monetary irresponsibility are becoming increasingly unaffordable and ineffective besides. As the bankers at the height of the subprime era understood, the likes of Obama and Bernanke innately reason that they'll be gone anyway as things sink into further oblivion. In other words, they fit right into contemporary America. It's alright, son, deficits don't really matter because there's a global savings glut. It's not really my fault that deficits have ballooned during my term, they're all Dubya's fault. And so on and so forth.

As before, my suggestion for these folks and their innate preference for appeasers is to just grow up and deal with it. Stop running massive deficits you expect others to fund. The rest of the world does not have infinite patience dealing with your tantrums as you suck up the world's capital and throw it out the pram. In the end, perpetual childhood being programmed into American youth is symptomatic of wider pathologies indicative of all-too-evident societal decline:

Or adultesence might be just the opposite: not evidence of progress but another sign of a generalized regression. Letting things slide is always the easiest thing to do, in parenting no less than in banking, public education, and environmental protection. A lack of discipline is apparent these days in just about every aspect of American society. Why this should be is a much larger question, one to ponder as we take out the garbage and tie our kids’ shoes. 

As ghastly as it is, observing the US self-destruct is not only useful but necessary for two reasons. First, the rest of us need to figure out how to refashion global governance in a way that is less dependent on these people who haven't the slightest idea of how to run a nation, let alone the world. We can make it without these infantile American whingers and should be better of without them. Second, their bad example is precisely that which we should seek to avoid--unless you want to as progress-free as they are, that is.

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So, When Will S&P Downgrade the US Again?

Friends, there are certain certainties in life: Germany will do well in whatever international football (soccer) competition it enters, Lucy will pull the football before Charlie Brown can kick it; and the United States will inevitably get fatter and more indebted. Unless you read too many Paul Krugman op-eds--or Dan Drezner USA#1 cheerleading blog posts for that matter--you probably get the idea that deficits do matter.

Recently, S&P--which famously did the first deed in downgrading the bedraggled US of A among the three major credit rating agencies--issued an updated outlook on its sovereign credit risk. You will be unsurprised to hear that it remains likely to be knocked down a further peg or four in the near future. This also takes into consideration that no fiscal consolidation takes place alike the discontinuance of the infamous Bush tax cuts (as if the country has done so much better with them). From S&P, then:

Instead, our current (and previous) base-case fiscal scenario assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place indefinitely and that the alternative minimum tax is indexed for inflation after 2011. On the expenditure side, our base case assumes Medicare's payment rates for physicians' services stay at their current level, although we also assume that BCA11 remains in force. (This includes both the original caps on discretionary appropriations and the automatic spending reductions applicable in light of the Supercommittee's failure to reach an agreement.) Our base-case fiscal scenario also assumes annual real GDP growth of 2%-3.5% and consumer price inflation near 2% through 2016. Finally, this fiscal scenario presumes near-zero (nominal) short-term Treasury borrowing rates until 2015, at which point the rates climb by just more than 100 basis points, as well as a slower rise of about the same magnitude in long-term Treasury yields from their 2011 level of just less than 3%.

I am highly distrustful of credit ratings in general, believing that they are no substitute for conducting independent evaluation. For instance, assuming that the country grows in the 2-3.5% range is a stretch--which in turn implies that a credit downgrade is more imminent if it fails to reach this range up to 2016 (which is absolutely certain IMHO). At any rate, we get to the dirty business of assigning probabilities:

The outlook on our 'AA+' long-term rating is negative, reflecting our view that the likelihood that we could lower our long-term rating on the U.S. within two years is at least one-in-three.

Pressure on the rating could build if, in our view, elected officials remain unable to agree on a credible, medium-term fiscal consolidation plan that represents significant (even if gradual) fiscal tightening beyond that envisaged in BCA11 [the deficit reduction supercommittee]. Pressure could also increase if real interest rates rise and result in a projected general government (net) interest expenditure of more than 5% of general government revenue.

On the other hand, the rating could stabilize at the current level with a medium-term fiscal consolidation plan, or if the U.S. government makes faster progress toward reducing the general government deficit than our base case currently presumes.

So here are the takeaway points for you: (1) To maintain its AA+, S&P requires that the US tighten its belt beyond the measures the deficit reduction supercommittee believes is necessary, which in any case are not being implemented due to partisan deadlock. (2) Growth assumptions of 2-3.5% are wildly optimistic IMHO based on recent growth figures Stateside, making debt-to-GDP figures look even worse going forward.

End result? Based on S&P's stated criteria compared to America's economic realities and political limitations, I would think that a credit downgrade in the next two years is an odds-on possibility. Even if the US is remarkably progress-free already, the momentum is on the downward path. And I believe that, given its fundamentals (or more accurately, the lack thereof), the pace of Americarnage should accelerate. Recall that as late as May 2010, Spain--yes, Spain--had a AAA rating.

It should be exciting to watch--as long as you fully divest yourself of Sammy's IOUs.

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Putin's a Smart Guy: Worry About $, Not €

Anglophone economic commentary about the euro usually veers towards the "I told you so" variety, nevermind that no one has actually wanted out of the EMU while many are still lining up to join it--including the most economically progressive economy that's still out of it. British Euroskeptic dyspeptics and their American wannabe counterparts aside, many recognize that the potential fallout from the US dollar is far greater given that it (unfortunately) is of more systemic consequence than the euro. Moreover, whoever said that being in a currency union absolves anyone of responsible economic stewardship? EMU members understood that they could no longer avail of devaluation strategies favoured by certain other countries (even though no one has ever devalued their way to prosperity).

So, it is refreshing to hear Vladimir Putin raise a concern many of us from the developing world have. Earlier on he was spot-on in describing the United States as a parasite on the world economy. Now he provides another good insight along similar lines: As far as we can tell, the Eurozone is getting serious about reining in fiscal deficits and whatnot...

"I am heartened by the approach of the European Commission, with whom we rarely agree, and of the key eurozone countries, to how they plan to resolve the problems they face," Putin said at a press conference at the end of the two-day summit of the Group of 20 powers in Los Cabos, Mexico. "We can expect the situation to change for the better, although institutional reasons of the crisis are still there," he said.

...whereas the United States is not, cannot, and will not...

But the Russian leader lamented the lack of clarity on the future of the US dollar, which makes for a sizeable share of Russia's reserves, after US elections in November. "If we keep (half of reserves) in dollars and US bonds, we would like to know what will happen with the dollar after the US presidential elections," the Russian leader said. "Their debt is 15 trillion!" he added with a bewildered pause. "What will happen with the world's main reserve currency? What should we prepare for? These are the questions that should be at the center of attention of the G20." 

For whatever character flaws you may ascribe to Putin, it makes eminent sense to rely less on the dollar as a reserve and vehicle currency when it is structurally biased towards devaluation (whereas the inflation-averse ECB's euro has always been biased towards revaluation). Hence the legitimacy of the earlier "parasite" claim wherein others are effectively being forced to hold detestable dollar-denominated detritus. The G20 or whomever should come to a sensible move to shift towards other alternatives: a basket of currencies or regional alternatives alike the yuan in the Asia-Pacific. Otherwise, we are all just waiting to go the way of progress-free America and its currency.

After all, the bigger they are, the harder they fall.

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I Knew It: 61% of Treasuries Purchased by the Fed

What do you get when you cross the soppy Bushite Lee Greenwood with Obama's pastor? For one thing, you get a more accurate (financial) portrayal of the current state of that benighted land:

I'm cowed to be an American
Where at last I know I'm unfree
And I won't forget Uncle Ben
Who sold me into debt slavery

You can modify the rest of the lyrics accordingly--especially with Jeremiah Wright's trademark catchphrase replacing the title of the Greenwood tune. Anyway, this lyrical reassessment was brought about by a TIME feature I read recently that revealed the lie behind the "deficit's don't matter because US borrowing rates are so low" favoured by assorted (and rather ignorant) USA #1-style cheerleaders who inhabit the blogosphere.

As it turns out, the Federal Reserve flow of funds report for the entire year of 2011 reveals how "strong" demand is in the "market" for US treasuries. With 61% of Treasury purchases accounted for by Federal Reserve buying, both terms in quotation marks are cast in doubt. Yes, we know that open market purchases of treasuries are the result of policy decisions. But no, we did not know the cumulative extent of these purchases viewed in annual terms.

The proper analogy is one I made before: It's like calling your kid a "great salesman" after setting up a lemonade stand....only for the rest to find out that nearly two-thirds of all his "sales" came from you. So it is when monetary authorities justify currently bedraggled  American finances via some variation on the "deficits don't matter because US borrowing rates are so low."

The questions I would like to see answered are following:

(1) If demand from foreigners for Treasuries is so great anyway since the US is providing a "safe haven" through "liquidity services," why is there a need for another arm of government to undertake such large-scale purchases? Why make the state do what the market would do by itself?

(2) Related to (1), there is also a concern about bloating the balance sheet of the Fed. Why needlessly do so if others would willingly lap up these securities?

(3)  Lastly, would rates be this low if the Bernanke Fed deemed it unnecessary to make purchases on this scale?

The upshot is that they are intervening so heavily because they know the market, left to its devices, will not likely depress Treasury yields to a similar extent. The market-clearing price is, in all likelihood, significantly higher. The unprecedented expansion of public debt is thus matched by the unprecedented gaming of the market for these securities. The corollary to unparalleled indebtedness is unparalleled subvention of market forces. There's no need for Obama's pastor to damn America in speech when you have monetary authorities doing so in deed. The latter is certainly worse.

I guess the joke's on you, factually challenged America #1 cheerleaders, for nobody's quite as interested in your dollar-denominated detritus than yourselves. On my part and the rest of us who don't support your folly, you're more than welcome to it.

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Yanks Never Learn: US Imports Hit Record High

This has to be the most ridiculous story I've seen all week long. One that once again demonstrates that you don't have to go much further than the Yahoo! News front page for IPE-relevant material. For all the hot air about "global rebalancing," the Yanks seem to be repeating the Bushite formula for Guaranteed Economic Disaster, with PIGs' pork seasoning for added flavouring to keep things current. We already know that after having run massive fiscal deficits which did not nothing other than make things ripe for a crisis, the US have upped the ante by running trillion dollar budget deficits for four straight years with no end in sight.

Others said, "well at least the current account deficit is getting under control." Which, unfortunately, is not really happening. The trouble with these people is that they do the same thing over and over again and expect different results. Just as a consumption binge was driving US "growth" in the run-up to the crisis, so we have another one going on now. The evidence is a return to skull-crushing external deficits to accompany the budgetary one. They don't call them twin deficits for nothing as US imports hit all-time highs:

The U.S. trade deficit widened more than expected in January as high oil prices and resurgent demand helped pushed imports to a record high, a Commerce Department report showed on Friday. The trade gap swelled more than 4 percent to $52.6 billion, the highest since October 2008. The department also raised its estimate of the December trade deficit to $50.4 billion, from its previous figure of $48.8 billion. Imports rose 2.1 percent to a record $233.4 billion. China accounted for a big share of the gain, with imports from that country rising 4.7 percent to $34.4 billion. 

For the chronologically-minded, the Reuters article reminds us of the last time the US began running these sorts of external deficits:

Goods imports reached the highest level since July 2008, just before the financial crisis caused world trade to plummet. Stronger U.S. demand also pushed imports of services, autos, capital goods and food, feeds and beverages to record highs. 

The overall point is this: the US economy has not really reoriented itself away from being consumption-driven. Although American exports are rising, they obviously aren't rising enough to offset runaway increases in consumption-driven importation.

Though I hate to make predictions, consider the situation at the moment Stateside to what it was right up to the breakout of the crisis when many economic commentators believed that things were just hunky-dory: Back then you had colossal budget and current account deficits plus a run-up in equity prices--record stock market index levels even--driven by money-for-nothing monetary policies. Add in other suspiciously good macroeconomic figures such as that for employment. And at the present time we have...exactly the same sorts of things.

Everything old is new again. Indeed, some people never learn. Another walloping of the US economy looks like it's in the offing, and it would be interesting to see the aftermath if it happens before the 2012 presidential elections. Yet sooner or later the US will pay a well-deserved price for its renewed prodigality--unless you're of the free lunch persuasion, of course.

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Attn Deficit Lovers: Why China Should Rule World

Balancing one's budget is the most fundamental money management task one faces. If there's eomething that so graphically illustrates Western decline, it is the inability to do anything other than run up massive debts that are a burden on future generations, all the while spouting all sorts of utterly contemptible free lunch stories of the "deficits don't matter" variety. Who knows? Maybe it's in the American genes.

With that in mind, it's heartening to hear that Hong Kong is having an old lady in a shoe-type problem when it comes to government finances. It has so many revenues it doesn't know what to do. Let's just say success begets success instead of the other way around. In contrast to various Western wasteleands alike the Washington wonderless-land, it's running out of ideas about how to redistribute a bountiful largesse. A fiscal surplus; what a concept:

The United States is shrinking its military and debating whether to cut social spending, raise taxes or both. European governments from Greece to Ireland are struggling to maintain payments to the unemployed and retirees. Japan is borrowing heavily to pay for earthquake reconstruction and care for a graying population.

And then there is Hong Kong.

Financial Secretary John Tsang announced a budget for the coming fiscal year that cuts income taxes, corporate taxes and real estate taxes. Household electricity bills will be subsidized, and people living in public housing will receive two months’ free rent.

Education spending will jump 7 percent. Senior citizens will receive an extra month’s pension payment; government hospitals will expand; and 10 billion Hong Kong dollars, or $1.29 billion, will be put in a special fund to help the needy buy medicine.

Perhaps most impressive, the budget is forecast to be roughly in balance – and Hong Kong’s budget forecasters have a reputation for consistently underestimating surpluses. The city, an autonomous region of China ever since Britain handed it back in 1997, has accumulated a rainy-day fund equal to more than a year and a half of government spending.

Hong Kong is running another large budget surplus for the current year, which ends on March 31, despite giving 6,000 dollars to each adult permanent resident. Economists attribute the bonanza to a series of factors: tight limits on senior citizen spending, no military spending and an economy that grew 5 percent last year, mostly because Hong Kong has cashed in on China’s economic boom.

Reuters has more on the specifics. It begs the question: Given the influence of Westerners at international financial institutions alike development agencies, what right do they have to teach LDCs about running a country? No one except the most imperceptive Yankee dolt would champion their nation spilling endless amounts of red ink as a global exemplar. No one respects a bankrupt since a bankrupt lacks self-respect by getting into such dire financial straits to begin with.

As a student of political economy, I humbly suggest that closer attention be paid to the China's example. Cheneynomic apologists aside, their money-management skills look far superior to those of their Western counterparts who still believe in the white man's burden via their laughable freedom 'n' growth shtick.

To paraphrase our very own Martin Jacques, what exactly is there to fear When China Rules the World compared to today's example of assorted Western spendthrifts and prodigals? It's a no-brainer. With which will you gain more spillover effects and positive externalities? Take your pick--do you want to be Atlanta or Hong Kong? Having something of a brain left, I'll go for the latter, thank you very much.

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Should US Borrow More Given Treasury 'Demand'?

To make a long story short, the answer to the post title is "no" contrary to what some IPE and economist types believe [1, 2]. At worst it is financially ruinous to do so and at best it is a very parochial assertion that there is limitless demand for US Treasuries out there. For, not only are there countries with significantly lower borrowing costs than the US, but they also have strong currencies that indicate continuing demand for assets denominated in their currencies unlike the slumping dollar which is near all-time lows on any number of indices. Those who think of the US as a "safe haven" obviously paint a very partial picture. Treasuries are just one asset class among many $ denominated assets. Foreigners also need to exchange their monies into dollars to invest in Treasuries.

Switzerland, Hong Kong, Sweden and Singapore that have both lower borrowing costs and currencies that actually hold their value unlike that of a certain North American nation do not take it as a signal to run up their debts as a "global public good." Even the most disingenuous American politician isn't mad enough to say "we're doing the world a service by running massive deficits."

This being an international political economy blog not a domestic economics blog spewing out Amerocentric regurgitations, I hold myself to a higher standard of looking at others' performance in issuing sovereign debt. Even the most cursory glance reveals their story does not hold up. Moreover, it goes unexplained in their version of events in which the world is flocking to American Treasuries how the currency that it's denominated in is slumping. It is simply not good social science to cherry-pick cases (limit yourself to n=1 America) or completely ignore the fact that foreigners would first have to change their currencies to that which your sovereign debt is denominated in. A more holistic picture suggests this simplistic low yields = limitless Treasury demand story is unwarranted.

On the other hand, an empirically verifiable and non-contradictory assertion is that the frequency of financial crises has increased ever since Richard Nixon dealt away with the dollar-gold standard in 1971. In other words, when the US no longer had its debt issuance levels constrained by the Bretton Woods system, we've had more instead of fewer financial crises. (The linked paper does not suggest their severity has increased, but remember that it was written prior to 2008/09--I'll give the benefit of the doubt to be charitable.) From this point of view, it is perverse that some call for unlimited American bond issuance if the goal is to stabilize the world economy since America being freed from such reins coincides with our, ahem, age of turbulence.

To properly apply the thinking behind Kindleberger's hegemonic stability theory, the current period when the US has been either unwilling or unable to keep the dollar-gold standard intact is marked by more frequent incidences of financial crises. There is no hegemon out there "stabilizing" anything, least of all itself. Moreover, a stable system of exchange rates was one of the things the hegemon was supposed to provide according to Kindleberger, not the mishmash of freely floating ones we have today.

A more cogent, logically defensible argument is that the dollar is now a liability to the international monetary system rather than an asset. Has the US channelled its resulting capital account surpluses in productive ways? I do not think it's far fetched to answer in the negative after the subprime crisis. Did the chances of a European crisis occurring increase in the aftermath of the US subprime mess? I do not think it's far-fetched to answer in the affirmative. Trouble in core Western nations is more suggestive of systemic breakdown than systemic assurance.

But deficits don't matter since interest rates are so low, right? Go buy Dick Cheney's autobiography if it maximizes your utility, but I for one prefer social science to Cheneynomics.

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