MacroScope

from Paul Smalera:

Downgrading democracy

By Paul Smalera
All views expressed are his own.

The Washington debt ceiling debate over these past months was the throwing open of the doors to the democratic slaughterhouse -- let’s please not ever complain again about not being able to watch the sausage get made. Though our media window onto the killing floor surely contributed to the S&P’s downgrade of U.S. debt, that’s not an entirely bad thing, as I’ll explain in a moment.

The preemptive downgrade of U.S. debt breaks a disturbing ratings agency pattern: Too-late downgrades from S&P and the other ratings agencies in the cases of Bear Stearns, Lehman Brothers, AIG, Greece and Ireland among many others. In the econoblogosphere, reliably hind-sighted ratings-agency downgrades, whether of sovereign debt or a teetering company’s bonds, have come to be something of a dark joke. It’s overdue that S&P got itself back into predictive rather than reactive mode. Yet the company’s sovereign debt committee surely chose the wrong target in U.S. Treasuries and broke the late-downgrade pattern for all the wrong reasons.

The ratings agency’s decision reads like nothing other than a fit of pique towards the government institutions and American people that had come to blame it as a prime enabler of the global financial crisis. The agencies, as my colleague Christopher Whalen just wrote, “prostituted themselves and their special position of trust with respect to mortgage-backed securities and exotic derivatives.” To get a little more anatomical, executives at the ratings agencies churned out AAA ratings on CDOs and other risky debt -- debt that their analysis should have shown to be junk-bond quality at best -- because they risked losing business if they were too critical. (Call it the, “every John is the best lover ever” theory of credit rating.)

The S&P’s biggest blunder here is that the U.S., thanks to the debt deal everyone hates, will continue never missing a debt payment. A close second is that even if the U.S. had run out of borrowing power, Timothy Geithner and the Treasury Department surely had a “Plan B” that would’ve prioritized debt payments to avoid a default, probably for at least a few more months before its cash-on-hand situation became truly dire.

But the real reason the S&P was wrong to downgrade the U.S. is because what we all just witnessed in D.C. was, as the famous quote goes, the sausage being made. It was an open, democratic process. The Tea Party Republicans who blocked more moderate debt ceiling legislation are duly-elected representatives who were fighting hard for their constituents and beliefs, however radical. It may frustrate moderate or liberal voters to no end that Tea Party governance appears to be little more than obstruction, but that’s been the prerogative of minorities in divided governments for centuries. In the end, as analysts conceded, they were brutally effective in swaying the Obama administration and Senate Democrats much closer to their preferred, fiscally constrictive debt ceiling deal. Since when are political compromises supposed to be pretty?

from The Great Debate:

The S&P downgrade: is the sky falling?

By Mark Thoma
The opinions expressed are his own. Paul Krugman on the S&P downgrade:

S&P and the USA, by Paul Krugman: OK, so Standard and Poors has gone ahead with the threatened downgrade. It’s a strange situation.

On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

from The Great Debate:

Can China afford to downgrade the U.S.?

By Joseph S. Nye, Jr.
The opinions expressed are his own.

After the rating agency Standard & Poor’s downgraded America’s long-term debt, China said that Washington needed to “cure its addiction to debts” and “live within its means.” It must have been a delicious moment in Beijing, accustomed over the years to lectures from Washington about its management of the yuan.

But actions speak louder than words. The real test will be whether China moves away from the dollar in any significant manner. While it makes modest adjustments to its reserve holdings, there are few good alternatives to the dollar. And while it calls for an international basket of currencies to replace the dollar, there are few takers. Of course, China might move toward opening its currency and credit markets in an effort to make the yuan a reserve currency, but the authoritarian political system is unwilling and unprepared to move to that degree of economic freedom.

Many commentators see the downgrading of American debt as a great shift in the global balance of power between the U.S. and China. Some wags have warned the American navy not to sail too close to China, because if the Chinese captured our ships, we would no longer have enough money to ransom them. But such jokes misunderstand the nature of power. Analysts point to China’s seemingly unstoppable growth and its holdings of United States dollars. But as I show in my latest book, The Future of Power, they fail to take into account the role of symmetry in interdependence in creating and limiting economic power. If I depend on you more than you depend on me, you have power. But if we both depend equally upon each other, there is little power in the relationship.