Scott Powell: Year after debt downgrade, U.S. in worse shape

America’s fiscal condition has worsened due to debt that’s been growing much faster than the economy Original Article

A year ago this month, Standard and Poor’s fired a shot across America’s bow, downgrading the nation’s coveted AAA rating to a AA-plus. S&P’s rationale for the cut was that Congress’s Budget Control Act “fell short of the amount … necessary to stabilize the general government debt burden by the middle of the decade.”

For several weeks, media pundits and Washington policy-makers were jolted out of denial about the assumption that deficit spending could continue in the same trajectory. Congress formed the Joint Select Committee on Deficit Reduction – aka the Supercomittee – as part of the Budget Control Act. Its mandate was to make recommendations within three months to reduce federal expenditures over 10 years by at least an additional $1.5 trillion on top of the $917 billion already agreed to – for a total reduction of $2.4 trillion.

Three months passed without agreement by the Supercommittee on any spending cuts. The sense of urgency dissipated, and an historic opportunity to bring measurable and real discipline to spending was lost. Meanwhile, the federal government entered its fourth-straight year projecting a $1.25 trillion deficit without a plan or a budget. In the preceding three years of the Obama administration, the annual deficit averaged $1.34 trillion. Previously, in any single year in U.S. history, the worst deficit had been $459 billion.

Looking back, when Barack Obama took office in January 2009, total U.S. government debt stood at about $10 trillion. Since then, more than $5.5 trillion has been added to the national debt, which is about to hit $16 trillion. This out-of-control spending and debt is the primary reason why all three credit rating agencies, Moody’s, Fitch and S&P, have negative outlooks on U.S. government debt, all but assuring further rating downgrades in the near future.

If credit rating downgrades are too abstract, the riots and economic near-collapse in Greece, Spain and elsewhere in the eurozone should have infused Washington with a sense of urgency to undertake structural reform of taxes and entitlements and make deeper cuts in government spending. Postponing the day of reckoning on deficit spending doesn’t just kick the can down the road. It brings us closer to the next financial crisis – a collapse in the government bond market – which would bring chaos to the streets and make the 2008 economic crisis look like a cakewalk.

In fact, a debt-driven collapse of the U.S is closer than most Americans realize. Consider what has happened in Spain and Italy, respectively, the world’s 12th- and eighth-largest economies. Just ten months ago Spain and Italy carried AA ratings, but today their debt ratings have plummeted to near-junk levels, at Baa3 and Baa2, respectively, driving their 10-year bond yields above 6 percent.

Since the deficit-to-GDP ratio of the United States is worse than that of Spain and Italy, higher funding costs for U.S. debt may come sooner than Fed Chairman Ben Bernanke forecasts. Recession or war would further blow out the deficit and accelerate debt rating downgrades. Either crisis could cause U.S. debt service costs to sharply rise and potentially trigger a downward spiral ending in a failed U.S. Treasury auction and a subsequent liquidity crisis. As happened in Greece and more recently in Spain, the U.S. could face funding shortfalls only solved by money printing, which would likely trigger unacceptable inflation.

An anticipated third round of quantitative easing by the Fed is really no more than a fancy term for money printing, which only papers over our fiscal problems while doing little to help the real economy. The Fed has shot all its bullets, having lowered federal funds interest rates to zero and twisting long bond rates to record lows. Money printing and inflation are about all that’s left in the Fed’s toolkit.

Sadly, things are worse today than they were a year ago when the U.S. lost its AAA rating from S&P. The national debt has grown by nearly 11 percent while the economy has grown by only 2 percent. And over the past four years of various government spending programs, debt has grown by 60 percent while GDP has grown 7.7 percent. So much for the benefits of Keynesian stimulus. Washington’s policies have left the country without shock absorbers or an effective insurance policy to counter another crisis.

But that is why we have elections. Americans likely to vote are better informed, and polls show they are more inclined than ever to send statesmen of new conviction to Washington. Clearly we need new leadership and a majority in both houses of Congress who have experience in creating private sector jobs and who have the courage and commitment to get our nation’s fiscal house on a sustainable path.

Scott S. Powell

Senior Fellow, Center on Wealth and Poverty
Scott Powell has enjoyed a career split between theory and practice with over 25 years of experience as an entrepreneur and rainmaker in several industries. He joins the Discovery Institute after having been a fellow at Stanford’s Hoover Institution for six years and serving as a managing partner at a consulting firm, RemingtonRand. His research and writing has resulted in over 250 published articles on economics, business and regulation. Scott Powell graduated from the University of Chicago with honors (B.A. and M.A.) and received his Ph.D. in political and economic theory from Boston University in 1987, writing his dissertation on the determinants of entrepreneurial activity and economic growth.