EconoMonitor

Nouriel Roubini's Global EconoMonitor

Wednesday Note: S&P Outlook Downgrade Reminds Washington to Do the Right Thing

S&P’s decision to cut its outlook for U.S. government debt from stable to negative—a historic first—sent markets tumbling: On April 18, the Dow Jones Industrial Average and the S&P 500 both recorded their biggest one-day drops in nearly a month (though U.S. Treasurys and the dollar did well). The landmark outlook downgrade reinforces what we have been saying since 2010: The United States is on an unsustainable fiscal path from which it cannot exit without political consensus. The key question is whether the gridlocked U.S. political system can respond in time to avert a bond market revolt.

The rise in public debt following a financial crisis is one of the main mechanisms by which a recovery may be supported in the short term. Typically, this happens via Keynesian consumption-smoothing across economies and income generation through the state’s redistribution of resources between economic sectors, financed by borrowing against future revenues and growth. But the flip side of this short-term recovery may be reduced post-recovery potential and actual growth: The larger public debt portends a future rise in taxes on wealth and/or income, which in turn weighs on growth and thereby on fiscal balance.

Since the precrisis leveraged asset bubble induced above-equilibrium public revenue, corporate profits and household income, wealth and spending, it is logical to expect a general reduction in net wealth, including a rise in net public debt. The capacity of the financial markets and the state to tolerate and manage that rising debt burden or adjust fiscally or structurally to reduce it will be the key to whether the markets buy the fiscal liabilities or sell them en masse.

A bond market revolt is not at all easy to engineer in the United States. There is no safer asset destination on the planet than the United States, which has the third-longest-running system of government in the world, despite being a young nation. Almost no other country’s structure of state—and hence property rights—have survived world and local wars (including defeats), economic depressions and financial and fiscal crises without major dislocations and arbitrary redistributions of wealth through inflation or more direct expropriation. The knee-jerk risk-off wave may well pass as people begin to recognize that this rating move will make little if any difference—and may even improve debt dynamics by cutting bond yields if risk-off persists. Unlike other debtor countries, the United States actually benefits from risk aversion, even domestic risk aversion, through a stronger dollar and lower bond yields, so the market impact will likely be transitory.

The United States has the most manageable fiscal issues of any major advanced economy because federal, state and local revenues as a share of GDP are very low, for cyclical and other reasons. Therefore, fiscal balance can be restored by fiscal adjustment without major economic difficulty in the near term. In the longer term, structural fiscal reform will be needed due to rising Social Security commitments. For the United States, debt sustainability is a function of political constraints. The political center has fractured as a result of the financial crisis, and healing it requires a consensus about the desired size of the state: Should the government bear the low level of responsibility of its 18-19th century libertarian predecessors or should it share the 20th century New Deal or Great Society vision of America?

The current shortage of consensus in Washington about the right balance between public and private responsibilities suggests no real action will be taken to address structural budget issues until at least after the 2013 presidential elections. On the other hand, there are now four potential plans to foster debate in Congress that would reduce the deficit by US$4-5 trillion over the next decade: the original Simpson-Bowles bipartisan proposal, the Republicans’ “Ryan Plan,” President Barack Obama’s new proposal and the impending “Gang of Six” proposal that potentially could have the most bipartisan appeal. So while formal progress will not be made until 2013, an agreement in principle that something will be done by 2013 could coalesce between 2011 and 2012.

18 Responses to “Wednesday Note: S&P Outlook Downgrade Reminds Washington to Do the Right Thing”

exercise logJune 12th, 2011 at 5:32 pm

I just couldn’t depart your site before suggesting that I really enjoyed the standard info a person provide for your visitors? Is going to be back often in order to check up on new posts

sandiego real estateJune 16th, 2011 at 11:55 am

Terrific job right here. I definitely enjoyed what you had to say. Keep going because you surely bring a new voice to this topic. Not many people would say what youve said and still make it interesting. Properly, at least Im interested. Cant wait to see far more of this from you.

Hilton ChallengerJune 16th, 2011 at 12:21 pm

To be a effective nursing assistant, an individual have to be a group individual who’s in a position obtain orders properly. They should moreover be emotionally secure and have absolutely a wonderful package of tolerance.

dog holidaysJune 16th, 2011 at 2:05 pm

I’ve learned new things through your blog post. One more thing to I have observed is that usually, FSBO sellers will probably reject you. Remember, they can prefer never to use your providers. But if an individual maintain a stable, professional partnership, offering support and staying in contact for about four to five weeks, you will usually be able to win interviews. From there, a listing follows. Thanks

approach a group of girlsJune 16th, 2011 at 5:44 pm

Congratulations on possessing actually considered one of one of the crucial refined blogs Ive arrive throughout in a while! Its simply amazing how a lot you’ll be capable to contemplate away from a thing basically simply due to how visually gorgeous it is. You’ve place collectively a fantastic blog web site house –great graphics, films, layout. That is certainly a must-see website!

Biuro Podróży GdyniaJune 16th, 2011 at 9:55 pm

Can I just say what a aid to seek out somebody who really knows what theyre talking about on the internet. You undoubtedly know how one can convey a problem to gentle and make it important. More people need to learn this and understand this aspect of the story. I cant consider youre not more common since you positively have the gift.

astoria hondaJune 17th, 2011 at 11:50 am

Hey – good weblog, just looking around some blogs, appears a pretty good platform you’re using. I’m presently utilizing WordPress for a few of my web sites but looking to change 1 of them over to a platform similar to yours as a trial run. Anything in particular you’d recommend about it?

coffee machineJune 17th, 2011 at 1:27 pm

I’m happy I found this weblog, I couldnt find any information on this subject matter prior to. I also run a site and if you want to ever serious in a little bit of guest writing for me if feasible feel free to let me know, i’m always appear for people to test out my site. Please stop by and leave a comment sometime!

canberra law firmJune 17th, 2011 at 1:37 pm

Good job right here. I genuinely enjoyed what you had to say. Keep going because you absolutely bring a new voice to this subject. Not many people would say what youve said and still make it interesting. Well, at least Im interested. Cant wait to see additional of this from you.

Marion HuttenJune 17th, 2011 at 3:08 pm

I wished to thank you for this nice read!! I positively having fun with every little little bit of it I’ve you bookmarked to check out new stuff you post

h1n1 fluJune 17th, 2011 at 6:16 pm

You may have simply been diagnosed with prostate cancer malignancy and don’t know what to do; the first thing to complete is don’t panic.