The European Union retains its AAA rating from S&P for now but Member EU States can Change That

Posted by PITHOCRATES - January 21st, 2012

Week in Review

Things may be bad for some individual members of the European Union (EU) but the EU as a whole is doing all right according to S&P (see S&P Affirms The European Union’s AAA Rating, Outlook Negative by Sam Ro posted 1/20/2012 on Business Insider).

S&P just affirmed the European Union’s AAA rating.  However, the outlook is negative.

This comes a week after S&P downgraded nine eurozone countries, including France and Austria.

And directly from the S&P press release.

The outlook is negative, in part reflecting the negative outlooks on 16 of the 27 member states of the EU…

During 2011, eurozone member states accounted for 62% of the EU’s total budgeted revenues; budgeted revenues from Germany and France were 30% of total EU revenues, at 16% and 14%, respectively. On Jan. 13, 2012, we lowered the ‘AAA’ long-term sovereign credit rating on France and Austria by one notch to ‘AA+’, and affirmed the long-term rating on Germany at ‘AAA’. As a consequence of the Jan. 13 downgrades, the pool of ‘AAA’ member states contributing to the EU’s revenues has declined to 33% of 2011 budgeted revenues, from 49%. Nevertheless, in our opinion, the supranational entity known as the EU benefits from multiple layers of debt-service protection sufficient to offset the current deterioration we see in member states’ creditworthiness. We are therefore affirming the long- and short-term issuer credit ratings on the EU at ‘AAA/A-1+’.

So everything is hunky-dory.  As long as France and Germany don’t go broke trying to bail out the Euro.  And with the Greek problem about to be resolved by screwing the private bondholders out of 70% of their investment the Eurozone should be right as rain.  As should the EU.

Of course, there are still more than half of the member EU states sucking air.  That could be a problem.  But why worry about that now when we can worry about that later?

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Standard & Poor lowers the Credit Rating for Nine European Countries

Posted by PITHOCRATES - January 15th, 2012

Week in Review

Interest rates are subject to the laws of supply and demand.  The more questionable a borrower looks to be able to repay the loan the higher the interest rate.  Because there is a low supply of people willing to loan to such risky borrowers.  So they have to offer higher rates to get people to take a greater risk.

When S&P took away America’s AAA rating this did not happen, though.  Not because America was immune to the laws of supply and demand in the bond market.  But because Europe had even bigger problems.  And they just got worse (see S&P cuts credit ratings for France, Italy, Spain by JAMEY KEATEN posted 1/14/2012 on Yahoo! News).

Standard & Poor’s swept the debt-ridden European continent with punishing credit downgrades Friday, stripping France of its coveted AAA status and dropping Italy even lower. Germany retained its top-notch rating, but Portugal’s debt was consigned to junk.

In all, S&P, which took away the United States’ AAA rating last summer, lowered the ratings of nine countries, complicating Europe’s efforts to find a way out of a debt crisis that still threatens to cause worldwide economic harm.

Austria also lost its AAA status, Italy and Spain fell by two notches, and S&P also cut ratings on Malta, Cyprus, Slovakia and Slovenia.

Some are arguing that this won’t impact the Eurozone bailout.  Because of the austerity measures the troubled countries have taken.  But it doesn’t help.  It just pushes the final resolution of the Eurozone debt crisis further out.  And probably makes it more unpleasant.

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Insufficient Spending Cuts triggers S&P Downgrade, not Insufficient Taxes

Posted by PITHOCRATES - August 6th, 2011

Ah, the Good Old Days when Communists didn’t school Americans in Capitalism

It happened.  S&P downgraded the U.S.  Just like they said they would if we didn’t make $4 trillion in spending cuts.  And our patron is not pleased (see China attacks US debt ‘addiction’ after America loses AAA credit rating by Richard Blackden posted 8/6/2011 on The Telegraph).

“The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” China said in a commentary carried by the Xinhua News Agency.

Ouch.  Strong words from a communist.  The Soviet Union never gave us lessons in capitalism when there was a Soviet Union.  Then again, we always had a AAA bond rating back then.  And their GDP growth wasn’t greater than ours.  Ah, the good old days.  When communists didn’t school Americans in capitalism.

Vince Cable, the British Business Secretary, said the downgrade was an “entirely predictable consequence of the mess that the Congress created a few weeks ago when they couldn’t agree on lifting the debt ceiling.”

Francois Baroin, France’s finance minister, said his country had total confidence in the US economy, while India called the “situation was grave” and Russia said it would keep the level of dollar investments in its national reserve funds, adding: “There is not a great difference between AAA and AA+.”

Those are some very supportive words from the Russians.  Which differ slightly from previous remarks when Putin said, “They are living like parasites off the global economy and their monopoly of the dollar.”  It’s subtle but it’s there.  On the one hand the downgrade is no big deal.  On the other we’re the scum of the earth.  It’s subtle but there is a distinct difference in these statements.  They resent us.  But they can’t live without us.  Kind of sweet.  In a bitter way.

In an explanation of the decision, S&P said that despite last week’s agreement, which raised the $14.3trillion debt ceiling and promised cuts of $2.5 trillion to the deficit over the next decade, the ratio of America’s public debt to the size of its economy may climb to 79pc in 2015 and 85pc by 2021. It is understood that an agreement that had delivered a $4 trillion reduction in the debt pile would have preserved the AAA rating.

S&P downgraded us, of course, for having too much debt.  Now debt grows from having annual deficits.  And deficits are caused by either taxing too little.  Or by spending too much.  S&P wanted to see the debt reduced by $4 trillion.  They only got $2.5 trillion.  Hence the downgrade. 

You can’t Reduce the Debt $4 Trillion by Raising Taxes, at least not Mathematically

Reducing the debt by $4 trillion won’t be easy.  That’s a lot of money.  About $333 billion each month.  Current tax revenue into Washington is about $200 billion each month.  So, to get this $4 trillion in deficit reduction with new taxes only would require raising monthly tax revenue from $200 billion to $533 billion (an increase of 166%).  Increasing taxes by 166% (income taxes, payroll taxes, capital gains taxes, etc.) is going to do some devastating economic damage.  The kind the economy is not going to get up and walk away from.  So it’s a non-solution.

But what about a balanced approach?  In addition to that $2.5 trillion in cuts we throw in $1.5 trillion in new taxes for a total $4 trillion in debt reduction.  $1.5 trillion is about $125 billion each month.  This would increase monthly tax revenue from $200 billion to $325 billion (an increase of 65%).  This will also do some serious economic damage.  So it’s a non-solution, too.

And sticking it to the ‘rich’ won’t work either.  For they can’t afford it.  Let’s look at the numbers.  The total adjusted gross income reported in 2009 was $7.626 trillion.  The percent of that total earned by the top 5% earners (earning $159,619 or more) is 31%.  So the total income of the top 5% in 2009 is $2.36 trillion.  Total federal income taxes paid in 2009 was $1.05 trillion.  The top 5% of earners pay 59% of all federal income taxes.  So the total they paid in income taxes in 2009 is $570 billion.  This leaves a balance of $1.79 trillion of their earnings they didn’t pay in federal income taxes, or about $150 billion each month.  Which is not enough to pay an additional $333 billion each month.  But it is enough to pay an additional $125 billion each month.  As long as these people are willing to pay an effective federal income tax rate of 87.6%.  Which I doubt.  For another 12.4% in taxes (state, country, local, property, gas, sales, etc.) and they’re working for free.  Like a slave.  Only without the free room and board.

You can’t reduce the debt enough by raising taxes a lot.  Or a little.  The rich people (those earning $159,619 or more) will run out of earnings before they can pay the $4 trillion in debt reduction.  It’s just mathematically impossible.  The only way you can do this is by cutting spending.  And they didn’t.  Hence the downgrade.

Paul Krugman ‘defends’ Ronald Reagan’s and George W. Bush’s Deficits

Meanwhile, while the S&P tragedy unfolds, Paul Krugman ‘defends’ Ronald Reagan‘s and George W. Bush‘s deficits.  Saying that big deficits aren’t a big deal.  And we don’t have to knock ourselves out trying to pay down the debt they create.  For depreciation of the dollar makes those once large numbers become trivial (see The Arithmetic of Near-term Deficits and Debt by Paul Krugman posted 8/6/2011 on The New York Times).

What matters for debt sustainability is the real interest rate, since what matters is keeping real debt, not nominal debt, from growing. (World War II debt never got paid off, it just eroded in real terms to the point where it was trivial). As of yesterday, the US government could lock in 30-year bonds at a real interest rate of 1.25%. That means that a trillion dollars in extra debt would mean $12.5 billion a year in additional real interest payments.

Meanwhile, the CBO estimates potential real GDP in 2021 at about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars.

Put these together, and they say that an extra trillion in borrowing adds something like 0.07% of GDP in future debt service costs. Yes, that zero belongs there. The $4 trillion S&P said it needed to see clocks in at less than 0.3% of GDP.

Of course I’m extrapolating his remarks to apply them to the Reagan and Bush deficits.  For if they hold for a $1.6 trillion dollar deficit then they surely hold for a $200 billion (Reagan) and a $400 billion deficit (Bush).  The key is to make that old debt worth less by making the dollar worth less.  The more you devalue the dollar the less that debt held by the Chinese is worth.  As well as the debt held by pension funds and retirement accounts.  And our personal savings.  For inflation is a killer of dollar-denominated assets.  Which is good for the debtor (the seller of treasuries).  But bad for the creditor (the buyer of treasuries).

Further extrapolating Krugman’s remarks one must conclude that with the deficit being trivial he would endorse the economic boom of the Eighties.  And agree that Reaganomics was a success.  For the argument has always been that Reaganomics traded exceptional GDP growth for deficits.  But with deficits being trivial, there is no tradeoff for that exceptional GDP growth.

To Live within our Means we will have to Cut Spending 

True, inflation will make bonds easier to redeem 30 years later.  But too much inflation causes a lot of damage.  Especially to those living on fixed incomes.  No, a better solution would be to live within our means.  And that doesn’t mean raising taxes.  Besides, the rich don’t have much left to give.  No, if we’re going to live within our means we will have to cut spending.  As painful as that may be.  And the longer we wait to make those cuts the more painful those cuts will be.

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