Deficit hawks more harmful to economy than deficits

[drkitten]

From the AP Newswire (http://hosted.ap.org/dynamic/stories/E/EU_SPAIN_CREDIT_RATING?SITE=OKPON&SECTION=HOME&TEMPLATE=DEFAULT):


LONDON (AP) -- Fitch Ratings cut Spain's credit rating on Friday, saying the government's efforts to reduce debt will weigh on economic growth in coming months.

The ratings agency cut the country's rating one notch from AAA to AA plus, saying Zapatero's efforts to close the budget deficit "will materially reduce the rate of growth of the Spanish economy over the medium term."

The ratings agency decision echoes concerns from economists that efforts to cut state debt will also withdraw stimulus from the economy and hinder growth. Lower growth in turn means gathering less in tax revenues.


Hmm... Stimulus packages and deficits are bad, and austerity is good, which is why Spain's ratings are cut, huh?

From a related story (http://hosted.ap.org/dynamic/stories/U/US_WALL_STREET?SITE=OKPON&SECTION=HOME&TEMPLATE=DEFAULT):

Stocks closed out their worst month in more than a year by sliding again on more unsettling news about Europe.

The Dow Jones industrials were down by about 125 points Friday after Spain suffered the second downgrade of its credit rating in a month.

Apparently the markets also disagree with the deficit hawks and think that crippling economies to stave off the non-existent threat of inflation is a bad idea.

But I'm sure there will be some deficit hawk out there in JREF-land who will be happy to explain that destroying wealth via false austerity is actually a good thing....

[Ziggurat]

Hmm... Stimulus packages and deficits are bad, and austerity is good, which is why Spain's ratings are cut, huh?

Fitch ratings... where have I heard of them before?
Oh... (http://www.telegraph.co.uk/finance/economics/6969163/US-must-cut-spending-to-save-AAA-rating-warns-Fitch.html)

[Malerin]

Sunlight is the best disenfectant when it comes to Doc's duplicitous blathering, so I'm posting Ziggurat's embedded link:

"Fitch Ratings has issued the starkest warning to date that the US will lose its AAA credit rating unless acts to bring the budget deficit under control, citing a spiral in debt service costs and dependence on foreign lenders."

...

"Mr Coulton said the US is vulnerable to "potential interest rate shocks" due to its reliance on short-term debt and foreign investors."

...

"Stephen Lewis, of Monument Securities, said a US downgrade would rip the anchor from the global system and pose a grave risk to the stability."

http://www.telegraph.co.uk/finance/economics/6969163/US-must-cut-spending-to-save-AAA-rating-warns-Fitch.html

How's that petard feel, Doc? :)

[drkitten]

How's that petard feel, Doc? :)

I don't know. You tell me -- you're the one hoist by it.

What's the current credit rating of the United States, the country that's not trying particularly hard to reduce the deficit?

What's the current credit rating of Spain, the country that is following your advice to the letter, and just got cut for it?

[Cyanotic Wasp]

This is my first post here, so I don't want to step on toes unduly or reply with insufficient thought or facts, and I know nothing at all about Fitch ratings, but ...

It seems to me from our recent history in the US with ratings agencies that their downgrading of national credit ratings generally occurs after the crash is pretty well underway. Isn't that pretty typical elsewhere?

It's somewhat analogous to running a high-speed auto race in wet or questionable weather until one or more of the cars wrecks ... and then waving the yellow "Caution" flag.

Aside from that analogy, how does downgrading a country's credit rating "hurt the economy"? (I agree that it makes credit harder to obtain and expansion more difficult than it would have been absent the bad rating, but ... how much of your economy do you want the government to be responsible for, anyway, if they're running increasing larger deficits and doing nothing about that?) Again, it seems to me that a government's continued apathy toward debt and deficit spending is harmful to the economy regardless of what a rating agency does or does not do.

[drkitten]

It seems to me from our recent history in the US with ratings agencies that their downgrading of national credit ratings generally occurs after the crash is pretty well underway. Isn't that pretty typical elsewhere?

Yes, but they're also usually related to specific news events. The ratings agencies are usually pretty transparent about why they up- or down-grade something.

In this case, they are quite clear about exactly why they're downgrading Spain, and it's not because they are running an unsustainably large deficit. It's because the actions they're taking to reduce the deficit are ill-advised and will have (or more accurately, are expected to have) strongly negative effects going forward, which will materially impact their ability to pay back any new debt that they issue.

Basically, they think that Spain's efforts to reduce the current deficit have cut into their ability to raise money in the future, which in turn means that any new debt they issue will be undercapitalized.



Aside from that analogy, how does downgrading a country's credit rating "hurt the economy"? (I agree that it makes credit harder to obtain and expansion more difficult than it would have been absent the bad rating,

Well, you've just partially answered your own question. The downgrading isn't supposed to be punitive; it's supposed to accurately reflect the current state of affairs. The problem is that the current state of affairs has just gotten much worse, because the business climate in Spain has just gotten substantially worse because recent policy changes have make it much less likely that the Spanish economy will see high growth. This, in turn, makes it much less likely that anyone will be investing in "the Spanish economy" generally, which is much larger than just Spanish sovereign debt.

E.g., let's suppose you wanted to open a branch office somewhere in Europe to sell your widgets? Would you rather put it in a high-growth country where there is expected to be a lot of disposable income, or a low-growth one where none of the locals will buy your stuff?

If you picked "high growth," then Fitch has just told you not to build in Spain, which will mean there are a lot of Spaniards who aren't going to be working for you....

Again, it seems to me that a government's continued apathy toward debt and deficit spending is harmful to the economy regardless of what a rating agency does or does not do.

Well, let me turn it around. Why do you think Fitch downgraded the Spanish bonds? They didn't downgrade Spain because they think Spain is doing the right thing with respect to debt and deficit spending.

The basic problem is that you typically have to spend money to make money. A farmer who decides to save money this spring by not buying and planting seeds is not acting in his own long-term interest, no matter how much in debt he is. A tech company that cuts its R&D department to save on costs is not going to be in business much longer.

And a government that allows itself to get caught in a liquidity trap (or worse, a deflationary spiral) is also not acting in its own long-term best interests, or the long-term interests of its citizens.

[Malerin]

This is my first post here, so I don't want to step on toes unduly or reply with insufficient thought or facts, and I know nothing at all about Fitch ratings, but ...

Spain's belt-tightening measures are going to be harder on it than other countries, so they got dinged by Fitch. They were also downgraded by S&P about a month ago. Fitch has issued a warning to UK and USA that they must bring down their deficits or risk a similar downgrade.

It seems to me from our recent history in the US with ratings agencies that their downgrading of national credit ratings generally occurs after the crash is pretty well underway. Isn't that pretty typical elsewhere?

It's somewhat analogous to running a high-speed auto race in wet or questionable weather until one or more of the cars wrecks ... and then waving the yellow "Caution" flag.

Aside from that analogy, how does downgrading a country's credit rating "hurt the economy"? (I agree that it makes credit harder to obtain and expansion more difficult than it would have been absent the bad rating, but ... how much of your economy do you want the government to be responsible for, anyway, if they're running increasing larger deficits and doing nothing about that?) Again, it seems to me that a government's continued apathy toward debt and deficit spending is harmful to the economy regardless of what a rating agency does or does not do.

Spot on.

[kevinquinnyo]

[...]

And a government that allows itself to get caught in a liquidity trap (or worse, a deflationary spiral) is also not acting in its own long-term best interests, or the long-term interests of its citizens.

Remember pogs? If you don't, they were these little thin cardboard circles, slightly bigger than a dollar coin, and had an image, usually some sort of pop culture slogan like "Totally Radical" or they were branded with characters from kids' movies.

(I like to imagine they must have been the byproduct of some cardboard company after they punch holes in a sheet of cardboard for some other use, and somehow, someone made the cognitive leap to print jar jar binks on them and sell them to kids)

There was some sort of game that you could play with them, but mainly they were just little useless things for kids to collect.

Then one day, pogs became uncool. The new thing, for the next generation of kids was Pokemon cards.

As interest in pogs declined, the price level for pogs decreased, until they were completely unprofitable and obsolete.


Here's what I'm getting at. In your opinion, would deflationary spirals be feared in a country where there weren't fiat currency?

Or rather if competing currencies were allowed to coexist?

[drkitten]

Here's what I'm getting at. In your opinion, would deflationary spirals be feared in a country where there weren't fiat currency?

Or rather if competing currencies were allowed to coexist?

Yes, and yes.

In fact, they'd be worse. Because in a country with fiat currency, deflationary spirals can be fought by simply enlarging the money supply; once a deflationary spiral happened in a country without fiat currency, a deflationary spiral would be self-reinforcing and could only be broken through an unplanned external event.

I.e. suppose that, for whatever reason (a crop failure, for instance), the supply of some particular good became very tight, and prices rose dramatically as a result. The effect, absent fiat currency, would be that prices for all other goods would drop dramatically (because there's only so much money to go around, and if people need to pay twice as much for X, they can't pay as much for Y). Either they buy less of Y or pay less per unit, either of which makes Y less profitable to produce. The producers of Y start going out of business, which in turn means that fewer people are employed producing Y, which means that fewer people are earning money and spending it. This means that public confidence will drop.

Remember that the effective money supply is not simply the amount of pesos printed, but the amount of pesos in circulation; economists talk about the "velocity of money" to take this factor into account.

When public confidence drops (justifiably, because people are being laid off), people will stop spending as much money on everything. That's the well-publicized "paradox of thrift." Saving money [excessively] is good for the individual but bad for the economy as a whole. The velocity of money will drop, which means demand for everything (X now included) will start to drop.

Once demand starts to drop, we're into a vicious, self-reinforcing cycle. Why spend a thousand pesos for a widget today, when you can buy the same widget in two months for nine hundred? Even the people who have money and aren't afraid have a rational reason for deferring purchases. But a purchase deferred is income not received by the producer, which means that the producer has to drop prices even further and lay off more people.

Oh, and the saved money? No one can afford to lend it out or to borrow it. With money earning a real interest rate just sitting there in a cookie jar, why should a bank risk not being paid back by putting it into a potentially-failing business venture? Why should a business borrow money knowing that it will have to pay back in much more expensive money later?

So layoffs turn into lowered production which turns into reduced spending which turns into more layoffs.

Notice that I've not mentioned the type of currency at all in this. We could be dealing with pesos, dollars, cowrie shells, or a combination of all three. The point is that the value of money is going up as fewer people are willing to part with it.

A fiat currency can deal with this by injecting money into the economy. Indeed if any one of the currencies involved were a fiat currency (and the central bank pumped up the supply enough), that particular currency might continue to circulate (because it's being artificially watered down, so the value of that currency isn't increasing). The effect would be Gresham's law; the "bad" fiat currency would end up driving out the "good," because people wouldn't want to spend the commodity-based money but would want to get rid of the depreciating paper. (I've seen that effect in real life when I visited Turkey during a particularly hyperinflationary period; people were happy to give me lira for dollars/pounds, but not the other way around. Many of the stores I visited had multiple prices in multiple currency, but the only currency non-tourists used were the local lira, because those were the ones they wanted to get rid of.)

If none of the currencies can be inflated to break the cycle, what do you do then? The answer appears to be "nothing." Wait until some external force stimulates demand all by itself.

Basically, the problem is that deflation is typically both caused by and the cause of decreasing demand for goods. Demand for goods isn't denominated in any particular currency -- if I don't want to buy a refrigerator today because it will be cheaper in a month, it doesn't matter if I'm not-buying it in euros, dollars, pesos, or cowrie shells. A drop in demand reinforces and causes further drops in demand. That's what a deflationary spiral is. The easiest way to stimulate demand is to relax the money supply.... but of course that's exactly what you can't do with commodity money.

[MikeMangum]

Apparently the markets also disagree with the deficit hawks and think that crippling economies to stave off the non-existent threat of inflation is a bad idea.

But I'm sure there will be some deficit hawk out there in JREF-land who will be happy to explain that destroying wealth via false austerity is actually a good thing....

Right. Spain's credit rating is downgraded because of the results of debt. In other words, past deficits.

I'll just link the wiki about Stock and flow here.

[drkitten]

Right. Spain's credit rating is downgraded because of the results of debt. In other words, past deficits.

Except for the fact that that's exactly what Fitch denied.

Spain's debt levels are in-line with the expectations for AAA credit.

I quote, again, from the OP -- "Fitch Ratings cut Spain's credit rating on Friday, saying the government's efforts to reduce debt will weigh on economic growth in coming months.

The ratings agency cut the country's rating one notch from AAA to AA plus, saying Zapatero's efforts to close the budget deficit "will materially reduce the rate of growth of the Spanish economy over the medium term."

The ratings agency decision echoes concerns from economists that efforts to cut state debt will also withdraw stimulus from the economy and hinder growth. Lower growth in turn means gathering less in tax revenues."

Three times, they point out that the problem is not "debt," but the efforts that are being taken to reduce the debt.

The debt is not the problem, no matter how deficit hawks would like to make it so. The deficit is not the problem. Cutting the stimulus to reduce the deficit is the problem. "Efforts to cut state debt will also withdraw stimulus from the economy and hinder growth." Without growth, there won't be enough tax revenue coming in.

A farmer who tries to save money by not buying seeds is in trouble. Fitch recognizes this, as do the "economists" cited above. But apparently modern deficit hawks don't....

[JohnnyG]

The debt is not the problem, no matter how deficit hawks would like to make it so.

I'm not a deficit hawk, but I'm not buying the statement that the debt is not the problem. If they had less debt there would be less concern for their ability to keep up with payments and they would not have been downgraded even with the predicted lower rate of growth. So debt from previous deficits compared to the current gdp and predicted rate of growth really is the source of the problem.

You only seem to point out the growth part of the equation, and it is a valid part, but you ignore the reason why that growth is required - to make payments on the debt.

[Malerin]

I'm not a deficit hawk, but I'm not buying the statement that the debt is not the problem. If they had less debt there would be less concern for their ability to keep up with payments and they would not have been downgraded even with the predicted lower rate of growth. So debt from previous deficits compared to the current gdp and predicted rate of growth really is the source of the problem.

Right. Fitch specifically highlighted the fact that Spain's spending cuts would cut growth more than comparable countries. Spain, however, has no choice. If they don't do anything, they would be probably be downgraded to junk status, as Greece currently is.

You only seem to point out the growth part of the equation, and it is a valid part, but you ignore the reason why that growth is required - to make payments on the debt.

And also ignoring Fitch's warning given to the UK and US to get their deficits under control or risk a credit downgrade (http://www.telegraph.co.uk/finance/economics/6969163/US-must-cut-spending-to-save-AAA-rating-warns-Fitch.html).

But Doc has a history of, shall we say, confirmation bias.

[Tippit]

Yes, and yes.

In fact, they'd be worse. Because in a country with fiat currency, deflationary spirals can be fought by simply enlarging the money supply; once a deflationary spiral happened in a country without fiat currency, a deflationary spiral would be self-reinforcing and could only be broken through an unplanned external event.



"Enlarging the money supply" entails a transfer of wealth ie: purchasing power. Who gets the new money, and for what purpose? Your runaway deflationary feedback loop sounds scary, it's a good thing you don't have any actual evidence that this occurs. Absent central banks artifically contracting the money supply as during the Great Depression when the Fed contracted money by 33%, it doesn't occur. Finally, deflation is accompanied by an increased demand for money, which results in higher interest rates, which results in more savings and investment. This is the natural remedy to recession, when all the prior bad investments (usually made by government, or as the result of speculation by huge influxes of fiat money) get liquidated.



I.e. suppose that, for whatever reason (a crop failure, for instance), the supply of some particular good became very tight, and prices rose dramatically as a result. The effect, absent fiat currency, would be that prices for all other goods would drop dramatically (because there's only so much money to go around, and if people need to pay twice as much for X, they can't pay as much for Y).



Only in your convoluted example. Why would the prices of "all" other goods necessarily drop "dramatically" just because prices in one sector rose? You're speculating on a ridiculous hypothetical. Granted, if the price in question were the price of oil, it would have an effect due to its inelasticity of demand, and the relative market share that oil has in the energy sector. Regardless, your "solution" is to inflate the general price level to match, thus placing the burden on the poor with yet another stealth expropriation of wealth. Not surprising, for a statist, because we know where the new money goes.



Either they buy less of Y or pay less per unit, either of which makes Y less profitable to produce. The producers of Y start going out of business, which in turn means that fewer people are employed producing Y, which means that fewer people are earning money and spending it. This means that public confidence will drop.



More faulty logic. While profits may suffer, profit margins will not necessarily suffer because in a deflationary environment like you've described unit costs will also be lower. And of course, once again, this is all predicated on the idea that there is a major supply shock in an important commodity, and your proposed solution of inflating the currency is still intellectually and morally bankrupt. The consequences of such a supply shock would be felt in the real economy regardless of monetary policy.



Remember that the effective money supply is not simply the amount of pesos printed, but the amount of pesos in circulation; economists talk about the "velocity of money" to take this factor into account.



From the wiki on inflation (emphasis mine):



http://en.wikipedia.org/wiki/Inflation_(economics)

"Velocity of money is often assumed to be constant, and the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money. With constant velocity, the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not constant, and can only be measured indirectly and so the formula does not necessarily imply a stable relationship between money supply and nominal output. However, in the long run, changes in money supply and level of economic activity usually dwarf changes in velocity. If velocity is relatively constant, the long run rate of increase in prices (inflation) is equal to the difference between the long run growth rate of money supply and the long run growth rate of real output.






When public confidence drops (justifiably, because people are being laid off), people will stop spending as much money on everything. That's the well-publicized "paradox of thrift." Saving money [excessively] is good for the individual but bad for the economy as a whole. The velocity of money will drop, which means demand for everything (X now included) will start to drop.



Here is "Keynes" talking about the "paradox of thrift". If you pay attention, you may notice the broken window parable too.

d0nERTFo-Sk




Once demand starts to drop, we're into a vicious, self-reinforcing cycle. Why spend a thousand pesos for a widget today, when you can buy the same widget in two months for nine hundred? Even the people who have money and aren't afraid have a rational reason for deferring purchases. But a purchase deferred is income not received by the producer, which means that the producer has to drop prices even further and lay off more people.



I'm not going to defer my purchase of a TV by much, because as there is a benefit to saving money as the value of money increases, there is a cost implicit in deferring my enjoyment of watching a new TV! This should be obvious, but apparently it isn't to you. If you fail to recognize this, then recognize that it follows that monetary inflation compels people to buy what they don't really need sooner than they otherwise would have, before the purchasing power of their money is stolen and wasted by its issuers.



Oh, and the saved money? No one can afford to lend it out or to borrow it. With money earning a real interest rate just sitting there in a cookie jar, why should a bank risk not being paid back by putting it into a potentially-failing business venture? Why should a business borrow money knowing that it will have to pay back in much more expensive money later?



Why? For the same reason that businesses borrow money at higher than the risk-free rate given inflation - because business returns are much higher than those enjoyed by merely saving money. And again, it follows that if a bank under an inflationary regime would be compelled to invest in a potentially failing business venture when it otherwise wouldn't, you have the essence of the cause of the business cycle. See the subprime mortgage market and the real estate collapse for evidence.



Notice that I've not mentioned the type of currency at all in this. We could be dealing with pesos, dollars, cowrie shells, or a combination of all three. The point is that the value of money is going up as fewer people are willing to part with it.



Or, more accurately, if the money supply weren't constantly inflated, interest rates would properly signal risk, and the natural scarcity of capital would weed out bad investments and mitigate boom and bust cycles, thus avoiding the calamity we've all witnessed.



If none of the currencies can be inflated to break the cycle, what do you do then? The answer appears to be "nothing." Wait until some external force stimulates demand all by itself.



The "cycle" you're describing only exists given central bank manipulation. Central banks can and have destroyed money throughout history with very bad economic consequences. "Deflationary spirals" are as inevitable as "inflationary spirals", which is to say that they aren't at all, absent wholesale manipulation of currencies (see Great Depression, Argentina, Zimbabwe). Deflation that mirrors the productivity norm has the same likelyhood of a deflationary spiral as price inflation with a conventional target of 2% does of causing an inflationary spiral - nil.



Basically, the problem is that deflation is typically both caused by and the cause of decreasing demand for goods. Demand for goods isn't denominated in any particular currency -- if I don't want to buy a refrigerator today because it will be cheaper in a month, it doesn't matter if I'm not-buying it in euros, dollars, pesos, or cowrie shells. A drop in demand reinforces and causes further drops in demand. That's what a deflationary spiral is. The easiest way to stimulate demand is to relax the money supply.... but of course that's exactly what you can't do with commodity money.

Or, viewed rationally, monetary inflation, which is a zero sum game resulting in winners and losers in a transfer of wealth, artificially stimulates demand by a policy of regressive taxation, with the inevitable consequence of malinvestment and recession.

[Aepervius]

OFF topic but when you are saying "doc" are you speaking of The DOC from the evidence from god thread or are you speaking of "dr" DOC kitten ? Because I don't see the DOC posting ehre about economy, but that w could have been from another thread...

[MattC]

OFF topic but when you are saying "doc" are you speaking of The DOC from the evidence from god thread or are you speaking of "dr" DOC kitten ? Because I don't see the DOC posting ehre about economy, but that w could have been from another thread...

It's a safe bet they reference drkitten.

There are certain realms in which DOC's god fears to tread - economics and science being two of them.

~ Matt

[drkitten]

I'm not a deficit hawk, but I'm not buying the statement that the debt is not the problem. If they had less debt there would be less concern for their ability to keep up with payments and they would not have been downgraded even with the predicted lower rate of growth.

That's vague to the point of meaningless, I'm afraid. Yes, if they weren't running any debt at all, there would be no payments to worry about.

The problem, however, isn't what to do about the existing debt.

There are basically two choices. Ignore the existing debt, increase spending to stimulate the (private) economy and thereby drive up economic growth which will (it is hoped) create increased government revenue down the line that can be used to make the payments. OR, to cut spending now in an effort to reduce the debt loads in the immediate future, which is what the "deficit hawks" are demanding.

Unfortunately, this will also hamper further growth (as Fitch has pointed out no less than three times in the statement cited in the OP), the point that the reduced payments will actually be more burdensome (as a percentage of income) than the current payments are.

A farmer who finds himself $20,000 in debt in late winter is faced with the same choices. He can basically ignore that debt and plant crops as usual, so that he'll have some income coming in come harvest time. Or he can cut back on his operational expenses, for example, but not buying and planting seeds.

Which of those approaches is a problem? And which is a solution?


You only seem to point out the growth part of the equation, and it is a valid part, but you ignore the reason why that growth is required - to make payments on the debt.

Well, even if growth weren't "required" to make payments on the debt, economic growth is generally a good thing. Are you suggesting that if Spain weren't carrying any debt, it should avoid carrying out pro-growth policies because they're not "required"?

The point is quite simple. Cutting deficits right now is an anti-growth policy that will lead to more harm than good. In the short term, it will intensify and prolong the economic crunch. In the long term, it will decrease government revenue and make the debt burden even greater in terms of a percentage of revenue.

Which is why Fitch cut Spain's rating. Not because their debt burden was too high (they explicitly stated they were cool with that) but because their ill-advised attempt to reduce their debt burden will make their problems worse.

[drkitten]

Right. Fitch specifically highlighted the fact that Spain's spending cuts would cut growth more than comparable countries.

And they also specifically highlighted the fact that Spain's debt levels are not problematic. "in-line with other AAA-rated countries," I believe, was their phrasing.

Spain, however, has no choice. If they don't do anything, they would be probably be downgraded to junk status, as Greece currently is.

In light of the fact that Fitch specifically denied that it had any concerns about debt levels, this statement is at best highly speculative and at worst directly contradicts what Fitch said.

[Malerin]

And they also specifically highlighted the fact that Spain's debt levels are not problematic. "in-line with other AAA-rated countries," I believe, was their phrasing.

Because Spain is doing something about it.



In light of the fact that Fitch specifically denied that it had any concerns about debt levels, this statement is at best highly speculative and at worst directly contradicts what Fitch said.

Unless you recall that Fitch warned the US and UK specifically about getting their deficits under control. Reposted here, yet again:

Fitch Ratings has issued its starkest warning that the US will lose its AAA credit rating unless it acts to bring the budget deficit under control, citing a spiral in debt servicing costs and dependence on foreign lenders.
http://www.smh.com.au/business/debt-crisis-looms-for-us-public-finances-20100112-m4mx.html

March 9 (Bloomberg) -- The U.K. needs to make a stronger fiscal adjustment to help reduce its debt ratio earlier than currently planned, Fitch Ratings analysts Paul Rawkins and Chris Pryce wrote in a presentation to be delivered in London today.
http://preview.bloomberg.com/apps/news?pid=newsarchive_en10&sid=azii0bmoKRvI

Honestly, this has been pointed out to you time and again now, and not just by me. Ziggurut was the first to post Fitch's warnings that came earlier this year. Is your worldview so rigid that you are reduced to putting your fingers in your ears like a two year old whenever anyone challenges it? I think you should be very glad you have tenure, if you conduct your classes in this way.

[CatOfGrey]

There's a couple of things that haven't been mentioned here.

1. Spain is not in the same political situation as the United States. Their currency is the Euro, which they share with what, 15 other countries? Unlike the USA, (and the UK) which can choose to print a bunch of money to cover a deficit (which then increases inflation), the Spanish gov't can't just print euros to cover their deficits unless the whole "euro club" agrees. And Germany and France aren't really keen on watching all their effort become less valuable because of the Greeks, Spanish, Italians, and Portuguese.

2. Ratings agencies are not in very good public standing right now. They rubber-stamped CMO's with AAA ratings long after it was clear that (pardon the double entendre) the financial house was going to crumble. They need to show that they know what's going on. Personally, I'm not convinced.

3. Things are probably worse than they seem. Greece is a country who spends a little more than they produce. In the 'old days', they would pay for this naturally with higher inflation, as the Drachma would fall in value relative to Francs, Marks, and Kronas. But joining the euro ended all that. So when push came to shove, the gov't chose to stop paying for so many benefits, instead of leaving the euro, and risking market collapse.

Why is this worse then it seems? Because over 40% of the Greek gov't voted for the collapse! If they had a leftist swing in the order of the USA's last election, the Euro might be gone now.

[drkitten]

Because Spain is doing something about it.



And what they're doing about it is harmful to the economy, which is why they're having their ratings cut.



Honestly, this has been pointed out to you time and again now, and not just by me.

That's because I have a tendency to ignore irrelevant and ill-informed outbursts.

Fitch pointed out that eventually the deficit would need to be dealt with, but provided no timetable, and didn't even threaten to cut the ratings. On the other hand, when Spain took the ill-advised step of actually cutting stimulus spending now, during a very fragile recovery, Fitch took the rather drastic step of actually cutting their rating, because this particular cut was a bad move, badly timed.

Basically, there are two facts in play:

The deficit levels of the AAA-rated countries are not necessarly sustainable in the long run and should be addressed eventually
Attempting to deal with the deficit levels now will be actively counterproductive and harmful, because it will greatly reduce any chance of the necessary economic growth happening that will allow the long-term debt to be successfully retired.


... which, of course, is what Fitch said, and why they merely "warned" the USA that it would need to do something eventually, but actively cut Spain when it tried to do something right away, something that they point out is mistimed and actually harmful.

Is your worldview so rigid that you are reduced to putting your fingers in your ears like a two year old whenever anyone challenges it?

No, but my reading skills are also good enough that I can tell the difference between a long-term warning and an actual ratings cut.

[Malerin]

Because Spain is doing something about it.



And what they're doing about it is harmful to the economy, which is why they're having their ratings cut.

And if they ignored the problem they would be in even worse shape.



Honestly, this has been pointed out to you time and again now, and not just by me.

That's because I have a tendency to ignore irrelevant and ill-informed outbursts.

You ignore everything and everyone who doesn't agree with you or Krugman.

Fitch pointed out that eventually the deficit would need to be dealt with, but provided no timetable, and didn't even threaten to cut the ratings.

Wrong and dishonest, because I know you're not that dumb:

"The rating agency warned that in the absence of measures to reduce the budget deficit over the next three-to-five years, government's indebtedness will approach levels by the latter half of the decade that will bring pressure to bear on the country's 'AAA' status."
http://www.rttnews.com/Content/USEconomicNews.aspx?Id=1177155



On the other hand, when Spain took the ill-advised step of actually cutting stimulus spending now, during a very fragile recovery, Fitch took the rather drastic step of actually cutting their rating, because this particular cut was a bad move, badly timed.

More dishonesty. Fitch cut their rating because:

Fitch anticipates that the economic adjustment process will be more difficult and prolonged than for other economies with AAA rated sovereign governments, which is why the agency has downgraded Spain’s rating to AA+,” Coulton added.
http://ftalphaville.ft.com/blog/2010/05/28/247066/bonfire-of-the-sovereign-ratings-fitch-strips-spain-of-its-triple-a/



Basically, there are two facts in play:
The deficit levels of the AAA-rated countries are not necessarly sustainable in the long run and should be addressed eventually within 3-5 years

FTFY

[Puppycow]

If you you don't mind registering for a free account, you can read the actual report here (http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=530689) and not rely on a reporter's characterization of the report.

The downgrade reflects
Fitch’s assessment that the process of adjustment to a lower level of private sector
and external indebtedness will materially reduce the rate of growth of the Spanish
economy over the medium term. Despite these expectations, the Stable Outlook on
Spain’s sovereign rating reflects Fitch’s view that the country’s credit profile will
remain very strong and consistent with its ‘AA+’ rating, even in the event of some
slippage relative to official fiscal targets.

The Spanish government has announced an ambitious fiscal consolidation plan to
ensure a return to sustainable public finances after the global financial crisis. Fitch
believes the Spanish government could find it hard to implement some of the
expenditure cuts. In particular, the agency has some doubts over the feasibility of
the cuts that need to be made by Spain’s autonomous communities, who may also
see a reduction in the transfers they will receive from the state budget.

Nevertheless, Fitch believes the risk that economic growth will fall short of the
government’s projections is a more important consideration. The Spanish
government is forecasting a sharp recovery in private consumption and investment.
Fitch believes that Spain’s unemployment rate, the legacy of its construction boom, and its high level of indebtedness will weigh on private consumption and
investment in the medium term. Consequently, Fitch is forecasting weaker growth for the Spanish economy in the medium term than the government is, although the agency’s projections on the contribution of net trade to growth in the medium term
are slightly more optimistic than those of the government.

It goes on for many more pages analyzing a large number of economic factors such as labor market flexibility.

I don't see in there an alternative, more optimistic economic growth forecast in the event that Spain forgoes its austerity plan. I think that the downgrade probably became inevitable prior to the decision to implement austerity measures.

I agree with CatOfGrey that Spain faces a different problem than the US, being reliant on the ECB for its currency, and thus having no independent control over its own monetary policy.

[Malerin]

Also found this:


Credit ratings agencies Moody's and Fitch said the new [austerity] measures lent credibility to Greece's fiscal adjustment plan.

Two of the three major debt watchdogs, Standard & Poor's and Fitch, have downgraded Greece's public debt to below A grade. If Moody's follows suit, Greek government bonds would no longer be eligible as collateral for European Central Bank lending from the end of this year.

Moody's said maintaining its A2 rating was contingent on Greece executing its deficit-cutting plan. "Signs that deficit reductions will fall short of what has been promised would likely lead to downgrades," it warned.

Fitch welcomed the measures but said they were not expected to change Greece's BBB+ rating or outlook.
http://uk.reuters.com/article/idUKLDE6220NA20100303

Hmm, looks like ratings agencies kind of care how these massively indebted countries are dealing with their deficits. So much so that they make their rating contingent on deficit reduction.

Shocking! :eek:

[Ziggurat]

It's strange, drkitten, that you use Fitch Ratings' opinion of Spain's deficit to analyze the US deficit, rather than Fitch Ratings' opinion of the US's deficit. I'm still having trouble figuring out the logic behind that.

[Puppycow]

Update time (http://mobile.bloomberg.com/apps/news?pid=2065100&sid=aF7TdMJ_pxic) :)

[Francesca R]

Not seen this thread before but the OP is disingenuous. If you experience the type of bust that Spain did then you likely don't get to keep an AAA rating whatever you do. The notion (if it was being advanced by drkitten, and it looks like it was) that had Spain undertaken new stimulus in 2010, it would still be rated AAA, is a pretty crazy one.

Spain's rating remains above Italy, Ireland, Portugal and Greece (registration required (http://www.fitchratings.com/jsp/sector/Sector.faces?selectedTab=Issuers&Ne=4293330737+11&N=416+4293330737)). Another agency (S&P) reaffirmed the UK as AAA shortly after it implemented big medium term deficit reduction policies.

[daenku32]

Don't forget that the only thing keeping up Greece and Latvia now that they put austerity measures in place, is handouts from the EU. Without the handouts they would be plunging into a deep recession.

[Francesca R]

What are "handouts" in that lexicon?

The rescues of various European states public finances are off-market loans to the respective governments because raising money in the market was so expensive it threatened rapid insolvency. Lending-of-last-resort is usually only seen as a handout by the political far-right.

So I don't know what your point is.

[daenku32]

My point is that the austerity measures are ready to push the nations off the cliff.

[Francesca R]

So your policy recommendation is that Latvia and Greece should run deficits in good years as well as bad years? And their response to sovereign debt crises should be what? "Float" the currency, hyper-inflate and default presumably?

Any idea why the countries themselves do not think that fiscal contraction is more harmful than that?