“This decision by S&P is the latest consequence of the out-of-control spending that has taken place in Washington for decades," House Speaker John Boehner declared in a statement Friday night. “The spending binge has resulted in job-destroying economic uncertainty and now threatens to send destructive ripple effects across our credit markets.”
Treasury officials, infuriated that S&P had gone ahead with the downgrade, complained that the rating agency had made a $2 trillion error in its deficit calculations as late as Friday evening. S&P, they said, delayed its announcement and revised its numbers – but stuck to the same conclusion.
But that was a sideshow, because the real thrust of the ratings downgrade wasn’t about the specific numbers so much as the political outlook for making headway on the deficit.
“S&P's judgment was not that the U.S. could not repay, but rather, given the political process, that it might choose not to repay,” said Vincent Reinhart, a senior fellow at the American Enterprise Institute and a former director of monetary affairs at the Federal Reserve. “That is in part a fall-out from Washington partisanship.”
In the short term, the downgrade may have little or no concrete impact. For the time being, global investors don’t have enough other places to park their money – particularly in times of great uncertainty, like now. Like them or hate them, but the market for U.S. Treasury securities is bigger, more liquid and in many ways still safer than any other markets in the world.
But over the longer term, it may well mark a watershed moment—the beginning of the end of what the late French president Charles De Gaulle called the “exorbitant privilege’’ of the dollar’s role as the world’s reserve currency. Even if the fiscal and inflationary risks of the United States are still tolerable to global investors, the political risks may not be. That can make a difference.
The potential costs may not be just be in the form of higher borrowing costs. Shortly after S&P made its announcement Friday night, China’s official news agency declared that the United States would have to use “common sense” to “cure its addiction to debts” but cutting military and social spending.
“China, the largest creditor of the world's sole superpower, has every right now to demand the United States address its structural debt problems and ensure the safety of China's dollar assets," Xinhua said.
That’s bluster, and not for the first time, and it has not stopped China from continuing to acquire mountains of Treasury debt. It’s the only way it can keep its currency from soaring in value against the dollar and making Chinese exports more expensive.
But it’s worth remembering that the United States and many other countries are pushing China hard for reforms on a host of fronts—letting its currency float at market rates; focusing more on domestic growth; opening up its financial system.
U.S. officials have always argued that those reforms are a matter of good government and would help reduce the massive global trade imbalances that played their own role in the last financial crisis.
But if U.S. creditworthiness is being knocked down because of its gridlock, gamesmanship and procrastination, its ability to make those good-government arguments is likely to be diminished.