The U.S. Deserved Its Downgrade
Perhaps the most stunning aspect of the downgrade of America’s long-term debt has been the ferocious assaults launched on the downgrader, Standard & Poor’s. The Obama administration, along with media supporters who rely on Democratic talking points, have argued—correctly—that S&P and the other rating agencies missed the problems with mortgage-backed securities that helped fuel the financial crisis. But blaming the messenger will not solve the problem.
Let’s suppose for the sake of argument that Standard & Poor’s is as villainous or incompetent as its critics claim—that the raters have misjudged the creditworthiness of the United States. If this is so, maybe we shouldn’t worry. What makes an economy capitalist is the general freedom of capital to seek its highest return. As Hernando de Soto reminds us in his brilliant monograph "The Mystery of Capital," this freedom is precisely what has made capitalism so unpopular around the world: under capitalism, government edict cannot, over the long run, force markets to move against the inclinations of capital, and governments everywhere hate forces they cannot control.
Well, the United States is up against one of those forces. The administration and its supporters insist that securities issued by the United States remain gold-plated, and that the burden of our long-term debt should not have triggered a downgrade. The thesis is simple enough to put to the test. The nation’s securities are traded on open capital markets, and their buyers are the most sophisticated investors in the world. The obvious way to prove S&P wrong, then, would be to continue to raise capital in the markets rather than through the compulsion of taxes, thus allowing the markets to tell us, as between the administration and S&P, who is right. (I am not against allowing effective tax rates to rise once the economy improves, and, indeed, I consider this inevitable; I am assuming taxes out of the equation here only in order to make a point.) If the downgrade was a mistake, the capital markets will ignore it, and the United States will pay no penalty for refusing to shrink its massive entitlement state.
My own view is that the administration and its supporters are wrong, and dangerously so. The United States deserved the downgrade, and it should have happened sooner. Sophisticated bond funds long ago began dumping Treasuries. Foreign governments and sovereign wealth funds hold dollar securities because they have no choice: in no other way can they stabilize their own currencies and manage their current accounts. But many private funds with options to look elsewhere have for a while now been doing just that: looking elsewhere.
Therefore we need a plan to get control of the long-term structural deficit. It is that long-term deficit, not the debt-ceiling wrangle, that principally generated the S&P downgrade. And the other ratings agencies, Moody’s and Fitch, have warned that although they are maintaining America’s AAA rating for the moment, they will have to revisit the question if firm action is not taken to reduce the nation’s long-term debt.
President Obama on Monday called for new negotiations with the Republicans. But this seems overcautious, and overcomplicated. Nobody needs a grand bargain, and we are past the point when anybody should be seeking political cover. The president need only announce a detailed plan of his own—and then fight for it.
The issues aren’t even particularly difficult. For example, President Obama might tell the country that he wants Congress to adopt, in total, the recommendations of the Simpson-Bowles commission—the deficit reduction panel Obama himself appointed. The commission’s recommendations include reform of by far the biggest driver of the long-term debt--entitlement programs. Indeed, every serious student of the nation’s long-term structural debt understands that the costs of our entitlement programs aren’t a part of the problem—they are the problem.
Yet just a handful of well-studied changes would sweep away most of the future deficits. The age for Medicare eligibility should be raised over the next few years to 68—or, assuming that the Affordable Care Act goes into effect, to 70, because uninsured workers and retirees in their sixties will be able to buy policies through the public exchanges. Medicare spending should be capped at GDP growth plus 1 percentage point. The Social Security retirement age should be raised to 68, or even, given general health and longevity, to 70. And a more sensible measure than the consumer price index should be used to determine benefit increases. These changes are relatively uncontroversial among experts without a horse in the political races. Together, they would wipe out the great bulk of the structural deficit.
Alas, the president’s call on Monday for “modest” reform in Medicare, and his failure to mention Social Security at all, reinforces the suspicion that the Democrats prefer not to touch entitlements, in order to preserve a campaign issue with which to clobber the Republicans. In other words, winning the 2012 election is more important than fixing the problem. The Republicans, for their part, are terrified of the likely political consequences of touching Social Security, and the budget that passed the House earlier this year left it alone.
Well, president and members of Congress are politicians, and running for office is part of the job. But it is the less important part. There is nothing remotely admirable about our two leading political parties jousting for the right to return to Washington to fix at some later date what they could fix today. The parties and their supporters are busy with their usual arguments over which side is to blame, when what is necessary is the willingness to take a risk for the sake of the country. And the risk is merely electoral. The worst that would happen to any politician as a result would be losing his or her office. Every day, we ask police officers and firefighters—to say nothing of members of our armed forces—to risk much more. And they do not even have the opportunity to jump to gold-plated consulting jobs when they leave the public payroll.
Courage is in short supply in Washington these days, along both sides of the aisle. That is why President Obama has to lead. He has to say, and actually mean, that controlling the cost of the entitlement state is more important than preserving issues for the election. The president’s critics, among them many onetime fans, insist that such leadership is beyond him. Let’s hope they’re wrong.