As reported by FXStreet.com’s Barbara Rockefeller, the S&P downgrade of the US rating, based more on political judgments than on good accounting, gets the blame for setting off the stock market slide. Whether S&P is qualified to make political judgments is irrelevant, for the moment, and we still think it will get a comeuppance some day for its role in the MBS fiasco. It’s kind of fun that the very thing S&P was warning against, Treasuries, rallied on the downgrade news. You might suspect all kinds of nefarious back-room maneuvering at S&P until you watch the top S&P guys on TV. They are not very impressive.
And it’s important not to shoot the messenger. S&P said US growth is not good enough to generate the revenue that would be needed for structural debt reduction, and both the stock and bond markets agree with this judgment. The not-so-hidden policy message is Keynesian—if you can’t cut spending or raise taxes, you must re-jigger priorities to promote growth (i.e., production and jobs). Sadly, bad policy choices like tariffs can come in the wake of this message as well as good ones, like tax rewards for companies that create jobs. But companies would be violating their responsibility to shareholders to increase production and create jobs if demand is not high enough to justify inventory-building.
It’s a mistake to say that what is at work here is “panic.” The stock market response to the downgrade of US debt is not irrational—a big drop in government spending tends to reduce activity and thus demand and thus sales and earnings. It’s the classic negative feedback loop where the thing feared causes behavior that creates the thing feared. In another context, the Tea Party is causing a resurgence of recession, which to them is incidental to the primary goal but in fact worsens the very conditions they think they are addressing. Slower growth means lower tax collections whatever the tax rate.