Down on the downgrade?

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Article Highlights

  • There's no getting away from #America's debt-to-GDP ratio of nearly 100%

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  • Is the #US on the verge of a default?

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  • The best response would be for #Obama to do his job by cutting long-term spending

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The widely anticipated downgrade of long-term U.S. debt finally happened on Friday night. S&P lowered the U.S. credit rating from AAA to AA+ amidst concerns about the government's budget and the rising debt burden. This further fueled the decline in the Dow Jones and the NASDAQ as nervous investors realized that the debt deal did not go far enough toward resolving the U.S.'s economic uncertainties. The administration reacted as one might expect, blaming the ratings agencies rather than acknowledging that there was a real problem to be handled. Gene Sperling, head of the National Economic Council, slammed S&P for a $2 trillion mistake in its debt calculations.

"It is a clear expression of unease at the state of the United States economy, and on that count it is right on target." -- Aparna Mathur

Statistical errors aside, there is no getting away from the fact that the U.S. today has a debt-to-GDP ratio of approximately 100 percent, and it is projected to go much higher. Many countries with debt to GDP ratios of less than that have defaulted in the past. Future spending projections make it clear that debt and spending are out of control.

Also, it is not as if the debt number is a sole dark spot in an otherwise bright scenario. There is little to suggest that the U.S. has ever fully recovered from the economic recession that began in December 2007. GDP growth rates have been weak, averaging 0.4-1.3 percent, annualized, for the first two quarters of this year. There are still 6.8 million fewer nonfarm jobs than there were at the start of the recession. Many institutions still hold bad mortgage debt, and with the S&P/Case-Shiller home-price index declining again, the less said about the housing market the better. The outlook for the economy is decidedly weak.

Does this mean the United States is on the verge of default?

S&P has the reputation of being influenced by subjective economic and political conditions, rather than purely objective data. Also, its track record is not the best when it comes to predicting the likelihood of sovereign default. For example, it has been criticized for not downgrading Ireland's debt rating until 2009 -- long after the financial problems had become obvious. It is quite possible that S&P's calculations have no predictive ability relating to the chance of U.S. default. The upward movement in ten-year Treasury prices Monday morning seems to indicate little market concern for the specter of default. But the S&P rating serves another purpose. It is a clear expression of unease at the state of the United States economy, and on that count it is right on target.

Many analysts fear that the U.S. may be heading for a double-dip recession. The downgrade therefore fit perceptions about the country's troubled economic scenario. Rather than attacking the rating agencies for doing their job, the best response would be for the administration to do its job by cutting long-term spending and providing a less-uncertain future for the markets' jittery participants.

Aparna Mathur is a resident scholar at AEI.

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