Wednesday, August 10, 2011

Balancing the Budget, Balancing the Books, Balance Sheet

S&P (Standard & Poor’s) last Friday downgraded the credit rating of the United States from AAA to AA+.This is the first time ever that the acknowledged most powerful nation in the world got a downgrading of its credit worthiness.

The other two rating agencies, Moody’s and Fitch decided correctly and understandably to retain America’s AAA rating.

This is basically a numbers game. The measurable standards are quantifiable, its effects reflected in numerical terms. The most decisive factor is the bottom line. It is based on objective facts and figures.

While the objective measures should be dominant, sometimes the judgment is tainted by the analyst’s subjective or biased views.

Does the United States have the capacity to pay? Is there any doubt on America’s willingness to pay or service its debt?

The debt ceiling debate displayed a seemingly dysfunctional Congress incapable of arriving at a defensible compromise. It gave the impression that a small minority group like the Tea Party could hold hostage its own majority Republican Party in the House and the nation by imposing impractical if not impossible conditions. It also allows a minority in the Senate to block any proposal using the power to filibuster.

This process was blown up by the media nationwide and worldwide putting more doubts on America’s willingness and capacity to pay thus risking default.

This is despite the assurances by Senate and House leaders of both parties and President Obama that they will never allow a default. The issue was really more on how much of the debt limit would be raised, how much of the budget to reduce, how to do it and for how long.

A deal was done; a default averted as expected; debt limit rose; and deficit reduction assured.

Yet, S&P still decided to downgrade America’s rating. This is despite the fact that, admittedly, it made a $2 trillion mistake in its analysis regarding the projected deficit over a period. It says, “It’s immaterial”.  What? When you balance the books, the credits must equal the debits. Under the double entry bookkeeping system, the balance must end up with zero. If there is a difference, something is wrong. If the difference is small like a few cents or dollars so that it would be more expensive to look for the discrepancy, you can declare it to be “immaterial”. You could then just charge it to “miscellaneous fees” or some other account thus balancing the books.

But a $2 trillion discrepancy is too much. If S&P’s math is way off by that much on this one, a fortiori (with more reason) it could be wrong on its computation somewhere else. Its capacity to compute is questionable and unreliable. So does its ability in quantitatively  rating other’s credit worthiness.

In fact, S&P is considered one of the “unindicted co-conspirators” of the financial collapse a few years ago. Laden with conflict of interest, its role in mistakenly rating mortgage-backed securities is still under investigation.

Qualitatively, S&P is as bad. While it enjoys the freedom provided and protected by the Constitutional democratic processes, it fails to recognize that Congress and the President of the United States are elected representatives of the sovereign people who are empowered by the Constitution with powers and obligations. The debates, the free press, the power to raise the debt ceiling, the obligation to pay its debts, even the right to rate among others are all parts of the democratic process.

It should have recognized that the United States will not and could not default on its debt. Article I of the U.S. Constitution mandates that no law or action could impair the obligation of contracts. The Fourteenth Amendment recognizes the validity of public debt and could not be questioned, thus empowering the President to raise the debt limit and pay U.S. obligations. If necessary, the President could even invoke the International Emergency Economic Powers Act.

As Former Federal Reserve Chairman Alan Greenspan said, “It could always print more money. It just hit a nerve, affecting U.S. self-esteem and psyche.”

Meanwhile, what do the numbers say? Government debts are supposed to be riskier by virtue of the downgrading hence U.S. Treasury bond rates should be higher. But reports indicate that the U.S. Treasury markets are seemingly laughing in S&P’s face. It has led to a buying spree of the Treasury instruments. Two-year Treasury yields fell to record lows. Ten-year Treasuries are selling at the highest prices since November of 2010.

Financial Times has questioned S&P’s credibility. In its editorial it says, “The future role of rating agencies will also now come under close scrutiny, bringing to the fore the question of who rates the rating agencies? S&P’s action will likely unite governments in America and Europe in an effort to erode their monopoly power and operational influence.”

U.S.A. remains the largest economy in the world. Its current GDP (Gross Domestic Product) is  $14.6 trillion which is about the same as the total GDP of all the countries that S&P rated as AAA. In fact, the GDP of each of these AAA-rated countries except United Kingdom is less than the $2 trillion mistake that S&P made. With the growth rate of each, it would take decades, centuries, even forever to reach the current GDP of the United States.

The political wisdom is for the democratic leaders to focus on JOBS. Spending on programs with goals “to out-educate, out-innovate and out-build” the competition” should be able to generate employment. While the cash budgeting and accounting system of the Federal Government would show increased expenditures, these costs are really investments for the future. In the books, it should not only decrease (credit) Cash but correspondingly it should increase (debit) another Asset Account either as Property (including Intellectual), Equipment, Building, etc.

Those who try to rate the United States of America must look at its Balance Sheet: its Assets, Liabilities and its Net worth. Configure into it its daunting military assets, its gold reserves, its natural resources, its museums, its infrastructures, its space ships, its institutions, and most importantly, its human and intellectual capital. One can not help but rate it what Warren Buffet said it deserved, “AAAA”.

S&P: Wrong Standards and Poor judgment!

No comments:

Post a Comment