Nobody wants to say it, but a major reason why corporations are not creating many jobs and expanding in the U.S. is due to increasing systemic risk being created by Washington. The U.S. is supposedly in economic recovery, yet President Obama projects a record $1.6 trillion deficit for 2011--with years more trillion-dollar annual deficits and growing debt ahead.
Government debt is growing by $120 billion a month, three times faster than the $40 billion monthly increase in GDP. What is going on?
The real issue is not the U.S. government's debt ceiling to accommodate ongoing deficit spending, but rather the wall that we are about to hit. This wall will be raised by foreign governments balking at financing U.S. debt, except at significantly higher yields to offset the dollar's declining value.
Recently, officials from China, Brazil and other countries blamed high food and raw materials prices on Washington--charging it with exporting inflation by degrading its currency through quantitative easing.
Another related debt wall that looms ahead is the one that arises from declining credit quality. An unsettling report, "The Evolution of Moody's Perspective on the U.S. Aaa Rating" received little attention when released Jan. 27 in the midst of upheaval in Egypt and the Middle East.
But, coming on the heels of a similar warning from Standard and Poor's, it has serious implications.
Moody's states that "recent trends in and the outlook for government financial metrics in particular indicate that the level of risk is rising... and likely to continue to rise in the next several years..." Furthermore, it continues, "the time frame...appears to be shortening, and the probability of assigning a negative outlook in the coming two years is rising."
Moody's infers that escalating government spending since the financial crisis of 2008-2009 is the reason for shortening the time horizon for the negative credit watch revision. The report cites specific causal metrics in terms of the federal government's ratio of debt to revenue rising from 230 to 460% between 2008 and 2010..."
The fact that debt is growing more than four times faster than revenue in the U.S. should be alarming by itself. But the Moody's report goes further and graphically illustrates the relative condition of the U.S. by comparing it to the other Aaa-rated countries.
It turns out that the U.S. is the high ratio outlier--having nearly three times more growth in debt to revenue than the Aaa median, and more than two times more than that of Germany, France, the U.K., and Canada--all of which have undertaken austerity measures.
The U.S. Government has enjoyed unlimited access to financing because of its role in having the reserve currency and "safe haven" in global financial markets. Thus, U.S. Treasuries have been the "risk-free" benchmark.
But if the credit rating outlook on U.S. sovereign debt turns negative, the dollar will risk losing its status as the world's reserve currency because its associated government debt could no longer be considered risk-free. As a result, the demand for dollars would decline precipitously and cause further devaluation.
Regulated by the SEC, Moody's and Standard and Poor's don't get the respect they once did after having assigned Aaa-ratings to dodgy mortgage securities that ended up defaulting during the financial crisis of 2008-2009. But the important take-away here is the imperative of reducing systemic risk by tying the debt ceiling to deficit reduction.
Longer term the debt ceiling should be capped at a percentage of GDP. Without telegraphing the will to radically cut spending, the U.S. will hit a Greek wall of deficit finance and liquidity problems. If that crisis becomes headline news it is too late. History reminds us that such crises happen faster than most anticipate and almost always before the ratings agencies take action.
Scott S. Powell is a visiting fellow at Stanford University's Hoover Institution and a former debt portfolio manager at several Wall Street firms.
