AAA Tax Rating

Drawing a Blank On Ratings?

Moody’s credit rating agency has maintained the U.S. government’s credit rating at “AAA”. Its review, which began on July 13, was coincidentally completed today with the following public statement:

“We have confirmed the AAA government bond rating now that the statutory debt limit has been raised.” (Emphasis added.)

The agency need not have bothered with the charade of an independent review during the eleventh hour political bickering in Washington if all it was going to do was sanction an increase in borrowing capacity once it was passed by Congress.

Bond investors look for safety in the “full faith and credit” of the U.S. government. That can be translated as full faith in the power of the government to tax its citizens. This AAA rating is therefore an AAA Tax Rating.

Negative Outlook

It is perverse that not raising the debt ceiling and making an honest attempt to cut the size and scope of government could have resulted in a ratings downgrade. It wouldn’t have mattered. Bond investors would still invest in Treasury Bills at some level. The short-term pain in going through an economic adjustment would be rewarded with a return to the much vaunted AAA rating in due course.

Moody’s is nevertheless hedging its bets. It has issued a “negative outlook” for the U.S., which it explains:

“…indicates a material risk of downgrade should fiscal discipline waneconsolidation measures not be adopted, the U.S. economy deteriorates, or funding costs rise beyond…expectations.” (Emphasis added.)

Let’s consider the elements of Moody’s “negative outlook” in turn.

Fiscal Discipline Wane(s)

Fiscal discipline went out the window a long time ago. The cost of government is an expense of civil society for properly maintaining the conditions that allow peace, prosperity and freedom to exist. When the cost of government must be financed by perpetual debt, fiscal discipline is non-existent. The debt of the U.S. government practically equals total annual economic output.

Consolidation Measures

Moody’s is referring to the legislated commitment to specific spending cuts of $917 billion over 10 years and the formation of a congressional committee to recommend measures to reduce the annual deficit by $1.5 trillion over 10 years. Understandably, based on demonstrated fiscal performance, there is no cause for optimism about the “consolidation measures” that will spring from such arrangements.

U.S. Economy Deteriorates

With recent news that the Bureau of Economic Statistics has revised previous growth figures significantly downward to levels that are frankly anaemic, it is a safe wager that further disappointment is likely to follow. From the vantage point of 2011, the recession that began in 2008 and officially ended in 2009 looks like economic deterioration. The continuing high unemployment rate and lack of new private capital investment may ensure that the U.S. economy deteriorates.

Funding Costs Rise

An increase in interest rates will make funding costs rise. All of the indicators for rising funding costs are swirling about the U.S. economy today. The conditions are favourable in the classic economic sense. Taxes are bound to be increased beyond the taxing impact the misdirection of capital has already wrought on private investor confidence. That means less disposable income and therefore less savings accumulation. The ridiculous government spending financed by more debt and/or higher taxes will put more pressure on rates to increase. More private capital will flow to the bond markets where safety is supposed to rule. Or, it may flow offshore.

Moody’s Independence

The equity markets continued to slide even as the debt ceiling crisis was resolved. Moody’s made a political gift to the U.S. government by maintaining its AAA credit rating, but it larded up its statements with enough “negative outlook” to at least salvage some credibility and independence as a ratings agency.

©Copyright 2011 Edward Podritske

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