Congress has now passed and the President signed the anti-growth, anti-jobs program that resulted from Republicans blackmailing the country about raising the debt ceiling. And lo and behold!—the stock market tumbles and the rumblings about losing our Triple A credit rating increase. Do you think maybe large institutional investors know a little something about the impact on any economy of reduced government spending?
Now here comes the happy face crowd to tell us that it won’t be such a big deal if the U.S. bond rating deteriorates a little. So far, most of the stories diminishing the impact of a lower rating say that interest rates will only go up a little bit. As usual, the New York Times is leading the mainstream news media, with an article by Eric Dash on the first page of today’s business section titled “AAA Rating Is a Rarity in Business.”
The premise of the Times article is that most businesses don’t have AAA ratings and they get along just fine. Paying the slightly higher interest rate of a slightly lower credit rating opens up new business opportunities for the companies. The article quotes the analogy of a senior bond manager from a company that sells bonds: “It’s like going from a Rolls Royce to a Mercedes—not from a Rolls Royce to a Yugo.” The article goes so far as to claim that many companies see the gold-plated AAA rating as a “financial straightjacket,” because maintaining it means they have less access to funds.
The failure of logic in the salesman’s analogy and Dash’s broader article is to compare a government to a business. First of all, a business can cease to operate, but if a government ceases to operate for any other reason than annexation by another government, then anarchy soon ensues: no security force, no emergency services, no judicial system, no infrastructure repair.
Furthermore, no business has the size of the United States economy and no business represents so large a share of the world’s economy. It’s not even close. When a company sees its credit rating drop a little, it pays slightly higher interest rates, which means goods and services for which it borrows money cost more. But when the interest rates rise on a country’s bonds, every one of the country’s businesses, nonprofit organizations and individuals borrowing money will find themselves paying more. Because most businesses borrow for cash flow or capital needs, the prices that consumers pay for goods and services go up. Even a quarter of a percentage point boost in government bonds can constrain an economy.
As illogical as the happy face argument about losing the AAA rating is, another comparison Dash makes in the Times version of this canard is odious:
“Just as many consumers relied on their credit cards to finance a higher standard of living, companies took on more debt to reap bigger returns.”
As an anti Dom Irrera might say, he means it in a good way. To support the idea that lowering your credit rating leads to good things for countries as well as companies, Dash invokes the idea of consumers living and spending beyond their means. Haven’t many consumers faced hard times these past few years because they spent beyond their means with money they borrowed on severely overvalued houses? A good business borrows for one of two reasons only: 1) To invest in expansion, product development and renovation; 2) To meet short-term cash flow needs. The analogy for consumers is to borrow for education. The business equivalent of “spending beyond your means” is to borrow money to pay key executives more money. We all know some big companies did that and still do, but we wouldn’t consider it a good business practice.
What I find so objectionable is to advocate that it’s okay for people to finance their high life with debt. It makes sense, though, that in a Pollyannaish and Panglossian article about the possibility of the United States losing its status as the very least risky investment in recorded history, the writer would find space for a subtle reminder that taking on debt to consume is a good thing. After all, in our society the primary goal in life and path to happiness is to spend, spend, spend, spend!!