Last Friday (September 1, 2023), the US Bureau of Labor Statistics (BLS) released their latest…
It’s Wednesday and there are a few topics that warrant some comment. But at the top of the topics were headlines this morning shouting out that the US treasury bonds had been downgraded by one of those self-serving credit rating agencies, as if it was an event worthy of some import. The journalists obviously do not understand anything if they think that decision was important. The ratings downgrade on US government debt is meaningless and the rating agency involved just wants to boost its revenue by sounding important. After I explain all that we will have a quiet musical reflection to finish the day.
Credit rating downgrade of US government debt – who cares?
We go through this farce regularly and the only variables are the country name and the ratings agency involved.
The basic news is that one of these self-serving waste-of-time organisations (ratings agency) decided it needed some publicitly (probably linked to some strategy to raise extra revenue) and so what better way than to the United States to AA+ from AAA.
According to the press release announcing the decision (August 1, 2023) – Fitch Downgrades the United States’ Long-Term Ratings to ‘AA+’ from ‘AAA’; Outlook Stable – the reasons for the decision were:
… the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance …
All sorts of other factors were cited:
1. “steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters”.
2. “repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”
3. “government lacks a medium-term fiscal framework.”
4. “and has a complex budgeting process”.
And the elephant is not mentioned.
That the US government will never default on its outstanding debt and thus there is zero credit risk for investors.
One could also ask who actually takes the recurring pantomine over the debt ceiling seriously?
No-one with a brain considers that political theatre to be anything other than what it is.
I also thought the contradiction in the Fitch rationale was hilarious.
On the one hand, they cite their prediction that the US economy is sliding into recession as a reason for their decision.
But a paragraph later they claim that the “resilience of the economy and the labor market are complicating the Fed’s goal of bringing inflation towards its 2% target.”
They obviously want a recession.
Sure enough, the Federal Reserve is intent on pushing unemployment and the economy into recession even though inflation has fallen dramatically in recent months.
But surely if Fitch is worried about ‘debt sustainability’ then it should be happy about the ‘resilience’.
They are not.
They are frauds.
Anyway, the media seemed to think it was a big deal.
Even the US Treasury Secretary didn’t address the issue correctly.
She claimed that the decision was:
… arbitrary and based on outdated data.
Which begs the question – is there some data that would have justified such a stupid assessment?
She obviously thinks there would be whereas in reality such a decision would never be justified unless the US government was borrowing heavily in foreign currencies, which it isn’t.
The White House press secretary, similarly, chose to reject the decision on the wrong grounds:
It defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world …
The reality it defies has nothing to do with the ‘strength’ of the economy or the recovery or anything else like that.
The reality it defies is that the US is a currency-issuer and can always fund its outstanding liabilities at any nominal price in US dollars.
That last capacity is a sufficient condition to render the ratings agencies irrelevant.
There is no risk of default unless the government debt is denominated in a foreign currency.
That last point is also misunderstood.
For example, the Peter G. Peterson Foundation likes to scare everyone about the US government’s national debt.
In their – Who Owns all That Debt – page, they claim:
At the end of 2022, the nation’s gross debt had reached nearly $31.4 trillion. Of that amount, about $24.5 trillion, or 78 percent, was debt held by the public — representing cash borrowed from domestic and foreign investors.
Which uninformed people interpret as borrowing heavily from foreigners.
But that is different from borrowing in a foreign currency.
Foreigners hold about 30 per cent of the outstanding US government debt and that proportion has been rising over the last several decades.
But those holdings are possible because the foreigners have acquired US dollars and have invested their stocks in government bonds.
That acquisition has mostly come from running trade surpluses against the US economy.
So they hand over more real goods and services (hence productive resources) for the enjoyment of the US citizens than the US reciprocates with and in return they get a risk-free financial asset that will always be repaid (in US dollars).
In material terms, the US gains from that transaction.
If I was examining the Fitch statement as a first-year undergraduate student essay in macroeconomics I would have failed them badly and advised them to explore another career option.
External debt arising as liabilities of a currency-issuing government, denominated in the local currency is no issue.
But the debt of the non-government sector may become an issue under certain circumstances, whether it is denominated in local currency or not.
Remember, the non-government sector is a user of the currency of issue.
In that sense, its access to it is not much different to its access to foreign currency. It has to earn income, use prior savings, sell assets or borrow in order to spend.
Accessing foreign currency to service foreign-currency denominated debt requires them to do the same.
I stand by my assessment in this blog post – Time to outlaw the credit rating agencies (December 23, 2009).
In this blog post – Ratings agencies and higher interest rates (April 26, 2009) – I recounted the hilarious Japanese downgrading by Moody’s Invester Services in November 1998.
The downgrading followed the day after the Japanese government had announced a large-scale fiscal stimulus to its ailing economy.
Moody’s Investors Service began the first of a series of downgradings of the Japanese Government’s yen-denominated bonds, by taking the Aaa (triple A) rating away.
The next major Moody’s downgrade occurred on September 8, 2000.
Then, in December 2001, Moody’s further downgraded the Japan Governments yen-denominated bond rating to Aa3 from Aa2.
On May 31, 2002, Moody’s Investors Service cut Japan’s long-term credit rating by a further two grades to A2, or below that given to Botswana, Chile and Hungary.
In a statement at the time, Moody’s said that its decision “reflects the conclusion that the Japanese government’s current and anticipated economic policies will be insufficient to prevent continued deterioration in Japan’s domestic debt position … Japan’s general government indebtedness, however measured, will approach levels unprecedented in the postwar era in the developed world, and as such Japan will be entering ‘uncharted territory’.”
The then Japanese Finance Minister responded (with some foresight):
They’re doing it for business. Just because they do such things we won’t change our policies … The market doesn’t seem to be paying attention.
Indeed, the Government continued to have no problems finding buyers for their debt, which is all yen-denominated and sold mainly to domestic investors.
In Moody’s logic, things have deteriorated massively over the last 25 years in Japan.
But none of their predictions have ever materialised.
In the New York Times article at the time – Japan Battles Bond Rating (July 6, 2002) – the logic of the rating was questioned:
How … could a country that receives foreign aid from Japan have a better rating than Japan itself? Japan, with an economy almost 1,000 times the size of Botswana’s, has the world’s largest foreign reserves, $446 billion; the world’s largest domestic savings, $11.4 trillion; and about $1 trillion in overseas investments. And 95 percent of the debt is held by Japanese people …
But again the elephant.
Japan issues the yen – no other nation or body issues the yen.
It only borrows in the currency it issues.
There is zero credit risk so the varying ratings make zero sense.
Former Moody’s President, John Bohn Jr. had in 1995 claimed that: “We’re in the integrity business: People pay us to be objective, to be independent and to forcefully tell it like it is.” (Reference: Ratings Trouble, Institutional Investor, October 1995: 245).
The GFC and subsequent Congressional Hearings on the conduct of the ratings agencies showed they were not in the “integrity business” at all.
The agencies continually claim that they are providing an indicator of the “probability that the issuer will default on the security over its life …”
Fitch’s justification shows they want us to believe that as the US public debt ratio rises, the risk that the US government will become insolvent rises.
And their logic must be that default follows sovereign insolvency even when the sovereign debt is denominated in the government’s own currency.
It doesn’t take long to realise that this logic is no logic.
While Japan’s economy was struggling at the time Moody’s tried to get headlines, the default risk on yen-denominated sovereign debt was nil given that the yen is a floating exchange rate.
Once we understand how a sovereign government operates with respect to the monetary system this point become obvious.
First, when a particular government bond matures (that is, becomes due for repayment) the issuing government would simply credit the bank account of the holder with the principle and interest and cancel the accounting record of that debt instrument.
Simple as that.
The banking reserves would rise by that amount and the wealth of the private investor would change in mix from bond to bank deposit.
Second, the massive fiscal deficits that the Japanese Government has run since the 1990s just work in the same way – adding reserves on a daily basis to the banking system (as people spend the yen and deposit them back into bank accounts etc).
The bond issues are designed to give the private sector an interest-bearing financial asset to replace the non-interest earning bank reserves.
The way the Bank of Japan (BOJ) continues to keep the interest rate in Japan at virtually zero is by leaving some excess reserves associated with the fiscal deficits in the monetary system.
They leave just enough excess reserves in the cash system overnight each day to force the interbank market to compete the rate down to zero.
This is a very clever way of ensuring that the longer rates (the so-called investment rates) are as low as they can be.
Third, what if the Japanese Government decided it didn’t want to issue any more debt but still ran the deficits?
The net spending would still occur – day by day – and provide stimulus to the economy.
But the liquidity effects would just remain in the excess banking reserves.
This would force the private sector to hold the new net financial assets pouring in each day via the deficits in the form of reserves rather than interest-bearing bonds.
The other angle on this that is often overlooked is that the bond holdings of the private sector also constitute an income source – that is, the government interest payments on its outstanding debt constitute another avenue for stimulus. So when the Government retires debt it reduces private incomes.
The Japanese Government is very sophisticated and knew that Government debt was seen as a safe haven during its decade or more of volatile economic times and also realised that the steady and predictable income flow derived by the private sector holding the public debt was a source of security and a positive influence on growth.
So any notion that a government that is running large fiscal deficits and also issuing debt for monetary policy reasons or in the Japanese case (given they have zero short-term interest rates anyway) for risk reduction purposes, might be a risk is ridiculous.
History bears that out.
Fitch and is incredulous crony agencies should be outlawed.
Music – ypsilon
This is what I have been listening to while working this morning.
It is from the Icelandic minimalist musician – Ólafur Arnalds – and appeared on his 2018 album – re:member – which was his fourth a solo artist and featured some very complex harmonies driven by technology.
This review – Ólafur Arnalds’ Re:member is sophisticated, explorative, and humane (August 24, 2018) – goes into detail about “the use of Stratus technology” which “allows notes played on a main piano to generate different notes on two supplementary pianos.”
A great album and perfect for my working mood this afternoon.
That is enough for today!
(c) Copyright 2023 William Mitchell. All Rights Reserved.