Standard & Poors decision to downgrade Americas credit rating from AAA to AA+ says far more about our dysfunctional political system than about U.S. markets.
Washington is injecting uncertainty and instability into an economy that otherwise can be quiet resilient in the face of change. Many businesses are doing well and making profits. But the economy isnt growing because businesses are uncertain about the how to best use those profits, and other resources.
Its the uncertainty over government policy and action that causes investors to lose confidence in the market.
For example, imagine a firm earning a 6 percent return on investment. If the owner is unsure how much the new health-care legislation will cost him, he will forgo hiring new workers or reinvesting his profits in job creating technology.
Virtually everything Washington has done for the last eight years has been seen by business as a long-term threat to American prosperity. The previous administration brought us into two wars and passed costly policies such as the Medicare drug benefit provision. The current administration picked up where George Bush left off, adding reckless monetary policies and bailouts to boot.
These and other actions have left our government drowning in debta projected $15 trillion by the end of this yearand have left businesses hamstrung by regulation, bureaucratic micromanagement and uncertainty.
S&P did not downgrade the U.S. economyit downgraded Americas politicians and political order.
In April, Treasury Secretary Timothy Geithner acknowledged that investors were extremely nervous about the governments fiscal condition and the political establishments inability to deal with it. Washington is a hard place to read. And its hard for people to look past the political rhetoric and try to understand whether the leadership of Washington is going to take the tough steps necessary to get ahead of this problem, he told Fox News.
When S&P expressed similar concerns, Geithner more or less disregarded the ratings agency: publicly stating there was no risk of a U.S. credit downgrade provided Congress raised the debt ceiling. Congress raised the ceiling, but did not mitigate the risk.
As Binyamin Appelbaum correctly noted in the New York Times soon after the debt deal was sealed, the deal does not actually reduce federal spending. Indeed, both the government and its debts will continue to grow more quickly than the U.S. economy.
Standard & Poors wasnt fooled.
In response to the downgrade, Geithner claimed that S&P had demonstrated a stunning lack of knowledge about basic U.S. fiscal budget math and had handled themselves very poorly. But its not S&P who had handled themselves poorly; its our political leaders. And its our political leaders as well who have ignored federal budget math: year after year, with few exceptions, producing large budget deficits.
My colleague, economic historian Robert Higgs has written extensively about the conditions that caused and prolonged the Great Depression.
Higgs research, confirmed by others, shows that President Franklin D. Roosevelts policies, rather than jump-starting the crippled economy, prolonged the Depression by reducing investor confidence and raising questions about the durability of private property rights. As several presidents have reminded us at various times: A government big enough to supply us with everything we need is a government big enough to take away everything we have.
While the experts speculate on the likelihood of another recession, a so-called double-dip, the lesson of the S&P downgrade is that government is the problem, not the solution. The bailouts, quantitative easing, stimulus, and excessive spending have done little, if anything, to ease our economic woes. What they have done is add political uncertainty and that is ruining the economy.
Washington needs to back off and stand down. The only way out of the current mess is a principled commitment to smaller government, coupled with deep, structural cuts in entitlement spending and defense.