In case anyone doesn't check CNN, S&P downgraded the US's credit rating on Friday from AAA to AA+. So of course everyone is predictably up in arms. The right is blaming "runaway spending". The left is blaming "Crazy Tea Partiers". The proximate cause is exclusively the latter-- Republicans in Congress decided to make a political issue out of what should have been a routine debt ceiling hike in hopes of extracting a pound of flesh. Had a clean hike in the debt ceiling been routinely passed, I can say with absolute certainty that S&P wouldn't have blinked. Instead, months of debate led to a crummy "deficit reduction" bill that won't reduce the deficit, and will hurt the economy, and S&P went ahead with its downgrade anyway. But the point of this post isn't to point fingers; it's to summarize what the downgrade means. And what it means is... next to nothing.
First, it's important to note that nothing fundamentally changed between a week ago, a month ago, a year ago, and today in terms of the budget picture, and S&P doesn't have any kind of special knowledge that no one else does. We've still got a big budget gap that is attributable predominantly to the fact that we're in the longest, deepest period of economic stagnation since the Great Depression, and we've still got a health care sector with runaway costs. That's all publicly available information, and it's something everyone who was paying attention knew if they could do basic math (which, granted, many Congresspeople either can't or pretend they can't). And, knowing all of this information, bond investors are still lending long-term to the US government at exceptionally low interest rates. S&P's opinion isn't going to force them to dump Treasuries that they've been holding for long periods of time.
Second, S&P has a miserable track record in, you know, doing its job. The most obvious example is the financial crisis, in which all three major rating agencies, S&P included, put their AAA stamp of approval on all kinds of financial toxic waste, and then were humiliated when those products blew up, endangering the entire global economy. But that's far from their only failure. As bad as they were at evaluating financial products and corporate bonds during the financial crisis, Mike Konczal presciently points out that they've been worse at evaluating sovereign debt. So, essentially, these agencies are consistent failures at their jobs. So there's absolutely no reason to care about what they have to say now. In 2002, S&P downgraded Japanese debt. In response, the markets... ignored them and continued to lend to the Japanese government at extremely low interest rates. In this case, markets will almost certainly do the same, mostly because nothing in S&P's track record should give anyone confidence in anything they say.
So do I think the downgrade is completely meaningless? Well, not COMPLETELY. I know some institutional investors like pension funds are contractually obligated to hold some proportion of AAA-rated securities, so if there are enough of those that have to dump their holdings as a result, there could be some spike in yield. But I don't think it will be too significant.
In short, don't panic-- the world isn't ending. What the US needs now is the same thing it needed a month ago and a year ago: more action by the government and the Fed to stimulate spending and job creation, and a long-term plan to raise more revenue and tackle the health care cost issue.
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