Myths and Facts Surrounding the S&P Downgrade of US Debt

  In the wake of the S&P downgrade of US debt, there have been claims and counter claims as to why it happened, who was responsible and what could be done to remedy the situation. Many of the claims deserve a closer look, as the truth of the matter must be addressed and exposed for what it is.

The lies and the distortions spread by those who opposed the lifting of the debt ceiling must be addressed and exposed for what it is—dirty politics wrapped in a baseless ideology.

The following is an incomplete list of myths and facts concerning the US economy and the implications associated with the debt, the deficit and the role of the government.

Myth The Debt Ceiling (I call it—the Death Ceiling) is conditioned upon a bi-partisan agreement on lowering or balancing the US Government budget.

Fact There is no dependence between the lifting of the debt ceiling and the budget deficit. In fact, it is my strong opinion that there should be no debt ceiling at all. The American government must honor its obligations regardless of the budget deficit’s size. The debt ceiling should be eliminated, since each and every time we approach it, we realize that we have no choice but to raise it yet again. Government spending must be conducted responsibly with an eye on the size of the deficit regardless of the existence or the absence of a debt ceiling. If the ceiling is not lifted or eliminated altogether, the US will bring about a self-inflicted long-term disaster on its economy and on its economic dominance in the world while drowning the rest of the world in the process.

Myth The debt ceiling is the best red alert or braking system on the continuing irresponsible spending by the US government

Fact The mere existence of a debt ceiling serves as a warning to creditors that some economically ignorant politicians may decide to hold it hostage or even trigger it, should their demands be slighted. It’s the only reason for the lack of AAA confidence in the US ability to fulfill its financial obligations.

The value of the dollar relative to the price of US treasuries is a much preferred index. As long as the world markets are willing to invest in US treasuries, they display confidence in the US financial strength and in the value of the dollar. If the dollar goes down in value faster than the price of US treasuries, then buying treasuries is a bad investment. The present situation is the reverse of this indicator; therefore we have not yet crossed the threshold of unacceptable of debt. The world's financial speculators are still willing to invest and hold US treasuries. They vote with their money.

Myth Recently, the rhetoric made use of the term “job creators” when referring to the rich. Is it the proper term or is it misleading?

Fact The real job creators are the consumers. The boss will hire more workers if present business capacity is unable to fully satisfy consumers’ demand for goods and services. The boss will lay off employees if business capacity exceeds consumers’ demand. Taxes have little to do with hiring or firing of employees. The bosses do not create jobs. In their attempts to maximize their profit they act to satisfy demand in response to the real job creators—the customers.

What we need right now is a “Demand-Side” economic policy.

Myth The budget deficit is a job killing apparatus.

Fact The only condition under which the above myth becomes true is when the budget deficit prevents government from spending more on job creations. During high unemployment, government spending cuts bring about job cuts and a reduction in the number of taxpayers. One of the main reasons for the larger deficit is the great recession, the high unemployment, and the government reluctance to grow the deficit in favor of job creations.

Myth The US needs a Balanced Budget amendment to the constitution. Government must act like responsible individuals and businesses, who balance their budgets and live within their means

Fact A balanced budget means that government expenditures must be equal to its revenues. Moreover, it implies that the government’s borrowing should be curbed because selling treasury bonds enables it to spend over and above its revenue.

This myth is ironic. Living within one’s means does not require that person or business to balance income versus expenses. Most of us sign in on a mortgage when buying our homes, take student loans, finance the purchase of a new car or incur some other form of debt to enable investments and other capital intensive purchases. Businesses sell stocks and bonds to support growth, investments and expenses exceeding their current income.

In short, most people and businesses use leverage to facilitate growth, investments and expenses. They all balance their budget eventually, once loans are fully paid. Except they do so over a long period of time rather than within a single year as proposed by the Congressional Republicans’ balanced budget amendment.

Under a balanced budget amendment Government may be paralyzed at times of emergencies when it’s most needed. It will not be able to act quickly and decisively during unforeseen events like natural disasters such as Katrina, man-made disasters such as wars, or economic calamities such as the collapse of the auto industry, the breakdown of the financial sector or both. History has demonstrated that attempts to balance the budget during an economic depression caused more harm than good, and the damage was not confined to the short term. There is no need for a balanced budget amendment, especially now, when the economy is sluggish and unemployment is high. Shocking the economy at this point by forcing massive budgetary cuts in the short term is insane, unless policy makers are nostalgic about the great depression and feel like living through a greater one.

A cyclically balanced budget was first proposed by the biblical Joseph who argued that government should create a budget (food) surplus in (the next seven) boom years to cover for a budget deficit in (the next seven) lean years. He applied the Keynesian economic model (thousands of years before Keynes was born) of an active government fiscal policy designed to smooth and level economic cycles by providing restrains (in the form of higher taxes and spending cuts) in boom years, while growing government expenditures and lowering taxes during recessions.

Joseph was proved right. He saved Egypt (including his own brothers) from mass starvation.

Myth Taxes are too high in the US

Fact Taxes are the lowest they have ever been. Income tax payments this year will be nearly 13% lower than in 2008—the last full year of the Bush presidency. The poor economy is largely to blame for the low tax rate, but the tax code is not an innocent bystander either. It grows each year with new deductions, credits and exemptions. Both rich and poor pay significantly less than they did in the past.

 Myth Supply Side Economics is what America needs.

Fact The Supply Side concept is that lower tax rates would provide strong incentives to earn more income, and as a consequence tax revenues would go up. The theory works when marginal taxes are very high. The idea does not work when the marginal tax rate is as low as it is now. There are historical proofs to that fact. Tax cuts in 1980 and in 2000 did not work as advertised. The 1980 tax cut did, however, raise more tax revenue from the highest tax bracket, but the theory failed at the lower ones. The 2000 tax cut reduced revenue in all brackets.

Most economists agree that the major US companies are sitting on piles of cash, not willing to invest, hire, or use it for growing their business. There is lack of consumers’ demand required to justify any form of expansion. It’s not the supply side that one needs to worry about these days. It’s the weakness presented by the demand side that prevents economic growth in the US.

Myth Government does not create jobs.

Fact There are two main roles the government plays in the economy. It is the largest employer of the American workforce in addition to being the private sector’s most significant customer. As of March, 2009 Total Federal government employees amounted to over 2.8 million people with monthly payroll exceeding $15 Billion, not including the armed forces. The number of state and local employees was equal to over 5.3 million with payroll for that month equal to a figure exceeding $19.3 Billion.

Government purchases of goods and services including healthcare, education and defense in 2010 amounted to $2.764 Trillion. The figure does not include expenditures for pensions, welfare and interest payments.

Government expenditures are directly responsible for spawning millions of jobs in the private sector. Government expenditures for pensions, welfare and interest provide an indirect stimulus, offsetting some of the counter-stimulus tax burden.

Myth The US Economy is like the Greek Economy

Fact One of conservatives’ favorite talking points these days is that the U.S. is going to end up like Greece if we don’t do something drastic. This statement ignores some basic realities.

Greece’s economy is small and relatively insignificant compared to the US economy. Unlike the US, Greece’s debt is not in its own currency. In fact, Greece doesn’t even have its own currency. Unlike the US, Greece’s fiscal and monetary policies are not coordinated because Greece has no control over its monetary policy.

The US can prevent defaulting on its own debt unless it chooses otherwise. All real economists are in the opinion that a country can always pay its debt when the debt is in its own currency. It can simply print more money and devalue its currency and its debt in the process.

In spite of the Great Recession the US has a vibrant economy. Its production capacity, innovative atmosphere and capital levels, are unmatched in the world. Not a single person can say that about Greece.

Myth The Obama/Bernanke bailouts have been wrong and ineffective

Fact TARP— the Troubled Assets Relief Program, created in October 2008 at the height of the financial crisis has been one of the most prominent success stories of the great recession. Not only most of the $410 billion (out of the authorized $700 billion) is being paid back, but it did hit the brakes on the down spiral of the economy following the Lehman Brothers’ collapse.

Real economists agree that without TARP and the massive quantitative easing (QE) by the Federal Reserve unemployment could have risen to levels matching or even exceeding the levels of the Great Depression. It is a fact that proper government economic policies have been directly responsible for 9.1% unemployment. This figure is high compared to an ideal level, but it is very low in comparison to what it could have been had TARP failed to materialize.

Without TARP the American auto industry would have disappeared forever, taking with it all supporting industries and a great deal of the American manufacturing base. Without TARP banks would have failed, AIG would have failed, taking with them numerous industries, shrinking the money supply to a bottom that prevents any economic recovery while sinking the rest of the US to levels equivalent or lower than levels experienced during the Great Depression.

Claiming that TARP has weakened the economy is like claiming that the CIA (rather than al Qaeda) flew airplanes into the World Trade Center. Go figure…

Myth The Obama Administration created the largest budget deficit ever

Fact This statement is actually true, but it fails to deliver an authentic picture. The Obama Administration had no choice but to save a troubled economy and to support the troops in two wars it inherited. The Administration shouldn’t be blamed for trying to get the economy out of the ditch; it had no choice. And given the circumstances, it was the right thing to do.

Myth The next generation will have to pay for the present government spending spree.

Fact True but distorted. The next generation would have paid much more if unemployment and underemployment reached levels of the Great Depression since parents would not have been able to invest in their children’s future. Government spending is not the only reason for the largest US budget deficit ever. The Bush tax cut is clearly a contributing factor. Still, tax cuts and greater levels of government spending were preferred to balancing the budget during the Great Recession. Running a budget deficit has been a better choice than sliding down the cliff the US was staring at, following the collapse of Lehman Brothers.

Had the US slide into a great depression by cutting on government spending following the collapse of Lehman Brothers, the next generation would have paid more by being deprived of opportunities to invest in self-growth such as education, business, and health care.

Myth Balancing the budget can only be accomplished by reducing spending rather than raising revenue since there is a need to transfer more resources to the private sector away from the government.

Fact As I have argued earlier, there is no evidence favoring Supply-Side Economics. Accordingly, there is no proof that the private sector can, on its own, lift the economy out of the ditch. There is plenty of evidence to the contrary. The private sector is frozen due to lack of demand. The only force that could jump start the economy at this point is an economic force not motivated by profit. Businesses will not invest and will not hire unless they see evidence of renewed economic activity justifying new spending. If we depend on the private sector to jump start the economy we must provide it with a compelling reason. In the absence of one, the recession will only get worse since leaving it unchecked will only cause it to feed upon itself, spiral down the cliff to levels of a Great Depression. Ubiquitous absence of demand generates more of the same, more layoffs, more depression.

The statement above is true only when the economy is healthy, when it fires on all cylinders at full force, when it benefits from full employment. In times of high unemployment when so many resources are unutilized, pulling resources out of an idle pool does not deprive the private sector. On the contrary, it spawns new job creators—more working consumers who are willing and eager to spend their earned income on goods and services produced by the private sector.

Myth Raising the debt ceiling is a Democrat’s Socialist’s idea

Fact When president Obama was a senator, and when Bush was president. Obama objected to raising the debt ceiling. When President Reagan faced the same issue he argued that “Unfortunately, Congress consistently brings the Government to the edge of default before facing its responsibility. This brinkmanship threatens the holders of government bonds and those who rely on Social Security and veterans benefits. Interest rates would skyrocket, instability would occur in financial markets, and the Federal deficit would soar. The United States has a special responsibility to itself and the world to meet its obligations. It means we have a well-earned reputation for reliability and credibility—two things that set us apart from much of the world.”

Would you still argue that it’s a democrat’s idea consistent with a tax and spend policy?

Myth Conservatives have accused the Obama Administration for following the Keynesian policy of Tax and Spend. Is it really what Keynes advocated?

Fact Keynes advocated an active fiscal policy by the government to balance and repair the economic conditions. In fact, he believed in increasing taxes and reducing spending in times of inflationary pressures while reducing taxes and increasing spending in times of high unemployment. This is the opposite of a straight tax and spends policy.

Myth There is a serious risk of default by the US government if the long term debt is not reduced

Fact Not true! There are no economic scenarios other than self-inflicted political ones, which could prevent the US from tending to its financial obligations. All real economists (including Alan Greenspan) are in the opinion that a country can always pay its debt when the debt is in its own currency. It can simply print more money and devalue its currency and its debt in the process.

Myth S&P downgrade of the American credit rating is due to the growing US government’s budget deficit

Fact Credit rating is a reflection or an assessment of the borrower’s probability of default. S&P downgraded the American credit rating because the risk of default on US government obligations has increased substantially due to the dysfunctional political environment in Washington. The US can always pay its debt and fulfill its financial obligations unless politics rather than economics prevent it from doing so. The probability of an American default on its government financial obligations has been shown to be positive due to the Tea Party’s suicidal declaration concerning their willingness to default should their demands be passed over. 

Myth The S&P downgrade of the American credit rating has taken place under Obama’s watch. Consequently, it’s all Obama’s fault.

Fact Had their demands failed to materialize, the Republican led Tea Party indicated that it was willing to default on US government’s obligation by refusing to raise the debt ceiling. The world was watching in horror as the Republicans took the American and the world’s economy hostage, held a gun to its head and threatened to kill it.

It becomes problematic for a lender to feel that his money is safe at the hands of lunatics who may refuse to honor their future obligations even if they have the ability to pay.

Myth The Tea Party is solely responsible for the S&P downgrade of the American credit rating

Fact Obama’s poor negotiating ability is partially responsible for the debt ceiling crisis. The president bought into the Republican strategy of linking the lifting of the debt ceiling to the budget deficit reduction. In fact, he kept reinforcing that false notion by stating his refusal to using the 14th amendment. He brought a knife to a gun fight; he should have threatened to raise or eliminate the debt ceiling regardless of the Republican’s position on the budget deficit. Had he done so, he would have eliminated the threat of default; he would have taken the extortion power away from the Tea Party by amputating the hand holding the gun to the US economy’s head. And he would have emerged a winner out of the budget deficit debate.

Obama should have made clear that he had not agreed to acknowledge any dependence between the lifting of the debt ceiling and the budget deficit. He should have tried to rip the debt ceiling to shreds, knock it down altogether. He should have made clear that the American government must honor its obligations regardless of the budget deficit’s size, since each and every time we approach it, we realize that we have no choice but to raise it yet again. Government spending must be conducted responsibly with an eye on the size of the deficit regardless of the existence or the absence of a debt ceiling.

The US is the only country in the world, which has a limiting debt ceiling (Denmark has one, but it is much too high in comparison to its budget, making it irrelevant).

Having an arbitrary debt ceiling is the only reason the US credit rating comes into question.

Fact A balanced budget means that government expenditures must be equal to its revenues. Moreover, it implies that the government’s borrowing should be curbed because selling treasury bonds enables it to spend over and above its revenue.

This myth is ironic. Living within one’s means does not require that person or business to balance income versus expenses. Most of us sign in on a mortgage when buying our homes, take student loans, finance the purchase of a new car or incur some other form of debt to enable investments and other capital intensive purchases. Businesses sell stocks and bonds to support growth, investments and expenses exceeding their current income.

In short, most people and businesses use leverage to facilitate growth, investments and expenses. They all balance their budget eventually, after loans are fully paid. Except they do so over a long period of time rather than within a single year as proposed by the Congressional Republicans’ balanced budget amendment.

A cyclically balanced budget was first proposed by the biblical Joseph who argued that government should create a budget (food) surplus in (the next seven) boom years to cover for a budget deficit in (the next seven) lean years. He applied the Keynesian economic model (thousands of years before Keynes was born) of an active government fiscal policy designed to smooth and level economic cycles by providing restrains (in the form of higher taxes and spending cuts) in boom years, while growing government expenditures and lowering taxes during recessions.

Joseph was proved right. He saved Egypt (including his own brothers) from mass starvation.

Myth There is plenty of proof that the Keynesian economic model does not work. Obama tried it with the failing stimulus; Japan applied it during the 90’s but still lost the decade to anemic growth; Roosevelt implemented it during the Great Depression, but it took more than a decade to finally spawn real economic growth.

Fact Jumping out of an airplane while the parachute opens, but only partially, may lead to serious injury short of death. Witnessing this tragedy, some may argue that parachutes are useless. Some others may counter by saying that the parachutist would have been killed had he jumped without it.

Truth is, parachutes work when they operate to their full extent.

The same is true with Keynesian economics.

During the Great Depression Roosevelt’s policies were able to stop the down spiral of the US economy. The American way of life was saved, but it was still in bad shape. Following Roosevelt’s ascent to power the economy changed course. It embarked on a positive trajectory until 1937. Then, fiscal conservatives were able to shape the agenda and force a reduction in government spending. The inevitable outcome turned out to be an economic contraction and a second dip in economic activity. World War II lifted the US out of the Great Depression thanks to massive government spending supported by a massive budget deficit (emphasis on massive).

History has demonstrated that the Keynesian model proved right when implemented to its full extent.

Japan’s lost decade can be characterized by government’s half measures. When economic activity seemed to converge on a positive trajectory, the Japanese government pulled back, bringing progress to a standstill once again. They kept playing the same music throughout the anemic decade.

Most objective economists agree that the US government’s (including the Federal Reserves’) economic programs saved the US from another Great Depression.

As I argued iearlier, TARP was a great success. The lowest ever tax rates during the past three years have helped lift the US economy out of its negative GDP growth. Other stimuli were not highly successful due to typical government inefficiencies, but they did save thousands of teachers’, police’s and firefighters’ jobs. The Feds’ two-phased Quantitative Easing was helpful in stabilizing the financial system and lifting the stock market. Overall, government spending during the Great Recession was high; it contributed to a pull from the brink of another Great Depression.

It has been insufficient. Unemployment is still high. The deficit has soared to a level unparalleled in history, giving birth to those claiming that Keynesian policies do not work—the Tea Party. The parachute opened half way only because fiscal conservatives were able to dominate the economic agenda. They were successful in changing the topic from job growth to deficit reduction. They were intent on repeating the mistakes of 1937.

Myth Obama is a liberal Marxist

Fact Obama’s track record is one of a person who has saved big business from massive failures. He saved the auto industry, the big banks, and AIG. Although TARP was initiated under his watch, his government’s ownership of these companies has never intended to assume permanency or operational control. In fact, most of the TARP money has been repaid and capitalism has been revitalized thanks to it.

Charging a president with communist tendencies may be more appropriate to someone who tries to control inflationary pressures, not through reduction in government spending, but rather via price, wage and rent control. These administrative measures represent a great departure from the free market forces of supply and demand. These are measures taken by communist s and socialists. These measures were taken by Richard Nixon, a Republican president.

Obama caved in to the Tea Party’s demands in his attempt to forestall a US government default on its debt. He sided with most of the conservative agenda. He did not raise taxes; he agreed to severe budget cuts. These facts make him more conservative than most members of his Democratic Party.

Myth The Tea Party victory in the latest election represents the will of the people

Fact In spite of numerous claims by members of the Tea Party, they do not represent the majority of the American people. They are a small minority elected out of highly conservative districts. Their agenda is not the “people’s agenda”, but rather a small “group of people’s agenda”.

The Tea Party’s source of power is their disregard to the welfare of the American people. When you say “No compromise” from the outset, your negotiating position is enhanced. When you take hostages and threaten to kill them if your demands are not met by the deadline, your negotiating position is enhanced as long as the other side cares. When you are willing to commit suicide defending your religion or your ideology, when you are willing to martyr yourself, kill and be killed in the process, you become an extremely tough opponent. Your aggression may pay off if the other side cares about the rest of us, if the other side is civilized.

There is a war in Washington. There are wars in parts of the world. Hate and killing is part of the equation. But even under these circumstances, there are rules. The warring parties are not allowed the use of WMD. Holding the debt ceiling hostage and announcing willingness to default was equivalent to using financial WMD. It should have been deemed illegal. Even though I support the cause of taking control of the budget, I resent the use of WMD in support of that cause. So please do not misunderstand my position. I support the goal of financial responsibility. I object to the means used by the tea party to achieve it.

The Tea Party’s winning record has made them more confident, more arrogant, more aggressive and more dangerous. S&P must have taken that fact into account when considering the probability of the US becoming irresponsible when it comes to fulfilling its financial obligations.

Myth Obama’s threat of defaulting on US debt had been merely scare tactics and fear mongering. Freezing the debt ceiling in place would not have caused any default. In the worst case, a frozen debt ceiling might have forced late payment on some bills.

Fact Those who spread that myth fail to understand the seriousness of a default on US financial obligations. It is not by any means equivalent to a late payment. It is a default. And had the US defaulted or even suggested that it would default, it would have set off a worldwide panic that would have made the S&P downgrade look insignificant compared to the long term world market downgrade of US financial viability and credit worthiness. The damage would have been felt by innocent bystanders all throughout the world.

Bio
Dr. Avi Perry, a talk show host at Paltalk News Network (PNN), is the author of "Fundamentals of Voice Quality Engineering in Wireless Networks," and more recently, "72 Virgins," a thriller about the covert war on Islamic terror. He was a VP at NMS Communications, a Bell Laboratories -distinguished staff member and manager, a delegate of the US and Lucent Technologies to the ITU—the UN International Standards body in Geneva, a professor at Northwestern University and Intelligence expert for the Israeli Government