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Home Publications Blogs Beat the Press What Does Moody's Mean If It Downgrades U.S. Debt?

What Does Moody's Mean If It Downgrades U.S. Debt?

Friday, 14 September 2012 04:52

The NYT tells us that Moody's, the bond-rating agency that thought all those subprime mortgage backed securities were Aaa, is threatening to downgrade U.S. government debt if Congress doesn't meet its conditions. While the markets will probably ignore a downgrade from Moody's, just as they did the downgrade from Standard and Poor's last year (the price of U.S. Treasury bonds soared in the period immediately following the downgrade), it still would be worth asking what Moody's might mean by a downgrade.

In principle, Moody's is rating the risk of default. U.S. government debt is issued in dollars. The U.S. government prints dollars. Does Moody's believe that there is a growing probability that the United States will forget how to print dollars?

There is the issue that the Fed has control of the money supply and the Fed is distinct from the Treasury. As an anti-inflation policy, the Fed may limit its issuance of money even as interest rates on U.S. government debt soared. However in a crisis can anyone believe that the Fed would actually let the country default rather than buy up government debt?

Furthermore, at the end of the day the Fed is answerable to Congress. If a particular group of Fed governors and bank presidents was prepared to let the government default rather than buy up bonds, does anyone think Congress would just let this happen rather than replace the individuals or restructure the Fed altogether? That seems highly unlikely, but is this what Moody's now thinks could happen?

There is another story sometimes told that Moody's is simply indicating that it believes that there is an increased risk of future inflation if deficits are not brought under control. That is an interesting proposition, but it means that Moody's is making an inflation prediction, not assessing the risk of default.


If Moody's is simply warning of a risk that higher inflation will erode the value of U.S. government debt then it should extend this concern to all dollar denominated assets regardless of the issuer. The point would be that anyone holding a bond denominated in dollars risks seeing its value eroded due to higher inflation in the future, therefore all bonds denominated in dollars should be downgraded if U.S. government debt is downgraded.

There is also the issue that Moody's does not seem to have been in the business of issuing inflation warnings in prior years. It did not downgrade U.S. government debt in the 70s even as inflation rose into the double digits. In those years bond holders really did see a substantial erosion of the value of the debt due to inflation yet the alarm bells never went off at Moody's or Standard and Poor's.

So if a risk of inflation is now the basis for a downgrade, this is a new policy. It would be worth asking when the bond rating agencies changed their approach.

Of course there is another possibility. It could be that the bond rating agencies are simply being political. That they are trying to impose the budget policies that the Wall Street crowd, of which they are a part, would like to see. While no one would want to accuse the bond rating agencies of using their ratings to push a political agenda, there does not seem to a plausible alternative explanation. If there is, the NYT and other media outlets should supply it.

Comments (7)Add Comment
Simultaneous Certainty in Opposite Directions = Uncertainty
written by Last Mover, September 14, 2012 8:59
It's good to know that fierce competition among credit rating agencies and their parroters help to achieve certainty from both the austerian supply side of debt avoidance in one direction and keynesian demand side of fiscal cliff avoidance financed by more debt in the other direction.

It's like Romney doing etch-a-sketch economics depending on what day it is.
written by skeptonomist, September 14, 2012 1:59
It's not as simple as Dean pictures. A central bank or government can print so much money that it becomes impossible to do business with the country, and its bonds become valueless (all of them as Dean says). This is what happened in Germany and Austria after WW I, apparently done deliberately to escape payment of war reparations. But I agree that the US is nowhere near that situation; and if it does get there, the whole world is in trouble. A small debt-ridden country like Greece would be a candidate for this kind of thing, so if it had its own currency and central bank that would not necessarily improve its credit rating.

If Congress is really deadlocked it is not out of the question that money to pay interest on bonds or redeem them would fail be approved - at least temporarily. This seems to be what Moody's had in mind, or at least what they claim.
written by jerry, September 14, 2012 3:06
"Furthermore, at the end of the day the Fed is answerable to Congress."

Not sure how you're arriving at that conclusion. Congress cannot even get a complete audit of the Fed's balance sheet, much less exert influence over monetary policy. I would have to say it is quite the opposite - Congress is answerable to the Fed (read Wall Street).
the rating agencies
written by mel in oregon, September 14, 2012 5:02
when you start your corporate career, you get interviews at various corporations (at least you did before the economy fell apart). if they are interested they ask you to go look up the corporation at moodys, fitch, best buy etc. then as a young adult, you are quite impressed with the glowing reports of how wonderful your propective employer is. but fairly soon you realize how corrupt both the corporation & the rating service that makes it's money off toadying to the corporation actually is. moody's & bernanke's fed are no different, their total allegiance is to wallstreet.
Welcome to the Jungle
written by Frankly Curious, September 14, 2012 10:25
I'm still trying to get my head around what the ratings agencies are. After the crash, they all said, "We're not responsible. This is just our opinion. Free speech!" And then they all sang "America the Beautiful" and the hearing was over.

What I heard was, "We are no good at our jobs. No one should ever listen to us, much less pay us. Free speech!" And we all sang "Welcome to the Jungle" and the hearing was over.

Why do these companies have any credibility at all?
written by Calgacus, September 15, 2012 4:58
Skeptonomist, that's not what happened in Germany. The basic principle is "unpayable debts won't be paid". Germany spent more & more marks to obtain foreign currency and gold, which their debts were denominated in, at an ever increasing price. Coupled with destruction of productive capacity, this caused the hyperinflation.

Second, Dean is right. The Fed & Treasury could print the money one way or another. If Congress behaves like jerks, a bondholder would sue, and as long as there are any ways out, and there are several, the Treasury must take them.

Stories that any country anywhere has ever just printed money like wild for the hell of it are pure fiction. The reality is that backed with the mythology that issuing bonds MUST BE disinflationary compared to "printing money" & mythology about debts and deficits automatically causing inflation, and the truly ludicrous modern myth of the inefficacy of fiscal policy & the magical potence of monetary policy, the real story is that nations everywhere have printed too little, ran deficits too small - and have gotten high unemployment, rotten growth, bigger deficits in the long run, maldistribution and higher inflation.

The main problem in economics is undersimplification, not oversimplification. The complexity usually comes from adding epicycles to intrinsically nonsensical theories. The idea that simplicity is alien to REAL, HARD SCIENCE, that the truth must be complicated, comprehensible only by us people with giant brains, shows awesome ignorance of the history of philosophy and mathematics. The simple and trivial is frequently very far from obvious, and often comes at the end of decades or centuries of development, not the beginning. (Not that I'm accusing you of such, not at all; just seemed an appropriate time to rant about it). :-)
Choice to Default
written by John M, September 17, 2012 8:34
Anyone who cites Wiemar or Zimbabwe's hyperinflation is oblivious to what really happened in those cases: destruction of productive capacity and/or debt to foreign countries not in their own currency. There's no way the Government or Fed will create enough money to give us runaway inflation.

The Government can't default in the sense of running out of dollars to pay its bills, any more than a football stadium can run out of points to award touchdowns and field goals. On the other hand, the Government may choose to default, in the same sense that a scoreboard operator may choose not to increase the score when a touchdown occurs.

If the government does choose to default, it would take years of litigation, with uncertain results, to hopefully enforce the 14th Amendment and undo the default choice. Why does the government want to control "entitlements" such as Social Security? They want to default on the Social Security debt exclusively, but can't. So they create horror stories calling for fixing Social Security in the sense of reducing benefits.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.