Friday, August 12, 2011

Reflections on Krugman's "Credibility, Chutzpah and Debt"

Click [Here] for the piece by Krugman in question.

I don't understand Krugman's approach of trying to prove his hypothesis by attacking those with opposing views (in this case S&P) for their previous failures; and not by addressing the actual issue at hand, which he glibly papers over with a vague "if you do the math.." remark. In that case, please talk about the math Mr. Krugman and not about what S&P did some years ago. In any case, a lack of vigilance earlier (on the part of S&P, in this case) is no reason to rubbish a greater vigilance now.

US debt has been downgraded from AAA to AA+. AA+ is still a great rating, below it are the ratings AA, AA-, A+, A, and then BBB, which is India's rating*. And none of us here believe that India's going to default on its debt any time soon. My point here is what looks like a downgrade, and factually speaking indeed is, should be seen as a correction, a long delayed revision.

The US government has a debt of 14 trillion USD, roughly equal to the GDP of US. Each year the government makes 2.2 trillion in tax and other revenues (~15% of GDP) and its annual public spending is 3.6 trillion, which Krugman and some others argue (not without some reason I concede) should be increased well above 3.6. Surely the 2.2 trillion is enough to pay the interest on its debt of 14 trillion [and counting; {currently at 1.4 trillion a year (3.6 - 2.2)}]; and therefore they surely won't default on their interest payments. If anyone thought they would, they would have been rated CCC and not AA+. But we have to consider that these are globally uncertain times, and sooner or later some of US's creditors, due to their own difficulties, may want the return of their money rather than the return on their money. When that happens, how ready is the US? The current fiscal standing, coupled with an economic outlook that all investors, economists and even people inside the federal government find grim, if not downright dismaying, certainly called for a rating that was not AAA.

As a little sidenote, I want to highlight 2 more things that I feel are informative with respect to this discussion:

1. The net present value of future liabilities of US is nearly 60 trillion USD.

2. A downgrade should not be equated straightaway to fears of default, as the media most loves to do. No government/nation that has control over its own currency can theoretically ever be forced to default. They can print money. Of course there are huge inflation costs to that action, but the point is, all governments (except Eurozone nations like Greece; since they do not have much control over Euro) can print money to avert default, if push comes to shove.

* After BBB are BB, B, CCC, CC and C. And then SD and D; but they are for nations that have already defaulted.

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