Double-A-Plus Debt and the Double-Dip Recession Threat
by Andrew Kliman
On August 5, Standard & Poor’s (S&P), one of the three main credit-rating agencies in the U.S., downgraded Treasury debt from AAA to AA+, and it noted that a further downgrade could occur within the next two years. The unprecedented downgrade of the world’s only military and economic superpower certainly made for dramatic news. Yet it is not clear that its significance is more than symbolic.
The factors that S&P cited as reasons for the downgrade are hardly news. It said that the “political brinksmanship” that led up to the recent increase in the government’s debt ceiling indicates that “America’s governance and policymaking [are] becoming less stable, less effective, and less predictable than what we previously believed.” It also commented that “elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden.” This assessment of the asinine debt-ceiling game of chicken and the budget-cutting deal that does next to nothing to solve the government’s rapidly worsening debt problems is very widely shared and difficult to disagree with.
And the downgrade doesn’t reflect any concern that the government is, or will be, unable to repay its debt. The absolute worst-case scenario is that, at some future point, it won’t be able to repay its existing debt by borrowing new funds in the bond market; but in that case it could still create new dollars out of nothing and use them to repay its debt. How many euros or renminbi, or how much gold, those dollars would be worth is another matter. S&P’s downgrade seems to reflect concern with the worth of the dollar rather than default on debt, and/or concern that future Republican shenanigans could cause the government to miss some debt payments even though it has the ability to make them.
There are reasons to doubt that the latest decline in stock prices has anything to do with the downgrading of Treasury debt or the events behind it. The stock-price decline has been worldwide, not confined to the U.S., and market participants had known for some time before S&P’s announcement that it and other rating agencies were considering reductions in the government’s rating. Moreover, participants in the bond market are not acting as if the U.S. government is a greater default risk than before. On the contrary, as the economic news has worsened, demand for Treasury securities has increased even though yields have fallen, which reflects a belief that U.S. government debt is a relatively safer investment than the alternatives.
But economic analyst David Rosenberg did recently put forward a plausible link between the downgrade and lower stock prices: “history shows that downgrades light a fire under policymakers and the belt-tightening budget cuts ensue, taking a big chunk out of demand growth and hence profits.” And reduced expectations of future profits are among the main reasons why stock prices fall.
Other Forces at Work
Other forces have also been at work in recent weeks that have reduced expectations of future profits. On July 29, the U.S. government released its initial estimate that real Gross Domestic Product increased at an annual rate of only 1.3% in the 2nd quarter of this year, which is only about two-fifths the average rate. But what was more shocking were the revisions to earlier figures, which indicate that the decline in production and income during the Great Recession was about 25% more than earlier figures suggested, and that the post-Recession recovery has been a good deal weaker. It is now three and a half years after the Recession officially began, and two full years after it officially ended, and the country’s production and income have still not recovered to their pre-Recession level.
The revised figures also indicate that while real GDP grew by 3.3% during the first 4 quarters of recovery—which is only average growth and below the average for recovery periods—the growth rate dropped in half, to 1.6%, during the latest 4 quarters. GDP growth during the past two quarters has been particularly week. This has caused productivity—output per labor-hour— to decline in both the first and second quarters, and growth of productivity compared to that of a year earlier has declined for 5 straight quarters, from 6.2% in the 1st quarter of 2010 to 0.8% in the 2nd quarter of this year. Negative productivity growth is especially troubling, because it means that output has not been increasing as fast as employment, and that a new upsurge of layoffs may begin to redress the imbalance if growth of output does not soon improve.
Economic news that came out after the GDP report also suggests that the recovery is stalling and that the U.S. economy is in danger of descending into a double-dip recession. For instance, the Institute for Supply Management announced that its manufacturing index has fallen from more than 61 a few months ago to less than 51 in July, barely more than the 50 benchmark level which would indicate that the manufacturing sector is no longer expanding. A couple of days later, the ISM reported that its non-manufacturing index stood at 52.7 in July, seven points lower than in February. This suggests that service sector activity is still expanding, but a good deal more slowly than before.
Sandwiched in between these two reports was the government’s latest estimate of consumer spending, which indicates that it has failed to increase, once inflation is taken into account, over the past 4 months. And the National Federation of Independent Business reported last week that its index of sentiment among small businesses had fallen in July for the fifth month in a row. The main reason for the decline is undoubtedly that, despite all we have read about US companies being in great financial shape, 46% of 350,000 small businesses that were recently surveyed reported that their profits were still falling while only 18% reported that their profits were rising.
The latest employment figures were not as bad as had been feared, but the 117,000 increase in payroll employment in July was only average for this recovery. At the current rate of employment growth, the unemployment problem will not go away; it will only get worse. Owing to population growth, somewhat more than 117,000 additional jobs are needed each month just to prevent a decline in the percentage of the population that has jobs. Indeed, that percentage fell to 58.1% last month, about 5 percentage point less than it stood prior to the start of the recession. The 58.1% employment-rate figure is the lowest in 28 years––though this is a misleading comparison, since the figure was generally a lot lower in the past because relatively fewer women were in the paid labor force.
This spate of bad news has caused economic forecasters to lower their projections for U.S. economic growth and increase their estimates of the risk that the economic will descend into another recession. The average estimate is that the probability of a double-dip recession is now about one in three. Martin Feldstein, former president of the National Bureau of Economic Research, who understands short-term economic data about as well as anyone, puts the probability at one in two. He has long argued that the government economic stimulus would pump up the economy temporarily, but be without lasting effects once the stimulus came to an end.
Meanwhile, concerns have been mounting that major French banks are in trouble and that the governments of Spain and Italy might be unable to repay their debts. Up until now, the European debt problems have reached critical levels only in smaller economies such as Greece, Portugal, and Ireland. The causes of the government debt problems vary from country to country, but one factor that cuts across the board is the Great Recession, and the weakness of the subsequent recovery, which have reduced tax revenues and triggered additional social service spending.
The European Central Bank has been reluctant to do much about the growing problem. But recent sharp increases in the rates that Spain and Italy must pay in order to borrow eventually impelled the ECB to start buying these countries’ bonds in order to bring the rates down. This action has been successful, but many economic analysts believe that the crisis will end only when these countries’ creditors are bailed out, in a manner similar to the bailout of creditors that took place in the U.S. during the last couple of years under the Troubled Assets Relief Program (TARP).
That is easier said than done. Much of the bailout money may have to come from Germany, and just as the American public did not want to foot the bill to bail out creditors, neither does the German public. At their joint press conference today, French President Nicolas Sarkozy and German Chancellor Angela Merkel rejected the idea of raising the needed funds by issuing Eurozone bonds. And in light of data released today which indicate that the quarterly growth rates of the German and the Eurozone economies were a paltry 0.1% and 0.2% in the second quarter of this year, doubts are increasing as to whether Germany and France have the financial ability to solve the looming crisis.
Persistent debt problems, combined with massive unemployment and the severe slump in home prices seem to be the main factors that are keeping the economy from growing rapidly since the end of the recession. For a long time, Americans were willing to increase their borrowing and reduce their saving, since they believed that increases in the prices of their houses and shares of stock were an adequate substitute for real cash savings. But those increases have vanished, and many people are worried about whether they will hold on to their jobs and homes, so they have begun to borrow less and save more. And because of continuing debt, unemployment, and housing-sector problems––and probably because of concerns that they will suffer additional losses on existing assets and ultimately have to report losses that they have not yet “recognized”––lenders are less willing to lend. The low level of borrowing/lending has caused spending and economic growth to be sluggish.
The persistent debt problem in this country is largely the result of a slowdown in economic growth that began in the mid-1970s and never improved in a sustained manner thereafter. Existing dollar levels of debt would not present the problems they now present if there were sufficient income to service them, but owing to the slowdown in the growth of income and output since 1973, the income to service them is not sufficient. The slowdown in growth is, in turn, largely due to a long-term slowdown in the rate of investment, or capital accumulation. And since the generation of profit is what makes possible the investment of profit, the dominant cause of the slowdown in investment is the long-term fall in U.S. corporations’ rate of profit, as I have discussed previously in these pages.
Since the collapse of Lehman Brothers in mid –September 2008, the U.S. Treasury’s debt has increased by more than 50%. This increase propped up the economy for a time, but it seems that Feldstein was correct when he argued that it would do so only temporarily. The effects of the Fed’s quantitative easing also seem to have run their course. It seems that policymakers have reached the bottom of their bag of tricks. Given the complex of long-term problems that persist well after the financial crisis and Great Recession have ended, it is hard to see how a sustained boom might begin any time soon. If the U.S. economy manages to avoid a double-dip recession, the most likely outcome seems to be a Japanese-style “lost decade.” We are a third of the way through such a decade already.
But if there is not a brisk turnaround, hundreds of millions of people here and abroad will long remain without jobs, burdened with unsustainable debt, and faced with worsening conditions as more and more austerity policies are imposed upon them. In response, struggles that are unmistakably class struggles have broken out in country after country, and they will undoubtedly continue.
For a quarter century or more, dominant tendencies in Marxist and radical thought have been preoccupied by the power of capital and the apparent totality and stability of the capitalist system. The class struggle has been ridiculed as a thing of the past, if not a myth. This way of thinking reflected the world of a particular moment. But we are now living in a very different moment.