The rating agency, whose "objectivity" was recently fully exposed after it has been persistently the one rater who refuses to downgrade Greece, even after its peers S&P and Fitch have made Greek bond eligibility for ECB collateral contingent purely on Moody's lack of conscience, is pretending that it has some credibility after all, by doing a little extra posturing, and grumbling that if things get much worse, it may, just may, consider dropping the US AAA rating. This, of course, despite Tim Geithner's promise that the US would only be downgraded over his dead body, or something like that. Furthermore, as we have recently learned, the FRBNY has a "proactive" influence in rating agency decisions. To assume that Mr. Brian Peters of the New York Fed would return a Moody's call and say "yes, we agree with your assumption that the US is not really AAA-worthy, please go ahead and downgrade us" requires copious amount of prior consumption of LSD and other hallucinogenics. Yet for those who still care about what output Moody's produces, here is the full relevant text discussing the outlook for the United States.
GDP Growth: One Quarter of Strength, But…?
Real GDP increased at a relatively strong annual rate of 5.9% in the fourth quarter of last year, following a rate of 2.2% in the third quarter. However, well over half of the rise in Q4 was the result of inventory accumulation, and personal consumption expenditures rose only 1.7%, a deceleration from the 2.8% rise in the previous quarter. The household savings rate for the year as a whole was 4.3%, more than double the rate of 2007 - as deleveraging affected spending patterns. Another factor that prevented consumption from growing more strongly is the unemployment rate, which averaged 10% during the last quarter before falling to 9.7% in January and February.
The pattern of growth and the high rate of unemployment raise the question of how strong the recovery will be going forward. The federal government budget assumes a 2.7% real growth rate in 2010, with private forecasts slightly higher. This figure is less than the average growth rate during the ten years up until 2007, which included a mild recession following the bursting of the “high-tech bubble.” During the same ten years, personal consumption rose at an average annual rate of 3.6%, and it appears unlikely to match that rate in the near term. Ultimately, the ability of the US economy to grow more rapidly and, therefore, for government revenues to contribute to fiscal consolidation, will have to depend on a revival in the growth rate of consumption. The need for fiscal consolidation, a poor (but stabilizing) housing market, and low capacity utilization that affects the level of business fixed investment all indicate that other areas of the economy are unlikely to provide strong growth impetus.
Very High Deficit in the Current Fiscal Year
In the budget announced in February for fiscal year 2011, the administration estimates that the federal deficit in the current fiscal year will rise to 10.6% of GDP, the highest level since 1946. For the second consecutive year, total revenues are estimated at 14.8% of GDP, down from 18.5% in 2007 and a recent peak of 20.6% in 2000. The 2009-2010 level of receipts as a proportion of the economy is the lowest since 1950. While this revenue drop shows the severe effects of the recession (and tax reductions that formed part of the stimulus package) on the government’s fiscal position, the exceptionally low level of revenue also indicates that there is room for increasing revenues once the effects of the recession recede.
Expenditures also are setting post World-War-II records, with the current year showing a peak of 25.4% of GDP and FY 2011 only slightly lower. The high levels of expenditure in these two years represent stimulus spending as well as peak spending for defense, although the latter is lower as a percentage of GDP than during the decades from 1950 to 1990.
The very high deficit in the current fiscal year will bring federal government debt to 64% of GDP, according to the budget estimates, compared with 40% two years earlier. Because of the drop in revenue, the ratio of debt to revenue will reach 430%, more than double its level at the end of FY 2007. Nonetheless, for the time being the affordability of the much larger debt has not deteriorated, with the ratio of interest payments to revenue falling to 8.7% in the current year from a recent peak of 10.0% in FY 2008. During the period through 2013, this ratio should rise but remain well below levels reached during the 1980s, according to the budget.
At the general government level (including state and local governments), a measure used for international comparison purposes, the level of debt in relation to GDP will rise to 92% at the end of the current year before reaching 101% by 2013. While this is a very high level, the affordability of the debt, with interest/revenue at 10% in 2013, will just breach the bottom of the reversibility band (as illustrated on the top left chart on page 16). Nonetheless, both federal and general government affordability is growing more vulnerable to any shift in market confidence that would lead to higher interest rates than assumed in these projections.
Uncertain Prospects for Further Fiscal Consolidation
The ten-year outlook included in the budget for the federal government shows a continuous rise in the ratios of debt to GDP and interest to revenue (despite some decline in the ratio of debt to revenue). By the end of the period, debt affordability would deteriorate to approximately the peak level seen during the 1980s, i.e., a ratio of interest to revenue of about 18%. The difference this time, however, is that the ratio would reach that level due to the size of the debt, whereas during the 1980s it was monetary policy that caused interest rates to be high. As monetary policy was eased, affordability improved.
If such a trajectory were to materialize, there would at some point be downward pressure on the Aaa rating of the federal government. The administration has announced the establishment of a National Commission on Fiscal Responsibility and Reform, which is charged with making recommendations for improving the debt trajectory by achieving a primary balance by 2015 (currently projected as a deficit of 0.9% of GDP), as well as other, longer-term reforms. The latter would most likely have to include entitlement programs to be successful. The politics of actually implementing such reforms remain uncertain.
In the charts on the next two pages, we illustrate debt trajectories for both the US general government (the relevant aggregate for international comparison and for an assessment of the degree of ‘constraint’ that public debt exerts on the economy) and the federal government alone (in recognition of the larger degree of separation of federal and local governments in the US than in peer Aaa countries).