As Reuters reported Monday morning, the S&P rating agency has just threatened to downgrade U.S. Treasury debt. It remains AAA, but S&P says that might change if measures aren't taken to correct the trajectory of growing indebtedness.
The political aspects of this decision by the S&P obviously favor conservative leverage on the upcoming debt ceiling vote. It doesn't change the actual realities of failure to raise the debt ceiling, it just gives conservatives rhetorical resources with which to clamor for deficit reduction during and after the essential act of raising the debt ceiling.
Failure to raise the debt ceiling will trigger default, which will cause staggering losses in the value of Treasuries currently held by U.S. creditors, most of whom are U.S. concerns. It will do so by raising the interest rates required to attract new creditors. Older lower interest T-bonds will become worthless while new ones will be purchased at the risk of their becoming worthless too.
Continued debt growth will do exactly the same thing, over the long run. How long a run is anyone's guess although the S&P says two to three years will tell the tale. It will raise rates paid by government as government absorbs more and more of the world's capital and or the ability of the U.S. economy to service the increasing debt becomes more doubtful. The assumption is that the U.S. will eventually default or inflate the dollar to retire debt if the deficit is not dealt with. For a lot of reasons though, chief of which is that the world is awash in capital, this is not likely to occur anytime soon.
Either way, current Treasury holders lose. That means widespread bankruptcies and bank failures as Treasury assets are marked down in value. It will have the same economic effect as the banking/credit crisis of 2008 where trillions in dollars worth of Collateralized Debt Obligations became worthless over night. The same only bigger. Like it or not, the global economy is super glued to the fate of U.S. credit worthiness.
Everyone already knew this. The S&P does not add information to the argument. The only question at issue is still whether you want to trigger global economic collapse in May/June with a politically motivated default in failure to raise the debt ceiling or work on changing the trajectory of growth in indebtedness in the long term. At issue still is which of the now high profile plans from the House and from the Administration, is most likely to actually lower the deficit and eventually retire the debt. Nothing has changed except that the GOP can now cite the S&P in order to promote deficit hysteria.
If the GOP succeeds in exacting more cuts in discretionary social spending prior to the raising of the debt ceiling with the help of the S&P citation, then the S&P itself will have harmed the economy and our ability to service the debt by its own hand. Also, the S&P may have, out of its own volition, damaged the market for Treasuries with this threat. That remains to be seen, but if so then the S&P may have just cost losses for the people it's supposed to serve. If you're going to screw around with the lynchpin of the global economy you had better consider whether or not it's going to do more harm than good, and the S&P downgrade threat can do no good except politically for the GOP.
Good job, S&P -- this may end up being a worse decision than giving all those CDOs an A rating in investment quality. All politics is about economics and finance. Get the politics right and the finance takes care of itself.