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« Get Started -- Buy One Stock | Main | Weighing the Week Ahead: Paradise for Pundits »

August 06, 2011



Hi Angel --

Try the Koo citations in this article:

I think that is where I saw it originally.

Thanks for helping to research this.


Angel Martin

Jeff, I am still looking for a reference for the 90% debt as an almost certain point of no return for eventual default. I don't believe it is in the Rogoff &Reinhardt "Debt reduces economic growth" paper. so i will have to go back to the book.


Proteus -- Judging from the comments both here and on Seeking Alpha, you are well in the majority.

Everyone thinks that the S&P is conveying a righteous message. I am listening, and I'll follow up.

Thanks for another typically constructive and helpful comment.



Reacher -- I think you are looking too deeply into possible motives.

Meanwhile, I just finished '61 Hours' and I am worried about your apparent death!

Is everything OK?



Hi Angel -- Concerning the 90% debt level - I read something that suggested that this was a tipping point for countries where interest rates were spiking, but not those with low rates.

This has some plausibility. It has been a hectic week and I cannot find the reference. I know that you are an excellent and open-minded researcher, so perhaps you will take a look.

I am sure that you know that there is a world view surrounding the Rogoff work, so this is a major point.




Jeff, it seems like more blog pages and comments have appeared on this topic than on the big market declines. Somewhat surprising.

I disagree with your comment about "Who elected S&P?", although I seem to be very much in the minority. I see nothing wrong with them voicing an opinion about steps needed to improve the US rating. I would feel the same way about other countries or individual companies. Should their being right or wrong in the past (on CDOs) be relevant to whether they are right or wrong now?

As for my own investing, one year ago I would have stated the probability of a US default was "zero". I would now reluctantly say it is still zero, but with a small asterisk.

Angel Martin

Jeff, I looked at Schiller's article and I still disagree with you and Schiller. Points:
-the structural deficit in the BIS article is claimed to be a "cyclically adjusted balance" so I don't think it is correct to state that it is projecting from the worst point in the cycle.
-Schiller references the Rogoff study but leaves out what I think is the most important finding, which is that countries that exceed the 90% debt threshold almost always go on to default via massive inflation or direct debt repudiation
-Schiller can change the denominator of the debt ratio if he wants to, but 90% debt to annual gdp (or 9% of decade gdp) has proven over 800 years to be an important tipping point that investors should not ignore.
-Jeff, "going for growth" and not worrying about debt or inflation was what UK politicians in both parties thought they doing in the 60's and 70's. It didn't really work in the short term and was disastrous in the long term
-what is frustrating to me about all this is that on a P/E and interest rate basis, the S&P offers almost unprecedented value. All of the worst risks to the market come from the government/political sector whether it's sovereign debt or the stability of the euro. If the public sector was not so screwed up, i believe the economy and market would take off like a rocket.


Jack Reacher

Not sure Obama didn't want to "empower the Chinese". Allinsky would. Also, how irresponsible for him to mention no SS checks, and the "threat of possible US default"?

Some leader.

But Jeff, thank you so much for this analysis. I read your work first. And again last. Thanks.



Angel --Three ideas in response to your thoughtful comment.

1) I have written many times about the long-term need to deal with the fiscal imbalance. There is a link at the top of this blog. It is an issue that is best dealt with right AFTER an election and with the deficit reduction commission proposals in hand. There will be entitlement cuts and increased revenue.

2) The chance of default was over-estimated by the media. The bond market did not expect it. If you listened carefully to Congressional leaders, as I did for weeks, it was obvious that there would be a solution. Only the final definition was in doubt.

3) The problem with your structural deficit analysis is that it is based on projecting our economy at the worst point, and assumes no policy changes. The S&P is wrong to demand that this problem be addressed RIGHT NOW.

I planned to use this quote from Robert Shiller in the weekly article (and may still do so) but take a look. Please read the entire article, which provides an excellent perspective.

"The fundamental problem that much of the world faces today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. They are asking governments to cut expenditure while their economies are still vulnerable. Households are running scared, so they cut expenditures as well, and businesses are being dissuaded from borrowing to finance capital expenditures.

The lesson is simple: We should worry less about debt ratios and thresholds, and more about our inability to see these indicators for the artificial – and often irrelevant – constructs that they are."

The point is that our focus should be on restoring economic growth. The ill-timed debt debate is making the problem harder to solve.


Angel Martin

Jeff, I really disagree with the public policy analysis put forward in this article.

The definition of AAA bond is "An obligor rated 'AAA' has EXTREMELY STRONG capacity to meet its financial commitments."

Frankly, if the political process surrounding the debt ceiling can put US creditworthiness at risk, it by definition does not have an "EXTREMELY STRONG capacity to meet its financial commitments."... and shouldn't be rated triple AAA.

Beyond that, the fundamentals of the structural deficit (USA: 8% of GDP for 2011) and the future costs of the retirement programs as reflected in the baseline scenario (table 1 and graph 4)
also suggest that the US should not be rated AAA. And neither should any of those other countries in graph 4. If they really were AAA, they would be solvent under the baseline scenario, and none of them are.

As it is, future solvency is likely only if the political process in these countries can deliver major policy changes that will have a lot of opposition. Any sovereign that is depending on politically uncertain future policy changes cannot honestly be rated as having an "EXTREMELY STRONG capacity to meet its financial commitments."

Based on the above, I think S&P is completely justified in the downgrade - frankly it was long overdue.

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