Standard & Poor’s downgraded the US government’s credit from “Supermassively Awesome” to “Slightly Less Supermassively Awesome But Still Totally Great”. Markets responded as you’d expect, with a blind irrational panic, selling out of stocks and corporate debt and buying US Treasuries. One of the lesser known underlying assumptions of the Efficient Market Hypothesis is that under no circumstances do traders crush up Xanax and snort it off the asses of escorts. In other words, trying to understand the situation using the rational approach only gets you so far.
One of the things that was interesting about the ratings downgrade was the explicit mention by S&P of the political intransigence in Washington. Despite this, many pundits on both sides–because there are always only two sides to any issue so shut the hell up–tried to spin the story to their advantage. On the right, the finger was squarely pointed at Obama, on the left the finger was pointed at the tea party.
Let’s start chopping off fingers.
What is happening here is that the reasonable and sane minorities of both parties have been basically held hostage by their respective extreme wings for just a wee bit too long. On the far left, no one ever wants to cut Social Security or Medicare, and much to the contrary, they want to expand government healthcare programs to cover everyone. On the Tea Party far right, they incessantly chant the mantra of “no new taxes on the top X%.” And oddly, as X becomes smaller the chanting gets louder.
What the S&P story did, and what the markets are are doing generally by careening headlong into the abyss is establishing a cover story for the rational few in Congress. The last budget deal was the product of the lunatics running the asylum. Wall Street responds with what amounts to an open call for any responsible grown-ups to take charge.
The downgrade allows the old-line, non-Tea Party moderate Republicans to “concede to” (read: “push aggressively for”) tax increases on the rich and blame Wall Street. “If we want to get our credit rating back, we need to raise taxes, and as much as I hate to do so…” The centrist democrats likewise can push for more spending cuts in the big entitlement programs by calling the downgrade and weak 401k portfolios as a “soft tax” on the middle class.
I’m not suggesting that this is a conscious or a deliberate orchestration or manipulation of the credit rating agencies or the news the like, but rather how it will play out. A problem begets a solution, but if that solution fails or is dysfunctional, the failed solution begets a reaction.
The finger-pointing by pundits is pointless fingering. The rating downgrade does not embolden either party against the other. No one won, no one can claim to be vindicated. What it does is embolden the moderates against their fringes. They can point to this chaos as the original problem returning (spending grossly in excess of revenue with no possibility to grow out of it), but aggravated and mutated by the failed solution (no faith in Washington, and leadership without credibility).
So this becomes one of those rare situations where the parties voluntarily give up that with they held most dear. In a divided Congress, Democrats can’t increase taxes on the wealthy. But moderate Republicans can, so they will. And Republicans can’t cut entitlement spending, but moderate Democrats can. This news is just bad enough for the moderates to cut a deal with each other and outnumber (and outvote) the combined fringes. And when the base is outraged over the deal, the moderates can point to S&P or Wall Street and say “We had no choice.”
And what will that deal be? Hefty tax increases and steep cuts to entitlements. Everyone will feel the pain, everyone will suffer, everyone will lose. And they will cut this deal because regardless of their party affiliation, no one wants to watch the world burn.