you loan money to an entity that can legally print as much
money as it desires? When you "purchase" a U.S Treasury
bill, note, or bond, you are loaning money to the federal
government which possesses that ever-menacing printing
press. Of course, the federal government is duty-bound to
repay you, the lender, as prescribed by the debt obligation.
Few people are willing to consider the possibility that the
U.S. government would default on its debt obligations. Nevertheless,
when examined objectively, one could make the case that Uncle
Sam’s sovereign credit rating should be downgraded
perhaps even to "junk." So where are the credit
rating agencies? Are
they going to miss this one just like Enron?
there is a widely-held perception that the U.S. government
is the safest credit risk on the planet heck, mathematical
economists even deem the yield on a U.S. Treasury bill to
be the "risk-free rate of return." If the aforesaid
perception met reality, then the U.S. government would have,
among many things, a sound monetary system (look out for that
printing press), a laissez-faire approach to business, excellent
control over its budget, honest financial reporting, along
with top-flight internal accounting and control systems. If
this doesn’t sound like the U.S. government you know, then
it makes sense to question the conventional wisdom that Uncle
Sam is the safest credit risk on the face of the Earth.
Moody’s Investors and Standard and Poor’s have granted the
U.S. the highest sovereign credit rating possible (Aaa and
AAA respectively). Most other countries are less fortunate
and have lower credit ratings which can affect such
a country’s interest rates and access to the credit markets.
The lower the credit rating, it is believed, the higher the
chances are for a country to default on its sovereign debt
obligations. Be aware S&P downgraded Japan’s sovereign
credit rating to AA on April 15, 2002 (more about this
later). No one wants to lend money to a party that is likely
to renege on its duty to repay with interest.
what comprises a sovereign credit rating system? In the Federal
Reserve Bank of New York’s October 1996 issue of its FRBNY
Economic Policy Review, Richard Cantor and Frank Packer
sifted out eight key variables that S&P and Moody’s
use to determine a country’s sovereign credit rating. In addition
to studying these eight important rating variables, Messrs.
Cantor and Packer conveyed an incredibly important aspect
of such ratings:
ratings are important not only because some of the largest
issuers in the international capital markets are national
governments, but also because these assessments affect the
ratings assigned to borrowers of the same nationality. For
example, agencies seldom, if ever, assign a credit rating
to a local municipality, provincial government, or private
company that is higher than that of the issuer’s home country.
presents quite a conundrum for the rating agencies. In other
words, is the United States becoming a banana-republic borrower
with top-flight companies domiciled on its soil? (I’m referring
to companies whose balance sheets haven’t been raped and pillaged
by Ivy League MBAs.) For example, if the U.S. government had
its rating lowered to a "junk" grade, such as BB+,
would Berkshire Hathaway lose its AAA rating? The ramifications
for downgrading Uncle Sam would be enormous. Thus, one must
wonder if there is the courage necessary, among the major
rating agencies, to properly assess the U.S. government’s
follows are descriptions of the eight key sovereign rating
variables reflecting verbiage exactly as provided by Messrs.
Cantor and Packer (variables 1 though 8). Directly,
after each variable, I provide analysis as to how the
U.S. government measures up in light of the specific variable
at hand. Please note that my analysis includes readily available
research, commentary, and other information. I liberally use
quotes from the likes of James Grant, Bill Gross, Hans-Hermann
Hoppe, Doug Noland, Kurt Richebacher, Murray Rothbard, Hans
Sennholz, and others which demonstrates that much credible
information is available to support a case for downgrading
Uncle Sam’s sovereign credit rating. Consequently, when tallying
how poorly the federal government measures up to each variable,
one must conclude that the U.S. government’s sovereign credit
rating should be revised dramatically downward unquestionably
to a level lower than Japan’s.
#1 per capita income: The greater the potential
tax-base of the borrowing country, the greater the ability
of a government to repay debt. This variable can also serve
as a proxy for the level of political stability and other
Dr. Kurt Richebacher and Tony Allison make the grim points
that personal incomes are not growing and that Americans,
thanks to easy credit, are living well beyond their means.
Not only does this bode ill for Uncle Sam’s tax base, a heavily
indebted populace is not one that provides a foundation for
social and political stability.
following commentary came from Dr. Kurt Richebacher as found
in the January 4, 2005 edition of The
"self-sustaining" U.S. economic recovery urgently needs
accelerating employment and income growth. Just the opposite
is happening. During the six months up to last November,
real disposable personal income grew just 1%, or 2% annualized.
This is down from 3% in the first half of 2004 and 4.8%
in the second half of 2003. Taxes and higher inflation rates
are taking their toll. Debt-financed spending went to new
records. During the third quarter, private households increased
their spending by $139.4 billion, while their earnings increased
only $81.6 billion.
follows is an excerpt from Tony Allison’s December 17, 2004
"Market Wrap Up" as found on Financial
recent years, consumer incomes have not kept up with expenditures.
This is clearly shown in the personal savings rate that
has plunged to near zero. The recurring charges at the grocery
store, dentist, gas station etc. will continue to add up.
As interest rates rise, these household expenses will become
painfully high if not paid off. Imagine how balances for
mortgage and income tax payments will grow over time. This
is the "magic of compounding" in reverse. "Survival
debt" grows into financial suicide when credit limits
the whole, America’s taxpayers are in poor financial shape
they are emulating Uncle Sam’s reckless borrowing habits.
For instance, the
average American household has $8,000 in credit card debt
while total consumer debt is nearly $2 trillion. Additionally,
household mortgage debt is approaching $7.8 trillion.
Thanks to the Federal Reserve, there is a debt bubble in the
United States. When combining stagnant personal income growth
with aggressive personal debt growth, America’s tax base is
built upon sand. It stands to reason that a country’s sovereign
credit rating will eventually reflect the financial health
of its citizens. This being the case, a downgrade of the United
States’ sovereign credit rating seems inevitable.
#2 inflation: A high rate of inflation points to
structural problems in the government’s finances. When a government
appears unable or unwilling to pay for current budgetary expenses
through taxes or debt issuance, it must resort to inflationary
money finance. Public dissatisfaction with inflation may in
turn lead to political instability.
Alan Greenspan is pulling a mass-psychological con job. He
continues to state that inflation is "quiescent"
although he has been a bit more hawkish of late. Apparently,
the maestro doesn’t go grocery shopping or to the gas station
or house hunting. Americans are living in a state of cognitive
dissonance. We know that prices are rising, but so many believe
that Mr. Greenspan has everything under control. Not surprisingly,
Doug Noland, of The Prudent Bear, does not share the maestro’s
view of quiescent inflation. Here is what he wrote in his
December 31, 2004 Credit
U.S. economy is in the midst of a distorted boom, with an
increasingly ingrained inflationary bias. Asset bubbles
are heavily influencing spending and investing patterns,
hence the underlying structure of the economy. The nature
of the U.S. bubble economy – where gross financial excess
is required to fuel minimally acceptable employment gains
– will be an issue for 2005. Current market rates and liquidity
conditions appear poised to initially foster stronger-than-expected
demand domestically and globally, although the unstable
and unbalanced nature of the current global expansion will
continue to provide fodder for those arguing for an imminent
slowdown. I expect the Chinese and Asian inflationary booms
to become increasingly problematic. Energy and commodities
will remain in tight supply, with prices extraordinarily
volatile but with a continued upward bias. The current minority
Fed view that inflation and marketplace speculation pose
increasing risks has potential to become consensus. And
I can certainly envisage a scenario of increasingly anxious
central bankers eyeing inflationary pressures and unstable
markets across the globe.
not lose sight of the fact that inflation itself is an assault
against private property (i.e. money) and should be viewed
accordingly by the bond market and credit rating agencies.
#3 GDP growth: A relatively high rate of economic
growth suggests that a country’s existing debt burden will
become easier to service over time.
As alluded to above, the U.S. government is lying about rising
prices. This also serves to distort the United States’ gross
domestic product (GDP) growth figures. Bill Gross, the highly
respected bond fund manager at PIMCO, penned the following
in the October 2004 issue of Investment
Outlook titled "Haute Con Job:"
I cannot sit quietly on this one, nor as I’ve mentioned,
have other notables in the past few years. The CPI as calculated
may not be a conspiracy but it’s definitely a con job foisted
on an unwitting public by government officials who choose
to look the other way or who convince themselves that they
are fostering some logical adjustment in a New Age Economy
dependent on the markets and not the marketplace for its
survival. If the CPI is so low and therefore real wages
in the black, tell me why U.S. consumers are resorting to
hundreds of billions in home equity takeouts to keep consumption
above the line. If real GDP growth is so high, tell me why
this economy hasn’t created any jobs over the past four
years. High productivity? Nonsense, in part – statistical,
hedonically created nonsense. My sense is that the CPI
is really 1% higher than official figures and that real
GDP is 1% less. You are witnessing a "haute con
job" and one day those gorgeous statistics just like
those gorgeous models, will lose their makeup, add a few
pounds and wind up resembling a middle-aged Mom in a cotton
skirt with better things to do than to chase the latest
fad or ephemeral fashion. (emphasis added)
we have spectacular evidence of moral hazard. The very entity
that owns the printing press is "measuring" the
depreciation of its monetary unit while also measuring economic
growth. The rating agencies must come to understand that the
federal government is putting out works of fiction with respect
to the CPI and to GDP growth.
#4 fiscal balance: A large federal deficit absorbs
private domestic savings and suggests that a government lacks
the ability or will to tax its citizenry to cover current
expenses or to service its debt.
The U.S. government’s debt increased by $595.8 billion during
its fiscal-year 2004. Consequently, at fiscal year-end 9/30/04,
the national debt stood at $7,379,052,696,330. As of January
20, 2005, the national debt totaled to $7,613,215,612,328.
the sheer magnitude of America’s national debt doesn’t cause
alarm, then reading over the U.S. government’s September 30,
2004 financial report should evoke terror. Please note the
federal government does not report its financial condition
according to generally accepted accounting principles (GAAP)
which serves to understate the magnitude of
its liabilities. Here is Uncle Sam’s balance sheet as presented
in the September
30, 2004 financial report:
billions of dollars) 2004
and other monetary assets (Note 2)
receivable, net (Note 3)
receivable, net (Note 4)
receivable, net (Note 5)
and related property, net (Note 6)
plant, and equipment, net (Note 7)
assets (Note 8)
payable (Note 9)
debt securities held by the public and accrued interest
employee and veteran benefits payable (Note 11)
and disposal liabilities (Note 12)
due and payable (Note 13)
guarantee liabilities (Note 4)
liabilities (Note 14)
(Note 18) and Commitments (Note 19)
liabilities and net position
preceding September 30, 2004 balance sheet illustrates that
the U.S. government has a negative net worth of over $7.7
trillion. Keep in mind this balance sheet does not reflect
intragovernmental debt holdings (such as those held by the
Social Security "trust" fund) nor does this balance
sheet include accrued liabilities such as the net present
value of pension, Social Security, and other obligations.
Hence, this balance sheet grossly understates the enormity
of the U.S. government’s deficit net worth position.
4 of the U.S. government’s 9/30/04 financial report contains
a section titled Liabilities and Additional Responsibilities.
This is where the staggering scope of Uncle Sam’s liabilities
is brought to light. Here is an excerpt:
2004 balance sheet shows assets of $1,397 billion and liabilities
of $9,107 billion, for a negative net position of $7,710
billion. In addition, the Government’s responsibilities
to make future payments for social insurance and certain
other programs are not shown as liabilities according to
Federal accounting standards; however, they are measured
in other contexts. These programmatic commitments remain
Federal responsibilities and as currently structured will
have a significant claim on budgetary resources in the future.
net present value for all of the responsibilities (for current
participants over a 75-year period) is $45,892 billion,
including Medicare and Social Security payments, pensions
and benefits for Federal employees and veterans, and other
financial responsibilities. The reader needs to understand
these responsibilities to get a more complete understanding
of the Government’s finances.
you read that correctly. The net present value of the federal
government’s "welfare" obligations is nearly $46
trillion. Add in the liabilities shown on the balance sheet
above, and Uncle Sam’s liabilities exceed $50 trillion. With
a government that took in a little over $1.9 trillion in revenues
in 2004 and has seen its national debt increase every year
since 1957, there is absolutely no way the federal government
can continue to service its debt and fund its welfare obligations
short of resorting to inflating away these liabilities.
Other options include outright repudiation of the national
debt (i.e. a default) and canceling all welfare programs.
How a country, with this horrible of a financial condition,
merits a AAA sovereign credit rating is beyond me.
#5 external balance. A large current account deficit
indicates that the public and private sectors together rely
heavily on funds from abroad. Current account deficits that
persist result in growth in foreign indebtedness, which may
become unsustainable over time.
Regarding the United States’ current account deficit,
it is rapidly approaching the point of unsustainability. Tony
Allison drives the point home
the most daunting debt of all is that owed to foreign sources,
our current account deficit. This is the evil twin to our
lack of domestic saving. We must borrow savings from the
rest of the world to sustain our economy. It is estimated
that the U.S. is currently sucking in 80% of the world’s
savings. Approximately 50% of Treasury debt is now in foreign
hands. The current account deficit is projected to exceed
$600 billion for 2004 and continue to increase in future
years. At 6% of GNP, the U.S. current account deficit has
reached a level that has precipitated currency crises in
numerous developing countries.
it any wonder that the U.S. dollar has become such a weak
kitten in the currency market? The day will come when we can
no longer count on the kindness of strangers. Are rating agencies
taking note of this?
#6 external debt. A higher debt burden should correspond
to a higher risk of default. The weight of the burden increases
as a country’s foreign currency debt rises relative to its
foreign currency earnings (exports).
Speaking of depending upon the kindness of strangers,
Uncle Sam’s overall debt to foreigners (i.e. governments,
etc.) has grown to distressing proportions. As Doug Noland
conveyed in his December 31, 2004 Credit Bubble Bulletin:
"Fed Foreign ‘Custody’ Holdings of Treasury, Agency
debt gained $5.7 billion to $1.336 trillion for the week ended
December 29. Year-to-date, Custody Holdings are up $269.0
billion, or 25.2% annualized." (emphasis in original)
the context of a gold standard, James
the following observation, about external debt, in a recent
hallmark of the classical gold standard was the prompt adjustment
of international payments imbalances. The hallmark of the
pure paper standard is the indefinite postponement of international
payments imbalances. Under the gold standard, a deficit
country, if it persisted in its deficit, would eventually
run out of gold. Under the pure paper standard, a deficit
country, if it's the U.S., can keep right on printing money.
is, it can keep on printing until its creditors cry: "Uncle!"
The New York Fed estimates that, at year-end 2003, foreign
central banks held $2.1 trillion in dollar-denominated securities,
"equivalent to more than half of marketable Treasury debt
this massive external-debt burden high enough to warrant the
interest of rating agencies? If not, then perhaps they should
read a topical Forbes article titled A
Word from a Dollar Bear: Warren Buffett’s vote of no confidence
in U.S. fiscal policies is up to $20 billion. When
Warren Buffett speaks, perhaps the rating agencies should
#7 economic development. Although level of development
is already measured by our per capita income variable, the
rating agencies appear to factor a threshold effect into the
relationship between economic development and risk. That is,
once countries reach a certain income or level of development,
they may be less likely to default. We proxy for this minimum
income or development level with a simple indicator variable
noting whether or not a country is classified as industrialized
by the International Monetary Fund.
One must not confuse a country’s past glory with its future
prospects. The United States has devolved from a republic
to a social democracy. I would argue that the U.S. is experiencing
economic "undevelopment" directly related to the
decivilization process occurring in America today. In Hans-Hermann
Hoppe’s fabulous book Democracy: The God That Failed, Dr.
Hoppe describes what happens to a populace living under nanny-statism.
He describes how the decivilizing nature of social democracy
led to permanently rising taxes, debts, and public employment.
It has led to the destruction of the gold standard, unparalleled
paper-money inflation, and increased protectionism and migration
controls. Even the most fundamental private law provisions
have been perverted by an unabating flood of legislation
and regulation. Simultaneously, as regards civil society,
the institutions of marriage and family have been increasingly
weakened, the number of children has declined, and the rates
of divorce, illegitimacy, single parenthood, singledom,
and abortion have increased…In comparison to the nineteenth
century, the cognitive prowess of the political and intellectual
elites and the quality of public education have declined.
And the rates of crime, structural unemployment, welfare
dependency, parasitism, negligence, recklessness, incivility,
pyschopathy, and hedonism have increased.
one may think that Dr. Hoppe’s words are much too harsh. Using,
as proxies, the staggering amount of debt and welfare obligations
being left for future American generations to tackle (as described
in the analysis of "variable #4" above), I would
argue that he is right on the money. In fact, I would add
that this intergenerational wealth transfer is utterly despicable
and immoral. The prior generations who supported income taxation,
the founding of the Federal Reserve, the New Deal, the Great
Society, etc. were morally and intellectually bankrupt and
bear direct responsibility for the social decay we see all
around us. A country experiencing a decivilization process,
like the U.S., is not one that will move forward with economic
it any wonder why American manufacturers are building factories
overseas? It isn’t just a matter of seeking less expensive
labor. It is a matter of seeking better educated and harder
working laborers than are available in the United States.
Quite frankly, America’s public schools are "cranking
out" high self-esteem, low skilled graduates who expect
large salaries and small workloads. Social-democratic "values"
are engrained in public schools at the expense of teaching
students reading, writing, math, and basic science. Accordingly,
public schools are at the heart of the problem of decivilization
and economic undevelopment. American manufacturers know this
and are voting with their feet and their wallets.
Hoppe does not stand alone in describing the ugliness of social
democracy and its inherent narcissism, recklessness, and hedonism.
Hans Sennholz aptly describes
the social implications of a heavily indebted social-democratic
debt generation is a sad generation misguided by false notions
and doctrines, and preoccupied with its own needs and wants.
When economic conditions begin to deteriorate it may grow
ever more egocentric and wretched, which tends to aggravate
the social tension and strife. Clinging tenaciously to its
transfer claims and rights, the unhappy society thus may
deteriorate into a militant assembly of diverse pressure
groups feuding and fighting each other.
Standard and Poor’s and Moody’s haven’t looked closely at
the terrible destruction social democracy has wrought on American
society. The U.S. is going through a decivilization process
and, therefore, economic undevelopment. As mentioned above,
this is a factor as to why jobs are moving overseas. This,
undoubtedly, should be factored in to Uncle Sam’s sovereign
#8 default history. Other things being equal, a
country that has defaulted on debt in the recent past is widely
perceived as a high credit risk. Both theoretical considerations
of the role of reputation in sovereign debt…and related empirical
evidence indicate that defaulting sovereigns suffer a severe
decline in their standing with creditors...We factor in credit
reputation by using an indicator variable that notes whether
or not a country has defaulted on its international bank debt
Over the years a mystique has emerged, regarding Uncle
Sam, in which "he" believes in the sanctity of debt
repayment which of course means that default is never
an option. Economics and finance professors perpetuate this
myth and ignore history. In reality, the U.S. government has
committed more serious transgressions than just defaulting
on international bank debt. It has committed defaults that
rating agency analysts should find appalling this entails
looking past mythology and seeking the truth.
the courageous and brilliant economist, Murray N. Rothbard,
had the intellectual fortitude to tell the truth regardless
of establishment thinking and conventional wisdom. In his
most excellent book Making
Economic Sense, Dr. Rothbard points out something
that the rating agencies mysteriously ignore. Not only has
Uncle Sam defaulted on its financial obligations (after the
aforementioned critical date of 1970), it defaulted on an
entire monetary system remember Bretton Woods?
Here is what Murray Rothbard had to say:
two decades, the system seemed to work well, as the U.S.
issued more and more dollars, and they were then used by
foreign central banks as a base for their own inflation.
In short, for years the U.S. was able to "export inflation"
to foreign countries without suffering the ravages itself.
Eventually, however, the ever-more inflated dollar became
depreciated on the gold market, and the lure of high priced
gold they could obtain from the U.S. at the bargain $35
per ounce led European central banks to cash in dollars
for gold. The house of cards collapsed when President
Nixon, in an ignominious declaration of bankruptcy,
slammed shut the gold window and went off the last remnants
of the gold standard in August 1971. (emphasis added)
Dr. Rothbard was correct that this was a national declaration
of bankruptcy. However, since gold was involved, perhaps this
was a forgivable event. After all, many other countries were
waging a war against gold (that barbarous relic) in pursuit
of establishing pure fiat currency regimes. Nevertheless,
this was a most spectacular default thus destroying the conventional
wisdom that the United States will always honor its obligations
debt or otherwise.
what about defaulting on Treasury bonds in the 20th
century? Has this ever happened in the U.S.? As a matter of
fact, it has refer to the U.S. Supreme Court case Perry
v. United States, 294 U.S.
330 (1935). Per this case, John M. Perry "purchased"
a $10,000 "Fourth Liberty Loan 4¼% Gold Bond of 19331938."
When Mr. Perry sought repayment, the federal government refused
to pay the loan back, in gold coin, and forced Mr. Perry to
accept $10,000 of legal tender currency instead. Briefly here
are some details from the case:
brought suit as the owner of an obligation of the United
States for $10,000, known as 'Fourth Liberty Loan 4 1/4%
Gold Bond of 1933 1938.' This bond was issued pursuant
to the Act of September 24, 1917, 1 et seq. (40 Stat. 288),
as amended, and Treasury Department circular No. 121 dated
September 28, 1918. The bond...provided: The principal and
interest hereof are payable in United States gold coin of
the present standard of value.
FDR, via his 1933
Executive Order, declared it illegal to own circulating
gold coins, gold bullion, and gold certificates, the federal
government forced itself into the position of defaulting
on paying the abovementioned Liberty bondholders in the prescribed
gold coin. Hence, subsequent to FDR’s executive order, all
holders of such bonds were forced to accept legal tender currency
instead of "gold coin of the present standard of value."
The act of confiscating gold itself was a violation of private
property rights and was illegal regardless of what
government apologists say. In turn, by not paying bondholders
in gold coin, the U.S. government has technically defaulted
on past Treasury bond obligations. As expected, the U.S. Supreme
Court ruled against Mr. Perry and in favor of Uncle Sam. This
does not change the chilling truth that, in the past, the
U.S. government has exercised arbitrary power to change the
rules of the bond market (i.e. the means of repayment) by
trampling private property rights. A default is a default.
gone through all eight variables, it should be obvious that
both Moody’s and Standard & Poor’s have grossly overrated
America’s sovereign debt it doesn’t merit the top grade
of AAA. In variables such as default history, inflation,
external balance, external debt, and economic development,
the U.S. should rate significantly lower than does Japan
and should rate worse in many variables as compared
to a developing country such as Botswana. Look at the table
below and decide for yourself. (Source The
Japan Times: Should Japan be rated below Botswana?)
variables considered by key to sovereign credit ratings
Each agency uses a different standard. Japan was rated
AA minus by Standard & Poor's, A2 by Moody's,
and AA by Fitch.
could reasonably conclude that if Japan has been assigned
a lower sovereign credit rating than Botswana (which reveals
that rating agencies aren’t showing favoritism in Japan’s
case), then logically the U.S.
should be assigned a lower rating than Japan. So why isn’t
the U.S. rated below Japan? Or is the U.S. the only country
worthy of favoritism? This calls into question the credibility
of the major rating agencies.
would you rate the United States’ sovereign debt? If you refer
to the embedded
you will see S&P’s and Moody’s various investment grades.
If you believe Uncle Sam is a non-investment grade risk, then
you have rated U.S. Treasury debt as "junk."
the major rating agencies sound the alarm with respect to
the U.S. government’s precariously debt-bloated financial
condition among other problems? I certainly hope so.
W. McDaniel, president of Moody’s Investors Service, has
stated: "In Moody's view, the main and proper role of
credit ratings is to enhance transparency and efficiency in
debt capital markets by reducing the information asymmetry
between borrowers and lenders." Sophisticated bond fund
managers, large insurance companies, and foreign central bankers
may not need to rely on Moody’s or S&P to bring information
between borrowers and lenders into symmetry. This aside, millions
of Americans lend money to Uncle Sam (via purchasing bonds)
and, on the whole, are economically illiterate thanks
largely to public schools. A downgrade of Uncle Sam’s credit
rating would surely be a huge news story and may wake up the
masses to the painful truth that their country is hurtling
toward a debt-induced economic disaster (even Chris
P. Dialynas, a Managing Director of PIMCO, is calling
for America’s foreign creditors to forgive a portion of the
U.S. Treasury debt they hold). A ratings downgrade may compel
Americans to direct their savings to safer havens thus
preserving a healthier pool of savings from which America’s
economy can be rebuilt. (Believe me, it will need to be rebuilt
after Alan Greenspan’s/America’s debt orgy comes to an end.)
It is time for the credit rating agencies to muster the courage
to do the right thing and downgrade Uncle Sam. Or will we
hear that all too familiar question: "How could the rating
agencies have missed this one?"