S & P Downgrades US Debt. Now What?

On Friday, Aug 5 2011 at 8:01 PM when all financial markets (ex ForEx) in all western countries have closed for trading, Standard and Poor’s downgraded US Debt. Via Bloomberg:

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday.

Lawmakers agreed on Aug. 2 to raise the nation’s $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion S&P had said it preferred. Even with the specter of a downgrade, demand for Treasuries surged as investors saw few alternatives amid concern global growth is slowing and Europe’s sovereign debt crisis is spreading.

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement late yesterday after markets closed.

This downgrade is not the first. Dagong Global, a Chinese State sponsored rating agency has downgraded US debt late last year. The act was laughed at by most Western investors and politicians alike. China now gloats about the latest downgrade. [Via Xinhua, the official Chinese news outlet]:

Dagong Global, a fledgling Chinese rating agency, degraded the U.S. treasury bonds late last year, yet its move was met then with a sense of arrogance and cynicism from some Western commentators. Now S&P has proved what its Chinese counterpart has done is nothing but telling the global investors the ugly truth.

China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.

To cure its addiction to debts, the United States has to reestablish the common sense principle that one should live within its means.

…

The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone.

It should also stop its old practice of letting its domestic electoral politics take the global economy hostage and rely on the deep pockets of major surplus countries to make up for its perennial deficits.

A little self-discipline would not be too uncomfortable for the United States, the world’s largest economy and issuer of international reserve currency, to bear.

Though chances for a full-blown U.S. default are still slim now, the S&P downgrade serves as another warning shot about the long-term sustainability of the U.S. government finances.

…

All Americans, both beltway politicians and those on Main Street, have to do some serious soul-searching to bring their country back from a potential financial abyss.

What caught my fancy are these lines:

For centuries, it was the exuberant energy and innovation that has sustained America’s role in the world and maintained investors’ confidence in dollar assets. But now, mounting debts and ridiculous political wrestling in Washington have damaged America’s image abroad.

There in lies recognition of true American spirit. Not only what sustained America’s leadership in the world is its exuberant energy and innovation, I am confident that it will continue to be the leader by getting its act together. The political circus of excessive deficit spending, especially on wars, and ideological demagoguery. Yes, US should cut its massive spending on defense, which is where the bulk of the waste is, and then on entitlements. At the same time, US should bite the bullet and revert Bush tax cuts.

It will be tempting to blame this entirely on Obama especially for those righwing nuts out there. Lest we forget, President Bush doubled the deficit in his 8 years by over $5 Trillion. Other than the $700 b stimulus he pushed for, Obama inherited all this mess from Bush.

Listeners of my Telugu internet show MMGL, heard me say on July 29th show the following:

• The US will not default on its debt this week as many callers feared (Check)
• A debt deal will be reached between Democrats and Republicans (Check)
• Just like the spoiled child rolling on the floor crying in a super market gets everything from his parents, Republicans will get what they want in the debt deal, like no tax increases. [It happened just as I said it would. Even the spoiled child analogy was used in the polls conducted afterwards. However, the polls were too politically correct – they referred all politicians as spoiled children. A child who only got 2% of what he asked for is not a spoiled child.]
• The debt downgrade would probably happen, regardless of the debt deal. [It did]
• The markets will most likely sell off. [They did]

All the above assertions by me played out almost exactly I said. A broken clock analogy comes to mind. 🙂 Seriously, they were educated guesses.

I am asking myself, “What next?” I am assimilating information from various sources. I will post my musings in a day or two.

In the immediate term, I think on Monday market will open down big (most likely go up at the close). The only regret I have is closing all equity puts towards the market close on Friday.