'A Year After S&P's Downgrade, Treasuries Trade Lower'

Mike Konczal says financial markets have rightfully ignored the political theater posing as analysis involved in the S&P downgrade of US bonds a year ago, a downgrade that, to the extent that it mattered at all, "collapsed demand" and hurt the economy by giving ammunition to proponents of immediate austerity:

A Year After S&P's Rating Downgrade, US Treasuries Trade 1% Lower, by Mike Konczal: On August 5th, 2011, one year ago today, S&P downgraded the United States from AAA to AA+. This was four days after Congress voted to raise the debt ceiling. S&P did this because they didn't like the politics of the debt ceiling, implicitly blaming the Republicans' aggressive threat of a default on the national debt to obtain their political goals. "The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed." And they did this because they wanted to nudge Congress to make big, Grand Bargain type changes. S&P was worried that, in the aftermath of the debt ceiling agreement, "new revenues have dropped down on the menu of policy options" and "only minor policy changes on Medicare and little change in other entitlements" would potentially be achieved in the near future.

Analysts at Treasury quickly noted, after reviewing the numbers, that S&P made a $2 trillion dollar mistake, which dramatically overstated the medium-term debt levels of the United States that were their economic justification. S&P stood by their downgrade while admitting the error.

The United States losing its AAA rating was a political shock. The verdict was quick from the center and the right - this would be incredibly harmful to the United States' ability to deal with its national debt. When S&P first brought up the possibility of the downgrade in July, the centrist think tank Third Way highlighted that "S&P estimates that a downgrade would increase the interest rates on U.S. treasuries by 50-basis points," and urged "Congress and the Administration [to] come together and pass a 'grand bargain' that will put us on a sustainable path and avoid a credit downgrade." ...

Did the downgrade increase interest rates on U.S. Treasuries 50-basis points? ... Here's FRED data on Treasury 10 years:... They are down a little over 1 full percentage point, from 2.58 percent to 1.51 percent. If you want to consider the baseline the 3 percent interest rates from right before the downgrade, or the 2 percent interest rates that happened afterwards, then rates are down either 1.5 or 0.5 percentage points. That's a major decline in the borrowing cost of the United States. One can't find the increase in rates in this market. Counterfactuals are difficult - perhaps S&P is correct, and 10-year Treasuries would be closer to 1 percent had there been no downgrade.

But that seems unlikely. ... A year later the downgrade appeared to have been irrelevant to United States' borrowing costs. To the extent that they were relevant they signaled and reinforced a further move away from potential stimulus for the economy, which collapsed demand and drove even more money into government bonds and the interest rate down to 2 percent almost right away. But either way, low interest rates on US debt continues their downward march. Contrary to S&P, the financial markets are calling for a larger deficit, not a smaller one.