On S&P and the US-Downgrade (amv)

When it comes to rating agencies, I generically side with the view expressed by my fellow co-blogger ls. S&P's rationale for the recent US-downgrade, however, is somewhat unconvincing: it is not so much based on economic fundamentals (let us forget for the moment the $2 trillion error in calculating US discretionary spending that S&P conceded), but on S&P's fuzzy political judgement:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.

Ah, I see! But the expenditure orgies of President Bush Jr. justified AAA? I'm not sure, to say the least, if and to what extent S&P has comparative advantages as a 'public policy think tank'. I, for one, doubt that the extrapolation of the current political mess in D.C. is appropriate to justify the downgrade. More precisely, I doubt that S&P has a robust model relating the recent political turmoil associated with the insane Tea Party with US default risk.

As you all know, everything is relative. In economics, however, everything is even more relative! I still see no alternative to the deep and, thus, liquid US-treasury markets. Anyone in the house who really believes that the Eurozone is going to outperform the US? Politically? Economically? Further, the Swiss market is simply too small to house the global demand for (relatively!) risk-free assets. This is also true for our economically and politically sound Scandinavian neighbors. Or does anyone really believe that China or other Asian countries will outperform the US? In the next 10 years? Because they have better political systems?

Anyway, my scepticism is reinforced by the Economics of Contempt (HT Thoma).

UPDATE: Still relying on the EMH, I would be quite uncomfortable to make such statements without market backing. I don't believe that I'm smarter than the market. Markets, however, do accommodate my position as you can check here:

Source: Bloomberg

green: current yield curve

red: yield curve at previous close



Treasury yields have fallen along the entire yield curve! Two-year yields are on a record low! Bad news for S&P: your downgrade is not credible; you are detached from the market.