Newton's Third Law of Motion: To every action there is always an equal and opposite reaction . . . That's what came to mind with all the chatter about the national debt crisis and the likelihood that the credit of the USA will be downgraded.
As the theory goes, the increased risk that the US will delay/default on payment of its debts caused by the bumbling in Congress will be reflected in a loss of our AAA credit rating among the various ratings agencies. Action = Reaction.
A downgrading of our credit rating makes US instruments less attractive to investors. Action = Reaction.
A decrease in attractiveness of US instruments requires an increase in interest rates to make the instruments more attractive. Action = Reaction.
Economics is not Newtonian Physics, but it seems to follow the same natural law. For every action there is a reaction.
Three years ago we had an alleged "credit crisis" where money available for loans dried up. One would have thought that the natural reaction would have been for interest rates to have gone up to entice people to make loans. Instead the Federal Reserve intervened and started printing money -- loaning it out for a song or outright giving it away.We had "Quantitative Easing (QE) I" and then II pumping dollars into the system. The interest rates that should have gone up were kept artificially low by all the new money the government pumped into the system . . . nice if you were a borrower, but terrible if you were a saver. The value of the money had to decline, too, because if you double the $ supply without a doubling of the economy which backs it up, each dollar represents a smaller portion of the economy. If money is cheap, it is treated that way, thrown around on risky or nonsense items.
If you constantly spend more than you make, your credit worthiness goes down because it becomes less likely for you to pay your bills on time. If you have the ability to pay your debts with money that you print yourself, you might get away with it for awhile, but people will eventually figure it out. Your credit worthiness SHOULD go down because you are not returning value for what you initially received.
Savvy investors, like the Chinese government, have figured this out and have slowly been shedding themselves of US instruments of late because the US has debased the value of its currency with QE I and II. They did not need a ratings agency to tell them what to do.
A downgrade in US credit must occur because the US is repaying its debts with money that is worth less.
While a downgrade would make the US look fiscally irresponsible, it is only because it is true. The good side of a downgrade is that borrowing will become more expensive . . . as it should have become three years ago before the Fed started pumping money into the system. Interest rates may actually return to normal levels from the ridiculously low rates they are at now.
Like Newtonian Physics . . . or Mother Nature . . . government tinkering can only get around the natural laws of Economics for so long.