Credit Ratings, Austerity and Markets

This is essentially what I said on KGW last night, but my take on the whole S&P downgrade is that the S&P action was essentially a non-action.  There is no new information out there that they revealed, they simply gave their opinion about the chance of a US default which is slightly higher now that Washington has revealed a new and higher level of disfunction.  The S&P statement was a political statement, not an economic one.  

So why have markets crashed?  It has everything to do with the global economic malaise and new threat of recession, especially coming from the Euro zone but also created by the debt ceiling deal's new spending cuts.  Cutting government spending in the midst of a recession cuts aggregate demand right at the moment the economy can least afford it.  I think investors are now very jittery as both Europe and the US are on similar trajectories - stumbling economies and new austerity measures.  The future does not look good at the moment.

I think the evidence in support of this comes from the fact that as investors were shedding equities, they were gobbling up US Treasuries, driving the 10 year T-Bill yield to a new yearly low.  This is the very security the S&P just downgraded - which demonstrates just how meaningless the S&P's action was in that sense.

I don't think the timing was entirely coincidental, however, the S&P action was still a shock to a system that is hyper-sensitive right now.  

Finally, I don't think you can take the markets' downturn as any evidence of an impending return to recession and in fact, as I said last night, I don't think it matters whether we return to slightly negative growth or stay with anemic positive growth: both imply unacceptable levels of long-term high unemployment.