Karl Denninger: The US *WILL* Be Downgraded

The Market Ticker

I told you this was going to happen…… you have not heard this on bubble vision, but all you had to do was use your brain:

Q: “There’s been a figure of $4 trillion dollars circulating as an example of the scope of  fiscal consolidation measures that could work to stabilize the U.S. debt-gdp ratios. Could you explain how that figure was arrived at since it was mentioned in S&P’s reports and where it figures in S&P analysis?”

A: “First of all, that figure comes initially from the Bowles-Simpson fiscal commission, and it was embraced by President Obama  in his April 13 speech and Paul Ryan in his counter-budget proposal. And so you had policy makers converging around the amount. Now actually the $4 trillion, depending on whether it is front-loaded or back-loaded, is not going to do the trick in terms of stabilizing U.S. government debt-to GDP ratios. But it takes you pretty far along. And I think a grand bargain of that nature would signal, you know, the seriousness of policy makers to address the fiscal issues of the United States, to actually stabilize the debt-to-GDP. The IMF says it takes  7.5% of GDP consolidation. I think we have more than that.”

For perspective: That means cutting the deficit by more than one trillion dollars a year at present run rates.

And that’s not enough either.  GDP will contract dollar for dollar as the deficit spending comes off and taxes will contract too, which means that the actual cut in spending (or increase in taxes) will be have to more that one trillion a year.

It does not matter how that difference between revenues and spending comes off.  It does not matter if you cut spending, raise taxes or some combination of the two.  The GDP impact is inescapable as is the tax receipts impact.

But so, at this point, is the downgrade.

The “most-recent” proposals cut anywhere from nothing in actual spending (Democrat proposal) for 2012 to $90 billion (Republican.)  And neither contains any actual cuts on a forward basis – the Republicans are at least honest about it and say they just “hold discretionary non-defense spending at 2011 levels.”

That’s not a cut in spending.

So here’s how it’s going to go down.  We will get downgraded, probably within days or weeks after this “short-term” blip passes Congress, however it does.  And when we do, interest rates will ratchet, at least a bit.  If the Congress refuses to respond to that downgrade with real budget cuts including the cost of the increased interest now, which means they have to be another $100 billion or so (that is, 10% more than if they did it now) we’ll get downgraded after a period (probably six to twelve months) again.

Note: I’m talking one trillion a year in cuts and/or tax receipt (not rate) increases. 

Not over ten years, per year.

Somewhere between now and that second move by the ratings agencies the market will figure it out and the squeeze will begin.

By then it will probably be too late for Congress to avoid the “coffin corner.”

The door is closing fast and we’re about to be left out in the cold.

I know this is claimed to be “politically impossible.”  But mathematics – specifically, exponents and subtraction – do not care about politics.  They just are. 

They are determining this outcome, not politics, and those who are in Congress had damn well better wise up and start demanding from their advisors who say we can manage to muddle through strict proof – not a claim, but an examination of borrowing expense and tax receipts until they project an actual balanced budget, whenever that projection is for them.  If the answer is “never” those people need to be tossed out of the nearest Capitol office building window – sans parachute.

Where does this take the stock market?  That depends on whether Congress responds before the downward spiral starts.  If they do the correction will be nasty, but we’ll get through it.  But if not…..

If what I heard today in the so-called “debate” on the floor of the House is an honest indication of what we can expect from Congress we’re just plain screwed.

I’m sorry.

The Constitutional American

Read more at Domas Jefferson, The Constitutional American