Buiter on the U.S.’s AAA Credit Rating Outlook

Willem Buiter at the CFR delivering a particularly lucid look at the outlook for the U.S.’ AAA credit rating.

QUESTIONER: Niso Abuaf, Pace University. You said before that three years down the road, there’s a likelihood that U.S. government debt can lose its AAA rating. How is that possible when the U.S. funds itself in the dollar that it itself prints?

BUITER: The U.S. is — like every every country that has independent monetary authority, when it has an unsustainable fiscal situation, has two options. One is default, right, and the other, if the debt is domestic currency-denominated — is the case for the U.S. — is inflation.

And (this incentives/disincentives ?) is stronger, based on, I think, the analysis of Rogoff and Reinhart– or rather not based on, but extrapolating from them — if much of the debt is held abroad, as it is in the case of the U.S. More than 50 percent of U.S. Treasury debt is held abroad. And it — it’s much easier for a country to, you know, reduce the real value of servicing interest-bearing debts with unanticipated bit of inflation if non-voting foreigners hold the stuff, rather than voting domestic residents.

Now — but there are powerful constituencies, domestic constituencies, against an inflationary solution to an excessive government debt crisis. That is because there are — there’s private debt as well, and depending on the political configuration in a country, the creditors’ lobby may be stronger than the debtors’ lobby. That will be the case at the moment. I think at the moment an inflationary solution to the U.S. private debt problem would be politically acceptable to the majority party and to the — and to the White House, because it would favor basically mortgage borrowers over the banks. Well, we know government would then have to recapitalize the banks, but you know, that’s for the next administration to worry about.

So what is the — but if the U.S. — if the political equilibrium shifts, then an inflationary solution may be less attractive, because it redistributes also from private creditors towards private debtors, than an outright default solution. Sovereign default is — (can effect ?) approximately a redistribution of conflict between the owners of the debt, the creditors, and the taxpayers and the beneficiaries of public spending, and it is — especially when much of the debt is held abroad, it is often attractive, especially if a country is no longer in a significant external imbalance, which the U.S. unfortunately still is — fortunately, if you’re a creditor — then you may choose the taxpayer and the — and the public spending beneficiary over the foreign — over the foreign creditor.

Now how likely is it — so the motive for a U.S. inflationary solution is there. All right? But you need opportunity as well. You need a non-independent central bank or at least a central bank not committed to price stability. And you’d need serious inflation to really erode the real value of U.S. debt service to a significant extent, because the maturity of the U.S. debt is only half of what it was the last time the U.S. engaged in a big reduction of the debt-to-GDP ratio, from ’46, when it was 121 percent of GDP, to ’75, when it was 31 percent of GDP.

So the maturity of the U.S. debt, on average, is just under four years. It was eight then. So that means that you have to go well into double-digit unanticipated inflation to make a big dent in that.

Now — and the current Federal Reserve Board and FOMC simply wouldn’t deliver that. They may not be as — you know, as fearsomely Teutonic in their price stability preferences as we saw the ECB was, but they won’t inflate the debt away. And that means — but of course, the — constitutionally, the Fed is not terribly independent; only, you know, an act of Congress stands between the Fed and either changing its mandate or change the composition of the board in the FOMC.

So the question is, how likely is it, politically, that you either get a double populist majority, you know, pro-inflation majority, in the Congress and in the White House, or a single superpopulist — there’s a populist supermajority in the Congress, sufficient to override a presidential veto. I think it’s possible but highly unlikely.

So I think the U.S. does not — while it has in principle an inflation option to serve it — to reconcile its unsustainable debt, through the debt problems, it is — it will not, you know, likely be able to exercise that option. And that means that if debt’s unsustainable, then for the U.S. too there’s only one option, and that is restructuring, default.

So (the risk still being on ?) zero and the market’s already recognized that through the CDS swaps.