I got some interesting commentary from Whitney Tilson’s email. See below for some interesting commentary from Whitney Tilson’s friend followed by my response:
A friend responds to Warren Buffett’s point that the U.S. can’t default because it controls the printing press:
The Bedford Park Opportunities Fund returned 13.5% net of all fees and expenses in the second quarter of 2021, bringing its year-to-date return to 27.6%. Q2 2021 hedge fund letters, conferences and more In the fund's second-quarter investor letter, which ValueWalk has been able to review, Jordan Zinberg, the President and CEO of Bedford Read More
Yeah, we all get that he is right that the U.S., by definition, can’t default on debt denominated in its own currency – it controls the printing presses. However the U.S. can and it has been defaulting in every other way. If a country is going to inflate away the value of its obligations, it’s just default in another form. There is more at stake than whether or not the principal gets paid back, the question is what is its purchasing power when it does get paid back. And credit ratings should reflect that behavior and the risk of that potential outcome (or other potential forms of theft for lack of a better term). And if they did, US credit would have already been Charmined (not even on par with the Ultra with Aloe they would be the single-ply generic) by every credit agency with a brain (oops, OK maybe those don’t exist). S&P is being generous, and the other guys are out to lunch. Ask the Chinese how they feel about the future purchasing power of their US treasuries. Honestly….pathetic IMO….
Later, he continues:
It’s amazing the guff S&P is taking over this downgrade. Virtually everyone asked where were the rating agencies ahead of time during the last crisis. They were under broad fire for their negligent ratings. Now a rating agency finally does what it is meant to do, and they are widely criticized? Shouldn’t people be asking instead, why didn’t the other guys downgrade as well?
Of course it’s just because people are p*ssed because they think it makes the equity market go down.
And all the criticism focuses on things not related to whether S&P ultimately did the right thing. Sure there was a potential $2 trillion mistake. But I ask but what about the absurdity of using the government’s forecast as the baseline upon which that mistake is judged? When has the Government been right on any forecast? Their expectations for what the stimulus would do for the economy? Sure there were other aspects to the downgrade including their view of the current state of the Government. And then there is a focus on comparing our rating to that of other countries in similar situations with higher ratings. So if other countries are mis-rated, ours should be too?
Shouldn’t the crux of the question be, does the US really merit a AAA rating on a fundamental basis? A lot of big buyers of treasuries (foreign governments) that are NOT idiots implicitly believe the USA is no longer an AAA credit and are voting with their feet and diversifying into other assets to preserve purchasing power.
Shouldn’t what S&P did be cheered? At least someone in the system (political or financial) is finally showing some courage and doing something painful and unpopular. There is NO upside to S&P for doing this. These types of unpopular decisions are what it will take to get the country back on a sound footing.
And for those that think the equity market is down because of this, I disagree as well. Sure it didn’t help. But it was well telegraphed. Treasuries actually rallied on this – there is no panic in the Treasury market (other than the panic to get in). A lot of this move should have happened Friday as well, but we got the late day bounce on the EU stuff. And there is an enormous amount of fluff and complacency out there. IMO the market is coming to grips with the likelihood of a slowing economy and what it means for EPS.
For the first time in my life I actually have sympathy for S&P.
Whitney Tilson, My take: I think the S&P downgrade could be a blessing in disguise if it wakes up the kick-the-can-down-the-road jokers in DC (esp the Tea Party nitwits) into getting serious about addressing our issues, which must include BOTH cuts AND more revenue/taxes. But I’m not optimistic – I think things will have to get a lot worse before our “leaders” act…
Me: I largely agree with the first point and take issue with Warren Buffett that the US can’t default(see below). Just because the US cannot defacto default, they have and can “default” in other ways. Kenneth Rogoff argues in This Time Is Different, that when the US changed the gold standard under FDR that was a defacto default, why? Because even though America still paid its debt, the dollars it paid it back with were worth less as a result of the Gold Reserve Act. Same as Whitney Tilson’s friend argues, if the Fed is devaluing the dollar (which seems to be its goal), then it is a “stealth default”. Similarly inflation would also be a default if the US has inflation of 10%, but holders of 10 year treausries are only getting paid 2%, they are losing 8% in real returns. I would argue how is that not a default?
Finally even though the US can keep printing money lets say they decide to stop. If our deficit gets so out of control and we do not want to cause hyper inflation the US can strategically default. Many people do not realize that a huge percentage of foreclosures now, are due to PRIME borrowers defaulting on their mortgages. They simply think that it does not make sense to keep paying a mortgage on a house worth far less than the equity they put in. Why would the US government be any different?
I disagree with Tilson’s friend about the $2 trillion mistake. As Diane of EconMatters, a regular contributor to the site pointed out in regards to the $2 trillion mistake of S&P:
Treasury Department’s dispute aside, what is not in dispute is the error made by S&P, so this whole drama just makes S&P’s findings less credible (i.e. what else might have been wrong?) considering the agency has had weeks and months to work their numbers for such an important decision, yet it only took the Treasury Dept. a few hours to spot the glaring error.(Emphasis mine).
I am still conflicted whether S&P made the right decision, but the fact they made such a massive mistake makes me very wary. I think S&P is going overboard to prove they are not incompetent, after proving totally inept during the financial crisis.
I try not to get political (although that will have to change that a bit as I write an article about defense cuts shortly), but people who follow me on twitter know I get political sometimes. At the end Tilson blames the tea party for the downgrade. I am not a fan of this president by any means, but I think the GOP is the most at fault for the ratings cut. They refuse/d to compromise on any revenue increases, even though Obama offered them 75% spending cuts, and 25% revenue increase to cut $4 trillion from the deficit. The GOP rejected this out of hand. Had they agreed, the US likely would never have been downgraded, and they cannot expect to get a better deal from the most left wing president in our history.