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U.S. Debt Downgraded – But Was That The Real Story?

What a month. Congress decided that it really did have to raise the debt ceiling, a rating agency decided there actually was some risk the U.S. could default on its debt, the government decided that the Great Recession was even worse than originally thought and the recovery was even weaker, and the Fed decided that the economy was going to be so weak that rates had to be kept low until mid-2013. Wow! Yes, that was the month that was.

Let’s start with the story of the month, the decision by S&P to downgrade the U.S. debt from AAA to AA+. While this may seem like a modest change, it was the first time anyone had ever seriously thought the U.S. could or would default on its debt. That, of course, is absurd. The U.S. has the capacity to pay its bills and always will.

The reality is the downgrade gave us no new information. We knew the U.S. economy was expanding slowly, given the pathetic 1.4% second quarter growth pace. That came on top of a first quarter that was downgraded to a distressingly slow 0.4% pace. We also knew that the deficit was way too wide and that Washington was a wonderland where economic facts never get in the way of political diatribes.

On another front, after the August 9th FOMC meeting, the monetary authorities – not surprisingly – described the economy as being soft and getting softer. But the monetary authorities created a real problem by saying that it “anticipates that economic conditions … are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” The setting of such a long time frame for policy was unheard of – and I believe wholly unnecessary. By saying rates would have to remain so low for so long, the Fed was signaling that it also thought the economy would muddle along for an extended period. What worries me is that business leaders will become even more cautious about hiring. Who wants to add to their workforce if growth may not be there to sustain those new hires? The clearly desultory message didn’t help psychology.

In spite of everything, economic conditions seem to be getting better. Investors realized that a U.S. default was unlikely and shook off that uncertainty to start focusing on other issues, such as European debt. Also, the economic data began showing that conditions were not that bad. Unemployment claims fell below the critical 400,000 level, manufacturing output is still soaring, and there were even signs that the housing market was beginning to move upward slowly. While the month was filled with huge issues, the road forward still looks to be positive even if that growth may not be anything great.

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Posted in Industry News.

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