December 12, 2009
Triple A
The big debate now raging is whether the UK is in danger of having its AAA rating down-graded unless major spending cuts are undertaken, and undertaken quickly.
As far as I can tell, there are two broad positions being taken, and they roughly track left-right divides.
The right, with Boy George as head cheerleader, warns that Britain is in imminent danger of losing the AAA rating, and that not only are spending cuts needed soon, but they are needed deep. Only a Conservative government will cut deep and fast enough to secure the rating. In support they quote, for example, Citi’s analysis:
“Unless we get a credible set of measures put in place quickly, which seems unlikely unless we get a Conservative Government with a clear majority at the next election, we think the UK’s AAA rating will be right up on the radar screens in a very short space of time. The lasting legacy of the current administration may well prove to be the loss of the UK’s AAA credit rating” (h/t)
On the left this perspective is rejected as Conservative scare-mongering. What Britain needs is to keep spending constant in the short-run so as to foster economic recovery, but making cuts 2-3 years down the line. Moody’s senior vice president Tom Byrne is quoted as saying that “the outlook is stable” and:
“Their [UK and US] resiliency will be tested in the next couple of years but for now they have a high degree of ‘financeability ‘ and debt affordability. The rise in debt and higher interest costs could test ratings under some scenarios but not right away.” (h/t)
Furthermore, the leftists tend to say, if it ever comes that the UK has its AAA rating downgraded, then the world financial system will be in such a mess that all bets are off anyway.
Confession time: I have no idea who’s right. Because I don’t know anything about finance, or much at all about (macro) economics. And lurking behind my non-understanding I have a further concern: do I trust the motivations of the rating agencies and the corporations (like Citi) deploying their assessments?
On one interpretation, the calls for cuts emanating from the corporate sector are simply fair, impartial warning to the people of Britain that if they don’t vote for the party brave enough to make the big decisions, then there will be big trouble.
On another, what we are seeing are partisan attempts to interfere with the democratic political process by self-interested actors who are effectively holding the population to ransom: vote for the party that will be lax on regulation and tax for the private sector, or we promise there will be big trouble.
Doubtless the situation is far more nuanced than this black-white reduction. I do, however, suspect there is something to be said for the second position. After all, it’s not particularly controversial to note that Citi Group has been previously mired in corruption allegations spanning the globe, and that credit rating agencies like Standard&Poor’s and Moodys were complicit in the boom-year practice of rating junk assets way above their true value.
My point, however, is the following. Next spring we get to choose a government. The big question is the economy, and who’s hands it is most safe in. The vast majority of voters are, surely, in my position. We know nothing about the workings of finance or economics, it is quite possible our conceptions of risk and necessity are being manipulated by vested interests, and our fears are being exploited by electioneering politicians*.
I’m no sucker. I know that parliamentary democracy is a far from perfect system, and that fear, ignorance and confusion play a role in every election. But given the importance of economics this time around, and the far-reaching impacts of either a huge Tory-led assault on public spending, or the UK losing its credit rating, the stakes are exceptionally high. And we voters – with the exception of a tiny minority who understand the mechanisms – are being asked to gamble on those stakes in profound ignorance.
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* On both sides. Compare “painful Tory cuts” with “Loss of AAA rating”.
Grace said,
December 12, 2009 at 5:46 pm
Voters aren’t just ignorant of economic issues. they’re irrational – hold systematically biased beliefs. (much more problematic than ignorance – irrationality means that concordet’s “miracle of aggregation” doesn’t work.)
this is because irrationality is a good. people have “preferences over beliefs” – for example believing that immigrants steal jobs may make me feel all warm and fuzzy inside, because i want to shut the dirty nasty foreigners out anyway, provides me with a (fairly respectable-sounding) justification.
and since it is a good the law of demand applies – as the cost of irrationality falls, the quantity consumed increases. if someone’s livelihood is at stake, they probably will make an effort to make sure their beliefs are actually true (to the best of their ability). i will hire foreigners if i will otherwise go out of business. however, if the cost of holding wrong beliefs is 0, consumers will consume a lot of irrationality…
and what is the cost of an individual voter’s irrational belief? precisely 0! (assuming that there is 0 chance of your individual vote being the deciding one in any particular election)… so voters are v. irrational
empirical evidence corroborates this… this is what bryan caplan shows in “the myth of the rational voter”. voters and economists give very different answers to questions about eg the federal deficit (economists don’t think it’s much of a problem), immigration (ditto), even when you adjust for income/race/political party membership… proof of systematic bias => irrationality
chris said,
December 14, 2009 at 11:33 am
One issue that’s being neglected here is: how disastrous would the loss of AAA status be?
Spain lost its AAA rating back in February, but its 10-year yields are below the UK’s, and only 0.6 percentage points above Germany’s.
This suggests that – as long as markets retain faith in the currency (a big if!) – a downgrade in itself needn’t be a calamity. Remember – AA and A ratings still imply a low probability of default, which is what really matters.
Could it be that AAA status has become what a “strong” pound once was – a national virility symbol more than an economic necessity?
Paul Sagar said,
December 14, 2009 at 1:33 pm
Chris,
Good point.
But does it serve to underline my point about general ignorance? I feel worried about the UK losing its AAA rating. But is that simply irrational? You give good reasons for suggesting that it is.
Problem is, irrational fears decide elections, as we’ve recently both observed.