RATING CUT OF U.S. DEBT ECHOES THE NERVOUSNESS OF GLOBAL MARKETS / THE NEW YORK TIMES NEWS ANALYSIS ( RECOMMENDED READING )

August 6, 2011


Rating Cut of U.S. Debt Echoes the Nervousness of Global Markets

By BINYAMIN APPELBAUM


WASHINGTON — The Standard & Poor’s decision to downgrade the credit rating of the United States for the first time echoed the nervousness of global markets in recent weeks, driven down by the relentless beat of grim economic news and a loss of confidence in the ability of political leaders to navigate challenges.


Governments on both sides of the Atlantic have avoided grappling with fundamental problems, counting on renewed growth to help borrowers who cannot afford to pay and creditors who cannot afford to walk away.


But four years into this age of financial contagion, the global economy cannot seem to pick up steam. Every promising leap seems to end with a sickening thud. The easy answers are exhausted, and political leaders face a rising tide of anger that is constraining their ability to make more difficult choices.


S.& P. said Friday that it was losing faith in America’s political leaders. Investors seem to be losing hope. The movements of markets are collective predictions of future prosperity, and the tidings are increasingly grim.


“Europe’s plan was to have growth fix the problem. America’s plan was to have growth fix the problem. And that’s not going to work,” said Kenneth Rogoff, an economics professor at Harvard. “I think it’s really starting to sink in that we’re not anywhere near an endgame.”


The United States and Europe face parallel debt problems. Here, banks and investors are pitted against homeowners. There, banks and investors are pitted against nations. In both cases, governments have struggled to rebalance their books.


There is no surplus of economic strength to throw at the problem. The United States and Europe ran up great debts in the years of plenty, living well and promising to pay later, even as they made expansive promises to aging populations.


“The restorative forces of the economy are very weak and the immediate forces that will be in place are worsening the problem,” said Joseph E. Stiglitz, an economist at Columbia University. “We already know it’s not going to be a V-shaped recovery. I had said in my book that it would be more of an L-shaped, slow recovery. I think the answer now is a Japan-style malaise.”


The weakness of the American economy is most evident in the lack of jobs. Only 55 percent of working-age adults held full-time jobs in July, the lowest level in modern times. About 25 million American adults want but cannot find full-time work, the government said Friday. The unemployment rate fell slightly, but mostly because 193,000 people stopped searching for jobs.


Consumer spending makes up 70 percent of the nation’s economic activity, and people without jobs spend less money. For more than a year the government has reported that the economy was expanding more quickly than employment, fueling hope that hiring would follow.


But last week the government said in a new estimate that it was mistaken, and that the economy actually had expanded at an annual rate of only 0.8 percent during the first half of the year — about the rate of population growth.


Falling home prices also shadow the recovery. Total household wealth remains 12 percent below its prerecession peak, according to the Federal Reserve. Consumer spending has not suffered a comparable decline, suggesting that people still see brighter days ahead. If they are wrong or if they lose faith, economists say, spending could dip even more sharply — and with it, the broader economy.


Corporate profits have climbed to record heights, but companies are not hiring. Long-term prosperity depends on investment in research and equipment and workers. But short-term fears are driving a turn toward austerity, said Gary P. Pisano, a professor at Harvard Business School.


“The dynamic that our government has gotten trapped in, companies are trapped in as well,” he said.


Professor Stiglitz said that falling stock prices could exacerbate the problem.


“Firms with stock prices in decline will be reinvigorated to cut costs,” he said. “And what does that mean? Lowering wages and firing people and making people work harder.”


Financial markets have also been slow to recover. A lack of confidence in the reported health of financial institutions is visible in the price of their shares. Bank of America closed Friday at $8.17, implying that investors believe the company is worth about $83 billion. Bank of America estimated its own value at roughly $206 billion at the end of June.


There are no easy solutions. Professor Rogoff, who studies the aftermath of financial crises, has written that recoveries tend to take a very long time, particularly when downturns are as long and as deep as this one has been. The only way to hasten the process, he said, is to force the transfer of wealth from creditors to debtors — to rebalance the books. He argues that this could be done through a policy of tolerance for higher inflation, which would reduce the value of debts over time.

“People sometimes ask, ‘What is the checklist of things that have to happen for a recovery?’ ” he said. “I think there’s basically one thing on it — improving the balance sheets.”

Lawrence H. Summers, President Obama’s former chief economic adviser who has returned to his previous role as a professor at Harvard, said that exacting a toll from creditors could constrain future growth by discouraging future investments.


“No one is satisfied with the efforts to reduce foreclosures and support the housing market,” he said. “The barrier to doing more has not been ideology or any solicitude for the financial sector, but concern about the adverse effects of inducing nonpayment by homeowners or reducing the flow of new mortgage credit.”


Mr. Summers argues instead that the government should focus on tax cuts and directed spending to stimulate private spending and investment, policies for which there is little political appetite.


But even such measures, he said, have only a limited effect.


Ultimately, he said, crises are caused by too much confidence, too much borrowing and too much spending — and the irony is that they must be solved by more confidence, more borrowing and more spending.