Montag, August 24, 2009

Obama Legacy Prediction I

First in a continuing series of predictions of what the legacy of the Obama presidency will look like.

Loss of US "AAA" rating

Given the $9tr deficit expected, coupled with a worse-than-expected decline in tax income, doubts at the rating agencies are now showing up that the US will be able to maintain its current AAA rating.

When this happens it means that the debt of the US will be refinanced by its creditors to reflect this: since interest rates cannot be adjusted externally, it means that bond prices will fall significantly, especially for new issues. Hence costs will go up significantly, as a bond price that can only be issued at, say, 95% of face value can only take in that much money, but has to be repaid in full. The worse the rating, the greater the discounting, since this gives bond holders an immediate return for their risk.

The effects will be extremely unpleasant, but not catastrophic. It means that unless taxes rise, US external debt will have to increase massively in order to counter the risk downgrades.

Now, you can't blame this on Obama alone: the 111th Congress deserves most of the blame, largely because of its abject failure to exercise its constitutional responsibilities. But it will be part of the Obama legacy.

To be continued...

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