In Moody's Action On Japan Another Blow To Stimulus

Moody’s put Japan’s sovereign debt on credit watch with “review for a possible downgrade.”

The agency wrote:

The review has been prompted by heightened concern that faltering economic growth prospects and a weak policy response would make more challenging the government’s ability to fashion and achieve a credible deficit reduction target. Without an effective strategy, government debt will rise inexorably from a level which already is well above that of other advanced economies.

The action is another example of the philosophy of Moody’s, Standard & Poor’s and Fitch that austerity and deficit cuts are the key to long-term financial soundness and that stimulus programs are not. That, of course, seems to make decisions to use stimulus as a way to improve large economies financially dangerous. Credit rating agency downgrades almost always raise borrowing costs. Borrowing is usually the key to the capital needed to spend money in the hope of accelerating GDP growth.

The credit rating philosophy about debt may make sense for small, weak economies like those of Greece, Portugal, and Spain. Their borrowing costs are too high to make the use of outside capital viable. They have nowhere to turn except to their neighbors and the IMF. That does not hold true for the UK, the US and Japan. These economies are large enough and productive enough to sustain more debt than they do now. But, what the credit ratings agencies see in each of them is a cycle of expenditures and slow growth. The expenditure observation is correct. The growth rate observation and predictions may not be. Economists led by Paul Krugman have argued since the beginning of the last recession that the US cannot improve its long-term economic health by austerity programs which do little to create jobs and stimulate business activity. The first Obama stimulus package needs to be followed by a second one.

The credit rating agencies do investors a disservice when they make decisions based almost strictly on debt and deficit reductions. These organizations have no better ability to forecast economic cause and effect than most economists. Moody’s, S&P, and Fitch do not leave capital markets investors who follow their advice the option of seeing stimulus as a path to financial health. That means they refuse to consider that there is more than one way to drive economic improvement.

Douglas A. McIntyre