Last week, the stock market suffered its worst stretch since 2008, while Standard & Poor’s downgraded the government’s credit rating for the first time in history. We asked finance expert Jeffrey Born, a professor in the College of Business Administration, to weigh in on the S&P downgrade, the impact of fiscal turmoil in Europe on the American economy and the risk of a double-dip recession — all factors weighing down investor sentiment when it comes to the world’s major economies.
What will be the long-term affects of the S&P downgrade of the United States — from AAA to AA+ — on the global economy?
There are going to be some practical difficulties that are going to arise if more ratings change. If Moody’s and Fitch jump in and downgrade the U.S., then there are going to be some problems because a lot of contracts and agreements are written in terms of risk-free rates and usually we use U.S. treasury bond yields as proxies for that.
No one believes the U.S. is going to default; this is just a reflection of where the finances of the U.S. government have gotten. There have been all sorts of warnings about this — it didn’t just happen last week, this is something that has been talked about for five or six months. We’ve seen an increase in borrowing levels as the U.S. tried to stimulate the economy. All that spending led the credit agencies to say that it was a bit too much, and that’s why we had the downgrade. While the U.S. economy isn’t spurred to a halt, it definitely is slowing down.
Is the American economy about to enter a double-dip recession? Is there anything that could be done to prevent it outright?
In normal circumstances, if monetary authorities or the government were convinced that we were about to enter a recession, they could try to stimulate the economy before the recession actually took hold. The problem we face now is that we’ve kind of shot all our guns — interest rates in the United States are already incredibly low, and it’s hard to imagine how banks could take them any lower. There’s very little that the Fed can do and unless Washington is going to immediately renege on the promises it made last week to cut spending, it looks like its hands are tied as well.
What it would take would be for consumers and investors to start spending and investing again, and there just hasn’t been enough good economic news to make people feel confident about where the economy is going. If [a double-dip recession] is coming, I don’t think there’s much that anybody can do to halt this one.
Much of the blame for last week’s steep declines on the American stock market fell on the European economy, not the debt-ceiling crisis at home. Why did the state of the European economy have a greater impact on the American market than the debt-ceiling deal?
The Eurozone countries, which share a currency and a larger political structure, are kind of in the same boat as we are — they have high unemployment and other similar problems — but their central bank is very conservative in terms of its willingness to print money, so there are even fewer tools available to solve their problems.
Of course there are some countries that are doing very well, but others — like Ireland, Greece, Portugal, Spain and Italy — are in far worse positions. This is leading some economists to think there might be a push to abandon the Euro. That would create very real problems and have ramifications that would be very hard to imagine.