January Stock Talk Part III

The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody’s, the credit rating agency, said on Thursday.

The warning over the future of the triple-A rating – granted to US government debt since it was first assessed in 1917 – reflects growing concerns over the country’s ability to retain its financial and economic supremacy.

The authors show that, although details may vary, banking crises follow the same broad script. Each blow-up is preceded by rising home and equity prices; an acceleration in capital inflows driven by optimistic foreign investors; a rapid build-up of debt; and—immediately before the storm hits—an inverted V-shaped path for the economy, with growth first picking up and then faltering. The years just before the start of the subprime meltdown fit the Reinhart-Rogoff template remarkably well. Indeed on most criteria, the portents of trouble were more marked than in past crises. House prices rose more sharply in real terms. Equity-market gains were more persistent. Capital inflows picked up too, though they were already running at an alarmingly high level. America's current-account deficit was much larger, relative to GDP, than in a typical crisis candidate.

Given such ominous indications, what of the aftermath? Mr Rogoff was careful to say that the malign effects of the subprime mess might not be as great as those of previous crises. A great deal of uncertainty remains, not least about the scale of lending losses. Yet the precedents are worrying. In the 18 earlier crises, the average drop in output growth was two percentage points and it took two years for growth to return to normal. For the five worst crises, growth rates tumbled by five percentage points from their peak and recovery took more than three years. If America avoids a material slowdown, say the authors, “it should either be considered very lucky or even more ‘special' than most optimistic theories suggest.”