Second thoughts about the debt debacle

I was pretty dismissive of Standard & Poor’s debt downgrade last month.  Re-reading that post, I stand by my political analysis of events going forward.  Furthermore, the recovery of U.S. equity markets, the sharp reduction of yields on U.S. debt, and the failure of the other ratings agencies to follow suit are further data points suggesting that the S&P decision was flawed. 

There’s reality and perceptions of reality, however.  On that latter front, after a recent expedition to Washington, I’ve concluded that regardless of whether S&P was right, they’ve won the argument in terms of perception.  The summer debt debacle is, in many ways, the political equivalent of Hurricane Katrina.  Perceptions of the Bush administration never recovered from that event, even though one could plausibly argue that the policy outputs of Bush’s second term were better than the first term.  Neverthelesss, Katrina was an inflection point that has caused a number of actors to reassess their perceptions about the political and policy competency of the White House and Congress. 

Something similar seems to have happened with the debt deal.  Politico’s Ben White relays the dramatic effect on consumer confidence: 

The Conference Board this week reported the biggest monthly decline in consumer confidence since the height of the financial crisis in 2008, its consumer confidence index falling from a reading of 59.2 to 44.5, the lowest in two years….

“The debt ceiling negotiation is an extremely significant event that is profoundly and sharply reshaping views of the economy and the federal government,” Republican pollster Bill McInturff wrote in a presentation of survey work he has done recently that suggests the debt ceiling debate has led to a significant shift in public opinion.

The partisan struggle over raising the debt went on for weeks before Obama finally announced on the night of Aug. 1 that a deal had been reached that resolves the issue for now. But while Washington has moved on to its next drama — the deliberations of the so-called supercommittee agreed to in the deal — its psychological impact has resonated widely.

McInturff said the result has been “a scary erosion in confidence” in both the economy and the government “at a time when this steep drop in confidence can be least afforded. … The perception of how Washington handled the debt ceiling negotiation led to an immediate collapse of confidence in government and all the major players, including President Obama and Republicans in Congress.”

A recent Washington Post poll found that 33 percent of Americans have confidence in Obama to make good decisions on the economy and just 18 percent have confidence in Congressional Republicans to do so.

These are especially dangerous readings when Federal Reserve Chairman Ben Bernanke has essentially said it is up to politicians to help boost the economy now that the Fed has fired nearly all its monetary policy bullets.

Speaking of Bernanke, he had this to say at Jackson Hole last week: 

[P]erhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals.

Ten days before Bernanke’s speech, FP’s Josh Rogin reported that Secretary of State Hillary Clinton had acknowledged the global ramifications of the debt fracas, telling a forum at National Defense University: 

I happened to be in Hong Kong a few weeks ago, and I said confidently that we were going to resolve this; we were not going to default; we would make some kind of political compromise.

But I have to tell you, it does cast a pall over our ability to project the kind of security interests that are in America’s interest. This is not about the Defense Department or the State Department or USAID. This is about the United States of America. And we need to have a responsible conversation about how we are going to prepare ourselves for the future

Clinton’s statements were confirmed by officials I talked to while down in DC. 

So, can this perception be changed?  Here, I’m bearish in the short-term.  These kind of perceptions can be self-fulfilling.  Economic growth is a remarkable political palliative, but growth looks anemic for a good long while.  The Obama administration can try to change the narrative, but that’s almost as difficult as Inception — for the same reasons: 

As Reinhart and Rogoff have observed, the economic aftereffects of debt crises are long-lasting.  From here on out, the political effects of such crises will be on full display. 

As someone who studies global political economy, this is fascinating.  As a U.S. citizen, this is utterly depressing.