August 8, 2011 11:12AM

What Are the Consequences of the Downgrade?

Even though I predicted it had to happen at some point because of the Bush‐​Obama spending binge and America’s giant long‐​run entitlement crisis, I confess that I’m somewhat surprised that the United States has suffered a debt downgrade for the first time.

That being said, I don’t think the downgrade will matter. Everyone knew the U.S. was heading in the wrong direction before the announcement by Standard & Poor. Moreover, big investors have very few attractive options for where to place their money – thanks to a weak global economy. As such, I suspect the federal government will still be able to borrow money at very low rates.

What does matter, however, is that the American economy is burdened with a bloated public sector that is sapping the nation’s economic vitality. And this problem will get worse every year because of a toxic combination of poorly designed entitlement programs and demographic change.

As the government gets bigger, this hinders growth by diverting resources from the productive sector of the economy. The damage is then compounded by the fact that the two main ways of financing the public sector – taxes and borrowing – both have additional adverse economic consequences.

In other words, the United States has fiscal cancer. Yet rather than try to cure the disease, politicians are – at best – kicking the can down the road. Here is my dour assessment on Bloomberg.

The only glimmer of hope, as I wrote yesterday, is that House Republicans have made serious efforts to restrain the burden of federal spending.