August 03, 2012
NPR told listeners that Standard & Poors downgrading of U.S. government debt caused the stock market plunge last summer:
“A year has passed since the debt ceiling debacle in Washington, D.C. The showdown cost the U.S. its AAA credit rating and sent the stock market and President Obama’s approval ratings plunging.”
Is that so? Let’s try a little logic 101 here. S&P downgraded U.S. government debt, meaning in principle that there was a greater risk that there would be a default on this debt. Let’s assume that the markets took S&P’s judgment seriously. What would we probably expect?
That’s right! We would expect the price of U.S. bonds to fall, this would cause the interest rate on U.S. debt to rise.
But, what actually happened was that U.S. bond prices soared and interest rates plummeted. This is 180 degrees at odds with the idea that the markets agreed with S&P’s assessment about the risk of holding U.S. bonds.
There is another factor that could explain both the jump in bond prices and the plunge in the stock market. This is the euro zone crisis, which became far more serious in early August as interest rates on Italian debt soared. That would cause investors to flee to U.S. bonds and make shareholders weary about the future of the economy.
That explanation logically fits the set of events that we saw in financial markets. Unfortunately it doesn’t fit the morality tale that NPR seems to want to give its listeners, so we apparently won’t get to hear it on the air.
Comments