Debt ratings are a lagging indicator. If you follow the prices of most debt, the damage occurs well in advance of the downgrade. In the current unique set of circumstances, our economy is so weak that bond prices might actually increase from here (for a while, that is) despite our crappy fiscal situation.
The beauty of S&P’s downgrade is that both political parties have something to grab hold of. The Democrats will correctly point out that S&P is saying that the government needs more revenue (“They’re telling us to raise taxes!”). The Republicans will correctly point out that S&P is saying that the government needs to spend less (“They’re telling us we need to reduce spending!”). They’re both right.
What S&P is saying is, “We don’t care how you go about reducing the deficit – that’s a political issue – but you’ve gotta materially reduce the gap between the inflows and the outflows. We’re indifferent as to how you do it; again, that’s a political issue. But until you figure it out, we’re going to downgrade you and put you on negative watch.” Regardless of how you feel about S&P’s recent (large) gaffes, this is a pretty reasonable position to take… some might even say generous given the circumstances.
