The warning by the credit rating agency Standard and Poor's that its concerns about federal deficits could cause it to lower its rating of U.S. Treasury bonds caused the stock market to dive this week. Unless President Obama and Congress get serious about working together to balance the budget and reduce the national debt, the market reaction will be just the first -- and hardly the biggest -- blow to the nation's fragile economic recovery.
S&P now rates Treasury bonds AAA -- the highest grade, and a symbol of the nation's economic strength. But for the first time ever, the agency this week imposed a "negative" rating on the nation's long-term creditworthiness.
S&P said there is a one-third prospect it will downgrade the bond rating by 2013. It cited a "material risk" that the President and lawmakers will not reach a meaningful deficit-reduction compromise in the next two years.
A lower bond rating would force the government to pay higher interest rates to borrow money. That would increase the national debt by billions of dollars.
Inevitably, private consumers and businesses also would have to pay more to borrow. If global investors lose confidence in the soundness of the U.S. economy, the value of the dollar could fall, inflation could reignite, and another worldwide economic slump could beckon.
Creditors generally are reluctant to lend to any country whose debt burden amounts to more than 80 percent of its gross domestic product. Without substantial action on the deficit, S&P says, U.S. public debt could reach 84 percent of GDP in two years.
S&P analysts call competing deficit-cutting proposals offered by President Obama and House Republicans "the starting point of a process," but added: "[T]he gap between the parties remains wide." It will only grow wider to the extent that both parties use the deficit as an occasion for partisan posturing in advance of next year's election, as occurred with this month's tiresome brinkmanship over finishing this year's budget.
As far apart as the parties appear now, there is middle ground, if they are willing to look for it rather than throw red meat to their most intransigent supporters.
President Obama and other lawmakers will have to accept larger spending cuts than they would like, not only in discretionary domestic programs, but also in entitlements -- Social Security, Medicare, and Medicaid.
Republicans will have to accept reductions in defense spending and higher taxes on wealthy individuals and corporations. Both parties will have to raise taxes on middle-class families.
Of course such moves won't be popular among voters. If they were, politicians would have embraced them long ago. But the S&P warning makes clear that neither of the parties can declare a particular area of spending or taxing off-limits. They aren't the only players in the game.
Much of the deficit spending the Obama Administration has engaged in was necessary to stimulate the economy toward recovery. And many of today's born-again deficit hawks were far less concerned with the costs of President George W. Bush's tax cuts, which primarily benefited the richest Americans, and of his wars in Iraq and Afghanistan.
But second-guessing is not needed now. Action is.
S&P is, of course, one of the rating agencies that helped set off the global financial meltdown by giving unrealistically glowing assessments of, and then abruptly downgrading, mortgage-backed securities that turned out to be toxic. So it's galling to listen to the agency deliver a lecture on fiscal responsibility now.
This time, though, S&P is right. Washington politicians can reach agreement if the future of the American economy means more to them than their, or their parties', immediate political futures. As S&P has reminded everyone, the stakes are much greater than merely the latter.