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Do the Math, Geithner!

The US Treasury secretary doesn't like the S&P downgrade. Must have been the right call then...

THERE WAS a time when the term "credit rating" would be sure to induce narcolepsy, writes Eric Fry for the Daily Reckoning.

Today, that same term promotes hysteria...especially when the credit in question is the United States government and the rating in question is a downgrade from AAA to AA+.

Warren Buffett immediately condemned the downgrade and insisted that the US is still a AAA credit, if not a "quadruple A" credit. Treasury Secretary Tim Geithner also blasted S&P's downgrade – citing the rating agency's "terrible judgment" and "stunning lack of knowledge about basic US fiscal math."

Obviously, therefore, S&P is on the right track.

Buffett's reaction typifies the billionaire's intellectually dishonest public commentary of recent years. S&P is, of course, the same rating agency that stripped Berkshire Hathaway of its AAA rating last year. S&P is also the firm that changed its rating outlook this morning on Berkshire from "stable" to "negative." Buffet's opinion, in other words, reflects more than a little self-interest.

But Buffett is just a business man; he does not have his fingers on the purse strings of the nation. Geithner's reaction, therefore, is more troubling. His rebuke of the downgrade reflects the stunning lack of basic math that has guided the Treasury Department's interventionist activities during the last three years.

Geithner's Treasury – aided and abetted by the Federal Reserve, the President and Congress – has conducted itself as though two minus signs make a plus sign. During the 2008-9 crisis, Treasury doled out trillions of Dollars in direct bailouts and indirect guarantees to a handful of well-connected financial firms. The financial firms got the money, we taxpayers got the bill. Bad trade. Terrible judgment.

And terrible judgment continues operating today. For example, it is the collective judgment of the Executive and Legislative branches of the government that $2 trillion of spending cuts (over a decade) is sufficient to close a monstrous $75 trillion debt hole. That's not just terrible judgment, that's moronic.

By now, all employees of the Congressional Budget Office know they need only red pens to do their jobs successfully. The federal government has not operated in the black for more than a decade.

The financial circus of the last few weeks – from the Congressional bickering about the debt ceiling to the President's "redistribution" agenda to the utterly toothless debt ceiling deal to the resulting stock market selloff to the downgrade by S&P to the whining about the downgrade by Geithner and Obama – show that the clowns are running the show.

But this circus doesn't need more clowns; it needs lion-tamers. If not, the investment capital that still resides in the United States looking for opportunities will, instead, start looking around for the "Egress."

The lesson of the story is that politicians and bureaucrats are not nearly as good at fixing economies as they are at breaking them. Politicians cannot actually cure economic problems, no matter how much of your money they spend.

Politicians say they can do all kinds of things for an economy. They say they can "stimulate growth" and "create jobs." (And they seem to genuinely believe it). But the accumulated evidence from multiple generations in multiple countries around the globe demonstrates that politicians are only good at creating legislation and stimulating taxation.

A politician's directive cannot cure an economic ill, any more than a shaman's dance can repair a broken transmission. The shaman can dance and chant and burn all the incense he wants; the transmission won't care. It will remain a broken until someone crawls under the car, starts cranking bolts and getting his hands greasy.

A broken economy is no different. It is deaf to political incantations (we call them "bills") and only responds to the hands-on efforts of capitalistic enterprise. Even so, politicians rarely admit their impotence. They rarely subject their activities to a critical analysis. Instead, they continuously indulge their urge to "do something" about almost everything. They call their incessant meddling "legislation."

A little legislation is sometimes helpful. The US Constitution comes to mind. But more than a little is usually a disaster. We cannot prove it empirically – or maybe we could and are just too lazy – but a very strong inverse correlation seems to operate between government involvement and economic vitality. The greater the amount of central planning, the smaller the economic output. The former Soviet Union illustrates the point.

When the Soviet Union ultimately collapsed, the wealthy nations of the West gloated about the superiority of capitalism. But the days of gloating about the Soviet's "flawed economic model" may be drawing to a close. With each passing day – and each passing legislation – the "mature economies" of the West are enhancing their Soviet look and feel. The weight of regulation, taxation and an "entitlement culture" is crushing the dynamism that produces economic growth.

The wealthier a nation becomes, the greater the political temptation to tax that wealth and spend it on something...anything.

The process begins slowly and innocently at first: A little bit of taxation and a little bit of spending. But before you know it, the politicians are spending – and promising to spend – money the government does not even have. Taxes go up. Borrowing goes up...and up...and up. Government deficits accumulate year-by-year, like knick-knacks in an attic. The nation's fiscal condition deteriorates know the rest of the story.

Eventually, the government piles up liabilities that are so large, it has no chance of ever repaying them. The fiscal game-playing begins – the goal of which is to ship debts out to some faceless future generation, like New York City shipping its garbage out to sea on a barge.

This story of seriously distressed government finances is unfolding right before our eyes, both here at home and on the European continent. Greece is the most conspicuous example, but it is hardly the only example. The plight of Greece is a shot across the bow of the entire Western World – warning the mature economies of the West that spendthrift governments produce bankrupt nations.

That's "basic fiscal math," Mr. Geithner.

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Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.

See full archive of Eric Fry articles

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