Washington’s bad habit of kicking the can down the road when it comes to the US budget deficit has economists worried that America’s top-notch credit rating may be in jeopardy. The issue of raising the current ceiling on U.S. government debt has created a stalemate between the congressional Republicans and the Biden administration with both sides unwilling to budge. Without a deal in place, the government could run out of money and default on its obligations as soon as June 1, according to Treasury Secretary Janet Yellen in a recent letter to lawmakers.
The X-date, as it has been called, is a hard deadline for Congress to raise the debt ceiling and avert an economic crisis. If Congress fails to act by the X-date and the government defaults on its debt, it could cause massive disruptions in global financial markets and lead to a downgrade of America’s credit rating.
While it is widely understood that any default on U.S. government debt could necessitate a downgrade of the country’s excellent credit rating, America may still face the risk of a downgrade even if it manages to avert default according to Fitch Ratings — one the world’s top three credit rating agencies. “Repeated episodes” of political brinkmanship, and failure to agree on a clear and credible deficit reduction plan, could still lead to a downgrade of U.S. credit ratings, the agency warned during a recent interview.
As the prolonged political gridlock in the nation’s capital continues to drag on with no solution in sight, the risk of a downgrade is becoming increasingly likely according to Fitch. And with a downgrade, comes serious economic consequences for both individuals and businesses, as the cost of borrowing for just about anything — from mortgages to car loans — will become more expensive.
What is a Credit Rating?
To understand why a downgrade in the U.S. credit rating is so damaging, it helps to know what a credit rating is and how it works. A rating is an assessment of a borrower’s financial soundness and ability to meet their debt obligations. It measures the risk that a borrower will default on its loans. The higher the credit rating, the lower the risk of default and therefore, the higher the confidence in a borrower’s ability to pay back its debts in full and on time.
The three major credit rating agencies — Moody’s, Fitch, and Standard & Poor’s — control over 90 percent of the global market for rating sovereign bonds, and are relied upon by investors when making decisions about which bonds to buy or sell. Rating symbols provide investors with a quick and easy way to evaluate the risk of a bond. The lower the rating, the higher risk the opportunity — and vice versa.
Ratings and borrowing costs are inextricably intertwined, with higher ratings leading to more attractive borrowing costs. While credit rating agencies’ ratings of corporations, municipalities, and financial institutions can be affected by a variety of factors including management changes or corporate restructuring, ratings for sovereign debt are largely determined by a country’s fundamentals — unless that country is the United States. Instead of economic fundamentals, the US rating tends to be based off of its position as the world’s largest economy and perceived financial stability, both of which may be in jeopardy according to analysts at Moody’s.
Early Warning Signs of a Downgrade
The U.S. had been one one of the few countries in the world to hold a coveted AAA rating from all three major credit ratings — that is, until 2011 when Standard & Poor’s downgraded the country one notch to AA+. The summer 2011 debt ceiling showdown between congressional Republicans and the Obama administration served as a major catalyst for the downgrade, with S&P citing the nation’s political gridlock as a key reason for its decision. “The political brinksmanship of recent months highlights what we see as America’s governance and policy making becoming less stable, less effective, and less predictable than what we previously believed,” S&P said in a report at the time.
The S&P also cited the country’s ballooning debt and inability to agree on a viable long-term solution as reasons for the downgrade. While the U.S. has been able to narrowly avoid a second downgrade since then, the country continues to face the same threats and risks that led to the original downgrade. Total national debt now exceeds $31 trillion — more than double what it was a decade ago — and again the two political parties remain deeply divided on how to address this issue.
In the wake of such persistent political dysfunction, credit rating agencies have begun to sound the alarm. Fitch warned that “repeated episodes” of political brinkmanship “chip away” at America’s perceived dependability and undermine the faith of global markets in U.S. decision-making. When asked about the possibility of a downgrade even if the debt ceiling is raised, Fitch spokeswoman James McCormack said “we absolutely could” if the market begins losing faith in the U.S’s ability to make long-term fiscal reforms.
Moody’s has similarly warned that without a credible plan for reducing the nation’s growing debt, U.S. credit ratings could be lowered in the near future. In a March report reviewed by the Senate Banking subcommittee, the agency said “credit rating agencies would downgrade Treasury debt” in the scenario that the “lawmakers breach the debt limit” and “the political impasse drags on for weeks.” The agency also referenced the S&P’s decision to downgrade the U.S. in 2011 on the basis of “political dysfunction” as proof such a move is not beyond the realm of possibility.
With time running out and lawmakers in Washington making little progress in the way of compromise, Americans should be aware of the potential risks posed by a downgrade and the possibility of a much more difficult economic future.
Implications of a US Downgrade
Even a small downgrade in the nation’s credit rating could have far-reaching implications for America’s economic standing and the global markets. One of the most immediate effects of a downgrade would be an increase in interest rates on loans, mortgages, and forms of financing — both public and private— as investors demand higher yields to offset their increased risk. Higher interest rates on US debt translates into less money available for programs like Social Security and Medicare as well as other important economic initiatives — something that could spell disaster for the nation’s long-term economy. With net interest payments on US debt already estimated to exceed $2 billion dollars as of 2023, a downgrade could easily double that figure in the coming years, putting even more strain on the country’s already stretched resources.
According to Peterson Institute economists, a downgrade could also have significant implications for the US dollar — namely, a weakened currency and decreased purchasing power in international markets. This could render US goods and services more expensive relative to foreign competitors, thereby putting US companies at a disadvantage in the global economy. Higher costs for imported goods and services could also lead to increased inflation, making it more difficult for American households and businesses to cope with rising prices.
At the same time, it would also make U.S. debt less attractive to foreign investors, reducing the demand for U.S. Treasuries and leading to further increases in interest rates according to experts like State Street’s CEO Ron O’Hanley. This could lead to a significant decline in the dollar’s value compared to other currencies, further increasing the cost of borrowing for American citizens and businesses.
Combined, these factors could lead to a dramatic decrease in the U.S’s economic competitiveness, making it even more difficult for American businesses to stay afloat and succeed in today’s global economy. With Scope Ratings — Europe’s leading provider for credit ratings — recently placing the US’s AA long-term issuer rating on review as a result of the current political polarization, the possibility of a downgrade is now more real than ever before.
Shelter from the Storm
With warning signs of a downgrade emerging and the U.S’s coveted AAA long-term issuer rating increasingly at risk, American citizens and businesses may want to start planning and preparing for the risk of a future where the US credit rating is no longer top-tier. Even if the Biden administration and Congress can find a way to reach an agreement before the X-date, the dangerous game of brinkmanship in Washington may have already cast a long shadow over the U.S’s economy. And with the proverbial debt-ceiling can kicked further down the road time and time again, investors are becoming concerned about the stability of America’s credit rating.
The impact of a downgrade could be widespread. During the 2011 S&P downgrade that left the U.S. with its current AA+ rating, the stock market plummeted by over 15% as investors rushed to sell their shares at discounted prices. At the same time, gold prices surged to a record high of $1,700 an ounce as investors flocked to the safe haven of precious metals. With a potential downgrade on the horizon, many investors are starting to prepare for a potentially tumultuous future and taking steps to protect from the risk. Gold and silver’s historic reputation for holding their value in times of crisis could make them an ideal asset to hold during a potential downgrade — and one that could potentially serve as a lifeline if the U.S. credit rating takes a hit.
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