The Biden administration was left shocked earlier this month after credit ratings agency Fitch Ratings downgraded the United States’ long-term creditor rating from AAA to AA+. The coveted AAA rating is akin to the gold standard in the world of finance, and this is only the second time in history that the US has been given such a downgrade. The first time was in 2011, following a similar political impasse over the nation’s debt ceiling.
The decision, which was announced on August 1st, cited several key factors in their assessment of US creditworthiness, including high levels of debt and deficits, the inadequate progress made on reducing structural budget deficits, and the political gridlock that has caused repeated episodes of brinkmanship over raising the debt ceiling.
The downgrade comes as tensions continue to mount over how the country will address its growing debt levels. The US government has been running up its budget deficit for years, and this year is no different. In February, the Congressional Budget Office estimated that the deficit for 2023 would total $1.4 trillion—already a staggering figure when compared to historical averages. In May, the CBO increased its estimate to $1.5 trillion citing revenue collections were “less than the agency expected.” Then, in August, the CBO raised its estimate again to $1.7 trillion on the grounds of higher outlays and less revenue.
The rating adjustment is an ominous sign of the US’s worsening fiscal position and serves as a warning of what could happen if Congress fails to pass meaningful fiscal reforms. While the announcement was met with fierce criticism from the White House, many in the US financial sector defended Fitch’s move. The trend of upward deficit revisions among a myriad of other factors have prompted market participants to question the sustainability of US debt.
It appears that Fitch’s decision was an attempt to send a message of responsibility and accountability to Washington but was Fitch’s assessment of the US justified? A closer look at the key factors of the decision helps to shed some light on the issue.
Prolonged Fiscal Mismanagement and Political Standoffs
It would be amiss to ignore the fact that mismanagement of the US budget has been a long-standing issue. Over the past two decades, US budget deficits, as a percentage of GDP, have almost tripled as government spending continues to outpace revenue.
Source: FRED | U.S. Office of Management and Budget
In its assessment, Fitch cited “a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters,” as a major factor in its decision, noting that the US has become increasingly reliant on standoffs to raise the government’s borrowing limit. The agency also drew attention to the nation’s lack of “a medium-term fiscal framework” and the failure of both parties to ever reach a agreement on fiscal management that could have provided long-term certainty.
In short, Fitch believes that the US government’s continued fiscal mismanagement has created an environment of instability and unpredictability in the markets, eroding investor confidence in the country’s ability to pay back its debt. Solely on the basis of fiscal irresponsibility and political gridlock, Fitch’s decision appears to be justified. But that’s only scratching the surface of the US’s financial woes.
Unsustainable Deficits Amid Mounting National Debt
The US is currently saddled with a massive debt burden, totaling $32.7 trillion as of August—already up $1 trillion since the debt ceiling deal in June. While the deal may have averted an immediate crisis, it does little to address the underlying problem of a dysfunctional budget process. With no real mechanism in place to ensure sustainable deficits going forward, the US debt is unlikely to shrink anytime soon, according to analysts.
Despite Treasury Secretary Janet Yellen’s claim that Fitch’s assessment is “arbitrary and based on outdated data,” the numbers suggest otherwise. National debt has grown exponentially in recent years and with no clear sign of fiscal reforms on the horizon, it’s not hard to see why Fitch has growing concerns over the US’s long-term ability to pay back its obligations.
Fitch expects the general government deficit to remain elevated in the near term and for debt as a share of GDP to rise amid “weaker federal revenues, new spending initiatives and a higher interest burden.” According to Fitch’s estimates, the US general government deficit will reach 6.6% of GDP in 2024 and is expected to continue to swell in the following years due to persistent deficits and a higher interest burden.
Equally concerning, the debt-to-GDP ratio, a key measure of debt sustainability, is expected to reach 118.4% by 2025, up from 112.9% today. With median debt-to-GDP ratios of other AA rated countries at 44.7%, Fitch’s decision to downgrade the US rating appears to be warranted.
Such a bleak outlook for US debt sustainability paints an alarming picture of the nation’s fiscal position. While Fitch’s assessment is likely to add fuel to the already heated debate over US debt and fiscal policies, it’s hard to ignore its sobering message. Without meaningful and lasting change, today’s downgrade could be just the beginning of a more serious, sustained decline in US creditworthiness. Fitch’s decision serves as a stark reminder of the risks posed by US debt accumulation and the need for fiscal restraint and responsible budget management.
Unresolved Medium-Term Challenges
Though the US government has faced significant fiscal challenges in the past few years, Fitch’s decision to downgrade the nation’s creditworthiness highlights an even more pressing issue: the lack of a medium-term fiscal framework.
The US federal budget process is designed for annual spending decisions with little consideration of long-term budgetary constraints and no real mechanism to prevent deficits from ballooning over time. This has led to repeated episodes of brinkmanship and political deadlock as Congress struggles to come up with a solution before the debt ceiling is reached.
Fitch expects interest costs to nearly double by 2033 to 3.6% of GDP due to mounting debt levels and a higher interest burden. For perspective, the US spent $476 billion in interest payments in 2022, about 2% of GDP. With such a large portion of the federal budget already going toward debt servicing, the US could face a fiscal crunch if interest payments were to double.
It’s hard to envision how Congress can find room to make meaningful investments in the economy when such a large portion of the budget is already eaten up by debt servicing. And with an aging population, increasing health care costs, and persistent revenue shortfalls, the US government is facing a growing list of financial challenges with few clear solutions.
While the downgrade by Fitch has been viewed by some as an undeserved and unwarranted blow to the US, a closer look at the underlying factors shows that the agency’s assessment was justified. Taken together, the mismanagement of US fiscal policy, mounting national debt, and unresolved medium-term challenges paint a bleak picture of the nation’s future financial health.
A Marred Reputation is the Least of Concerns
The downgrade by Fitch is a reminder of the grave consequences of fiscal irresponsibility. While the immediate impact has been somewhat limited, it’s hard to ignore the message it sends to markets and investors around the world. As one of only two major credit rating agencies to downgrade the US since the country attained AAA status in 1917, the decision by Fitch is a serious blemish on its reputation.
As Michael Schulman, chief investment officer at Running Point Capital Advisors noted, the “U.S. overall will be seen as strong but I think it’s a little chink in our armor,” adding “it is a dent against the U.S. reputation and standing.”
But a marred reputation is the least of concerns for US policymakers. With interest payments set to double in just over 10 years, the US may soon face a fiscal crisis if Congress fails to address underlying issues. Current estimates point to interest costs becoming the largest expense in the federal budget, surpassing even defense spending.
With an already tight budget, such a scenario could spell disaster for the US economy according to economists. And with the cost of borrowing rising in the wake of the downgrade, it’s not hard to see why Fitch expects “fiscal deterioration over the next three years.”
Preparing for Future
The outlook for US debt sustainability may be grim, but it’s not all doom and gloom for Americans looking to safeguard their financial future. While Fitch’s decision serves as a wake-up call that the US may be inching closer to the edge of a fiscal crunch, it’s also an opportunity for citizens to get their financial house in order.
With the Fed’s dogged battle against inflation set to continue and the odds of a recession still high, diversifying your savings into alternatives like precious metals could prove wise in the long run, according to experts. Gold and silver can help protect against inflation and hedge against the risk of a stock market downturn, say advisors, and may prove to be a viable alternative to traditional investments.
“When economic uncertainty looms, gold can provide stability and maintain value as it typically has an inverse relationship with traditional assets like stocks and bonds,” noted financial expert Andrew Latham. “When the market struggles, gold’s value often rises,” he added.
As the full impact of the downgrade slowly unfolds, preparing for any eventuality could be the difference between financial health and ruin. Fitch’s decision serves as a stark reminder of just how tenuous economic stability is even for the world’s largest economy. With responsible fiscal management unlikely to come from Washington anytime soon, it will be up to individual Americans to take action and prepare for what may lay ahead.