An increasingly unstable fiscal outlook and an elected government that won’t do anything about it have triggered America’s second-ever credit rating downgrade.
Fitch Ratings downgraded the U.S. government’s credit rating from “AAA” to “AA+” on Tuesday afternoon, signaling to investors that America’s Treasury bonds are a qualitatively less ideal purchase. In its announcement, Fitch said the downgrade reflected the federal government’s growing mountain of debt and the country’s fraught political dynamics—most recently evidenced by the brinksmanship over the debt ceiling that nearly triggered a default on the national debt.
“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch said in its announcement. The change also reflects an “expected fiscal deterioration” over the next few years, as the federal deficit is projected to grow wider, adding to America’s already staggering total of $32 trillion in national debt.
The rating service also pointed to the widening gap between the federal government’s tax revenue and its spending, as well as the “limited progress” being made toward solving looming issues like the projected insolvency of Social Security in the early 2030s.
While the AA+ rating reflects that U.S. debt remains a trustworthy investment, Fitch’s downgrade is a warning signal about the federal government’s fiscal trajectory.
The downgrade “should be a wake-up call,” said Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a nonprofit that advocates for smaller deficits, in a statement. “We need to get our country’s fiscal and political house in order. The United States economy remains strong, but we are on an unsustainable trajectory.”
The national debt is on course to double relative to the size of America’s economy in the next 30 years, and as the debt grows, so will the cost of interest payments. The Congressional Budget Office (CBO) estimates that interest on the national debt will consume one-third of the federal budget by 2050. That means more than 30 cents of every dollar taxed out of the economy will be directed towards the ongoing costs of past deficit spending rather than being used to cover government services.
“High and rising debt would have significant economic and financial consequences,” the CBO warned in June, echoing similar recent concerns raised by the Government Accountability Office and non-governmental groups. The mountain of debt will “slow economic growth, drive up interest payments to foreign holders of U.S. debt, elevate the risk of a fiscal crisis, increase the likelihood of other adverse effects that could occur more gradually, and make the nation’s fiscal position more vulnerable to an increase in interest rates,” the CBO said.
Fitch is the second of the “big three” credit rating firms to downgrade the federal government from its highest to second-highest category. In 2011, Standard and Poor’s (S&P) knocked America’s debt rating from AAA to AA+, where it remains today.
That change also followed a tense political standoff over the debt ceiling, though the federal government had a now-quaint $14 trillion in debt at the time. The current total is over $32.6 trillion.
Doubling your debt in just over a decade is a good way to scare off those who might lend you more money in the future. Given current fiscal and political trends in Washington, it was a question of when, not if, the U.S. would see another credit rating downgrade.
Unless something dramatically changes, this is unlikely to be the last.
The decision by Fitch Ratings on Tuesday to downgrade U.S. debt has irritated Wall Street and Washington, but why is anyone surprised? The downgrade to AA+ from AAA may even be an overly optimistic assessment of the U.S. fiscal outlook, and it ought to be a warning to the political class, which will ignore it.
“The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions,” Fitch said in explaining its decision.
The credit raters aren’t perfect oracles. And we don’t agree with Fitch’s complaint about debt-limit standoffs, since those have been the only recent times when anyone in Washington considers spending restraint. But Fitch’s decision captures the unseriousness of America’s economic decision-making.
For evidence, consider how much the U.S. fiscal and political outlook has deteriorated since the previous debt downgrade in 2011. Standard & Poor’s dropped its AAA rating on U.S. debt while Fitch and Moody’s didn’t.
The ratio of U.S. debt held by the public to GDP at the time was only 65.5%, while the Congressional Budget Office expects it to be 98.2% this year. That’s up from 79.4% before the pandemic, and it is expected to rise to 115% of GDP by 2033 on present budget trend. As Fitch notes, U.S. “general government debt,” including state and local government, is more than two-and-a-half times greater than the median 39.6% of GDP for a AAA rating.
The future looks worse. The deficit in the first nine months of this fiscal year hit $1.39 trillion, up 169% from the same period the year before. The deficit is supposed to shrink when the economy grows, but revenue isn’t keeping pace with runaway spending. The debt-ceiling deal this year did little to curtail the spending bulge still in the pipeline from the first two Biden years. Interest on the debt this year is expected to be $663 billion, which is $188 billion more than all corporate tax revenue.
Democrats are attacking Fitch, and Treasury Secretary Janet Yellen criticized the decision as “arbitrary and based on outdated data.” Outdated? Her own department on Monday increased the government’s expected borrowing from July to September to $1 trillion from $733 billion. That’s for three months.
She also claims that “governance” has improved under President Biden, citing the infrastructure bill and “other investments in America’s competitiveness.” She must be joking. Since when is blowout spending a credit recommendation?
Ms. Yellen and Democrats spent months trying to scare markets about even modest future spending reduction. Congress’s budget process is broken and its tax and spending estimates are often wildly wrong.
The EV subsidies in the hilariously named Inflation Reduction Act were scored at a cost of $14 billion, but Goldman Sachs estimates they will cost $393 billion because the subsidies are open-ended. Goldman estimates the climate spending will total $1.2 trillion—three times more than CBO’s estimate.
Neither Mr. Biden nor Donald Trump show the remotest interest in reforming entitlements, which will explode as the baby boomers retire. Mr. Biden and his progressive allies want to expand entitlements by trillions of more dollars, while Mr. Trump attacks any Republican who even mentions reform.
As Piper Sandler’s Andy Laperriere notes, the Trump GOP is moving away from its traditional pro-growth, free-market beliefs to favor protectionism and anti-business policies. As a result, the U.S. may be settling into a slow growth trajectory as Europe has. Without faster growth or policy reform, the U.S. fiscal outlook will worsen.
The reason U.S. debt hasn’t been downgraded earlier and more often is because the dollar remains the world’s reserve currency. But that “exorbitant privilege,” as the French like to call it, is not a birthright. It can vanish in a flash if markets perceive a broader American decline in governance or its ability to meet its financial obligations.
This is where political leadership matters, and where it has failed. The White House criticized Fitch’s decision, but there’s a reason the downgrade happened on Mr. Biden’s watch. It’s a no-confidence vote in U.S. political leaders, and that starts at the top.
I’m not a big fan of Moody’s, Fitch, and Standard & Poor’s. As I explained in this 2011 interview, these credit rating firms don’t provide much insight, at least with regards to assessing whether governments can be trusted to honor their debts.
That being said, I don’t object to Fitch’s decision to reduce America’s rating from AAA to AA.
Here’s some of what the company wrote.
FitchRatings has downgraded the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’. …The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions. …Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population.
While I agree with the downgrade, I have a couple of observations.
- The US is in strong shape in the short run: There is zero chance that bondholders will lose money in the next 20 years. Even if Republicans and Democrats had a bigger-than-normal fight over the debt limit, leading to some bondholders not getting paid on time, lawmakers would fully compensate them in any eventual agreement.
- The US is in terrible shape in the long run: American politicians are grotesquely irresponsible. They mostly understand that America faces an entitlement crisis, but most of them are unwilling to address the problem. Heck, some of them want to dig the hole deeper by expanding the welfare state.
- America’s long-run fiscal problem is bipartisan: Starting with LBJ and Nixon, politicians from both parties have expanded the burden of government. The deterioration has continued this century with two Republican presidents and two Democratic presidents pushing for more spending.
By the way, there’s little reason for future optimism. Trump and Biden attack anyone who wants to do the right thing on entitlements, so that makes it more likely that politicians eventually will compound the damage of higher spending by enacting higher taxes.
P.S. A big problem with the credit rating firms is that they seemingly think tax increases and spending restraint are equally acceptable ways of reducing red ink and improving creditworthiness. But since higher taxes lead to less growth and encourage more spending, the inevitable result is that tax increases lead to more debt. Just look at what’s happened in Europe.
The move by market agency Fitch Ratings to downgrade the United States’s debt rating has startled lawmakers and policymakers alike, who said Wednesday that they were perplexed by the move amid strong recent economic indicators. …
Fitch downgraded its issuer default rating for the U.S. on Tuesday evening, surprising investors, roiling equity markets and sending bond yields higher Wednesday morning.
Treasury Secretary Janet Yellen was also vocal about the move by Fitch Ratings, slamming it on Wednesday as “flawed” and “entirely unwarranted.”
“Fitch’s decision is puzzling in light of the economic strength we see in the United States,” Yellen said in prepared remarks. “[The U.S.] remains the world’s largest, most dynamic, and most innovative economy — with the strongest financial system in the world.”
The agency cited the “erosion of governance” and “fiscal deterioration over the next three years” as reasons for the downgrade, also mentioning the debt ceiling default that nearly crashed the U.S. and global economy in June.
“You have the debt ceiling, you have Jan. 6. Clearly, if you look at polarization with both parties … the Democrats have gone further left and Republicans further right, so the middle is kind of falling apart basically,” Richard Francis, a senior director at Fitch, told Reuters.
The downgrade is being met with criticism from both parties, who don’t seem to be shying away from pointed partisan rhetoric despite the assessment of increasing polarization.
“We strongly disagree with this decision. The ratings model used by Fitch declined under President Trump and then improved under President Biden,” White House press secretary Karine Jean-Pierre said in a Tuesday statement.
“It’s clear that extremism by Republican officials — from cheerleading default, to undermining governance and democracy, to seeking to extend deficit-busting tax giveaways for the wealthy and corporations — is a continued threat to our economy,” she said.
“The United States faces serious long-run fiscal challenges. But the decision of a credit rating agency today, as the economy looks stronger than expected, to downgrade the United States is bizarre and inept,” posted former Treasury Secretary Larry Summers on X, the platform formerly known as Twitter.
Rep. Blaine Luetkemeyer (R-Mo.) said in a Wednesday statement he had concerns about “Fitch’s history of subjective ratings” but also went after Democrats’ spending that he called “reckless.”
“Reckless fiscal policy that caused the inflation we’re still suffering is also harming confidence in our currency and treasuries. House Republicans understood this truth which is the reason Speaker [Kevin McCarthy] made countless attempts to start a dialogue with the White House months before the debt limit was reached,” Luetkemeyer said.
Other GOP members said that Biden’s recent legislative decisions were key in pushing Fitch into deciding the government could not work together.
“When Fitch specifically cited the problem of ‘last-minute’ resolutions, they may as well have noted Biden’s refusal to negotiate with Republicans for months, while insisting on even more wasteful spending,” House Ways and Means Committee Chairman Jason Smith (R-Mo.) said on Fox News on Tuesday.
“President Biden’s brinksmanship — not to mention the $10 trillion in new spending he and Washington Democrats passed over the past two years — pushed America’s credit rating off the ledge,” Smith said.
“Now families and small businesses already dealing with soaring interest rates and lost wages from Biden’s inflation crisis will also have to face the consequences of a reduced confidence in America’s sovereign debt.”
Well, here’s some free advice for Congress and the 2024 candidates. Some time ago a writer who actually cares about the deficit and the federal debt posited that balancing the budget without raising taxes would require across-the-board 7-percent budget cuts. Just to be safe, cut everything 10 percent, and if someone can’t agree upon cutting everything 10 percent, that person gets to suggest how to reach the net 10-percent threshold. That includes anyone else who thinks the feds should be doing things the feds are now not doing.
That also means cutting the 2.87-million-employee federal workforce. Which creates this joke:
Q: What do you call it when metro Washington, D.C., has the nation’s highest unemployment rate, and state capitals have their state’s highest unemployment rate?
A: Progress.
The next thing on the fiscal to-do list is to replace Social Security for those who are not near retirement (repeat those last six words if you’re confused) with a privatized investment program that Chile, Sweden and other countries have done.
Then comes a balanced-budget amendment to the U.S. Constitution (which must be approved by both houses of Congress and 38 states) to ban deficit spending for any reason regardless of circumstances.
Steve Prestegard.com: The Presteblog 