Date: 08/02/2023
Author: Mr. X
My entire life, I’ve been told debt will bring down the American economy. It will happen eventually. It won’t happen soon. Nonetheless, I expect plenty of excitable headlines based on what Fitch Ratings just did.
It downgraded U.S. long-term debt from a AAA rating to a AA+ rating. The reasons why were deeply ominous. “The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” it said, referring to the now traditional battles over raising the federal debt limit. Of course, some might argue that the proper response to this is to avoid battles altogether and make it so that the debt limit can be raised automatically.
The White House and Senate Majority Leader Chuck Schumer both capitalized on this idea earlier this week, accusing the Republican Party of being responsible for the rating downgrade by forcing a confrontation over the debt limit. Janet Yellen steered clear of that, but said the decision was “arbitrary and based on outdated data.”
However, that would mean missing the core element behind the debt downgrade. Fitch also said “tax cuts and new spending initiatives” were responsible for soaring levels of debt – a crisis for which both parties are responsible. The entitlement crisis will also pose huge problems, as Congress has proven unable to come up with a solution to the long-term unviability of Social Security and Medicare. Fitch bemoaned “limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population.” Fitch also didn’t limit itself to purely long-term projections, saying that there would be an “expected fiscal deterioration over the next three years.”
Fitch followed up the move by downgrading Freddie Mac and Fannie Mae, which are both linked to the sovereign rating of the United States. In short, the agency is sounding the alarm on the fiscal health of the United States as a whole.
S&P Global ratings downgraded the United States during the financial crisis of the Obama Administration. That was seen as a major financial milestone. This time, there hasn’t been a major reaction. Markets were down yesterday, including the Nasdaq, which was down by more than 2%. Yet there was hardly panic, and some financial leaders openly mocked the decision.
JPMorgan Chase CEO Jamie Dimon said that the decision “doesn’t really matter that much.” He also said the decision was unwarranted. “To have [other countries] be triple-A and not America is kind of ridiculous,” he said. “It’s still the most prosperous nation on the planet, it’s the most secure nation on the planet.”
“My sense is that the Fitch downgrade of the US credit rating is an insignificant development and will not move financial markets or the economy,” said the chief economist at RSM US, Joseph Brusuelas, in an interview with CNN. “As long as the Federal Reserve continues to treat US issued paper as AAA rated credit so will financial market participants.”
Mohamed El-Erian, President of Queens’ College and a widely cited economist, said that it was a “strange” move. “I am very puzzled by many aspects of this announcement, as well as by the timing,” he posted on X. “I suspect I won’t be the only one. The vast majority of economists and market analysts looking at this are likely to be equally perplexed by the reasons cited and the timing. Overall, this announcement is much more likely to be dismissed than have a lasting disruptive impact on the US #economy and #markets.”
Barry Eichengreen, a UC Berkeley economist, argued that the debt-to-GDP ratio is heading down and the debt limit was just raised. “There is no ‘news’ to justify this action,” he said.
Alec Phillips of Goldman Sachs said the downgrade “should have little direct impact on financial markets as it is unlikely there are major holders of Treasury securities who would be forced to sell based on the ratings change.”
And yet there is an underlying story. The national debt will soon exceed 100% of GDP, which is remarkable considering the strong growth of the Americna economy. Because of increasing interest rates, the Congressional Budget Office has projected that the government will pay 3.9% on 10-year borrowing and 4.5% on 3-year borrowing in 2023, up from 3% and 2% in 2022. Net interest costs will total $663 billion in 2023 and approximately double over the next decade. It will be $745 billion in 2024, about $1.4 trillion in 2033 – and then it gets worse.
Clearly, this is not a problem that can be ignored forever. Yet it almost certainly will be. There is no political will for solving the problem. There was a broad consensus for it when President George W. Bush wanted to reform Social Security, possibly by privatizing part of it. In retrospect, he was right, and both recipients and the government would be far better off today. Yet the opportunity was missed, and no one will be so foolish as to try again.
In the short term, Fitch’s decision makes little sense and doesn’t really matter. However, for investors looking at the next 10 or 20 years, the moment of crisis is approaching. The government will not confront the problem, but we will all have to live with the consequences. Just not soon.
As Lord Keynes (in)famously said, in the long run, we’re all dead.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing
