The Downgrade of U.S. Creditworthiness and Its Implications

Monday - August 14 2023, 09:22 UTC - 1 year ago

The pristine reputation of the U.S. government’s debt decreased after the rating agency Fitch downgraded Uncle Sam from its AAA perch of creditworthiness to AA+. The downgrade is unlikely to have much of an impact in the short term, but investors will likely be wary of the implications for U.S. economic growth and will look to Capitol Hill for negotiations on a budget agreement to avert the first Biden administration government shutdown.

The formerly pristine reputation of the U.S. government’s debt lost a little more luster after another prominent rating agency demoted Uncle Sam from its AAA perch.

What does a downgrade of U.S. creditworthiness like this actually mean? .

While the downgrade is unlikely to have much of an impact in the short term, its implications about the state and size of U.S. indebtedness will likely reverberate on Capitol Hill, where stalled negotiations over the budget could mark a step toward the Biden administration’s first government shutdown.

Fitch Ratings’ decision on Aug. 1, 2023, led to small declines in the stock and bond markets. But as an economist who studies the effects of monetary and fiscal policies, I’ve got longer-term concerns about the downgrade’s implications for U.S. economic growth.

To understand why, you have to look at both the reasons for Fitch’s downgrade and what it means for U.S. borrowing going forward.

Why Fitch downgraded the US .

Just like people, the federal government has to balance the income it takes in and the money it spends for each fiscal year. Most federal income consists of tax revenue.

Since 2001, that revenue has rarely covered enough of the costs of everything the U.S. government pays for, from roadways to wars. When federal income falls short, the government fills the gap by borrowing money from investors.

That gap has gotten a lot bigger in recent years as the U.S. has spent trillions fighting COVID-19, contending with financial crises and funding several wars. As of Aug. 1, the U.S. Treasury owed US$32.6 trillion, both to bondholders and other parts of the federal government.

That’s part of the reason that Fitch cut the U.S. government’s long-term creditworthiness by one notch, from AAA – its highest rating – to AA+. Fitch also cited an "erosion of governance," specifically pointing to recent efforts by conservatives to prevent the U.S. from raising its debt ceiling.

What happened last time .

This was not the first time that a rating agency lowered the credit of the U.S. government.

In 2011, Standard & Poor’s, one of Fitch’s competitors, also downgraded its rating for the U.S. from AAA to AA+. S&P similarly blamed governance issues – that downgrade followed a similar debt ceiling standoff – as well as the burden of rising government debt.

At the time, Fitch issued a warning but it didn’t cut the U.S.’s credit rating until now.

The 2011 episode had no long-term effects on financial markets, including Treasury bonds – meaning investors remained happy to continue lending to the U.S. at favorable rates.

Does that mean Fitch’s downgrade will similarly have little long-term impact? Not necessarily.

Why things might be different .

Any country seeking to borrow money in perpetuity needs lenders who are happy to lend.

For the U.S., that means it needs a constant supply of buyers for Treasury bonds and the other securities it sells. These securities are sold in auctions and then traded on global financial markets.

Investors of all kinds around the world find Treasurys attractive. They’re seen as safe, because the U.S. government is considered less likely to default than, say, a troubled small country or a failing business.