On August 1, the Fitch Ratings agency downgraded the United States’ long-term credit rating from AAA to AA+ for only the second time in the nation’s history, in what’s generally seen as a signal of concern about the US’s creditworthiness.
Many seemed perplexed by the move. Former Treasury Secretary Lawrence Summers called it “bizarre and inept,” economist and Bloomberg columnist Mohamed El-Erian said it was “strange,” and the White House said in a statement that the move “defies reality.”
In a statement, Fitch cited three reasons for downgrading the US rating: concerns the US economy is going to deteriorate over the next three years; a high national debt; and repeated political standoffs over managing the country’s finances (specifically, brinksmanship over the country’s self-imposed debt limit, the cap on how much to US can borrow to pay its bills).
However, many economists and other financial experts have expressed bewilderment over the motivation for the downgrade. The agency provided little hard data to back up its stated concerns about looming economic collapse, said Stephanie Kelton, a professor of economics and public policy at Stony Brook University. And many experts disagree with Fitch’s pessimistic view of the country’s financial future.
“If you don’t have credible evidence of a long-term inflation problem, then you don’t have reason to be concerned about a long-term debt problem,” said Kelton.
The real reasons for the downgrade, Kelton said, may be less related to the US’s ability to pay its debts, and more related to its willingness to do so. That much was clear from the agency’s repeated mention of its concerns about the country’s “erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades,” specifically with respect to difficulties in raising the debt ceiling, oscillations in tax policy, and increases in government spending.
Whatever stimulated the move, both history and math suggest the changed credit rating will not have meaningful effects on the US economy.
Who is Fitch and why does anyone care what they think?
Fitch is one of the three big independent credit rating agencies whose takes on countries’ creditworthiness really matter on the world stage. The other two are Standard & Poor’s and Moody’s.
These credit rating agencies’ credibility is rooted at least in part in tradition. All three have come under some fire in the past — notably, for exacerbating Europe’s financial crisis between 2008 and 2012 by overrating struggling financial institutions and underrating several European countries. Still, after the US and European governments passed reforms aimed at improving the agencies’ transparency and competitiveness (and after Standard & Poor’s paid an enormous settlement for fraudulent activities contributing to the crisis), their assessments of countries’ creditworthiness remain the financial world’s gold standard.
Big institutions (like pension funds, insurance companies, banks, and the like) rely on these agencies because they don’t keep their money under mattresses or in checking accounts: They generally invest their assets in a variety of ways in the hopes their money will grow as economies grow over the years. And they decide where to invest those assets based on ratings like Fitch’s.
If a country has a high credit rating, an institution can feel secure that investing in companies and industries in that country will probably yield long-term gains, and that the country will eventually make good on the financial promises it makes.
For years, US Treasury bonds have stood fast as one of the safest and most reliable investments where institutions can watch their assets grow. And over most of that time, the US has had a consistently high credit rating across all three agencies (with one notable exception; more on that later). The fact that may be changing now is part of why Fitch’s decision is such a big deal.
Fitch’s reasons for downgrading the US’s credit rating are a little sus
Although Fitch cited recession concerns, high national debt, and political dysfunction as their reasons for the downgrade, Kelton said those reasons don’t really track.
“Judging by their own commentary, they did it because they’re very confused,” she said. The bulk of Fitch’s rationale for the downgrade rested on concerns about the country’s fiscal trajectory, but there isn’t any evidence for that, she said.
A high national debt is also not a legitimate cause for creditworthiness concerns in a country that, as Alan Greenspan said earlier this year, can print money. In this situation, the US’s solvency, and its ability to pay its debts, isn’t really in question.
It’s pretty common for the governments of large, industrial economies to spend more than they take in, said Kelton. If all Fitch needs “to arrive at the conclusion that the government’s fiscal trajectory is unsustainable, then I’m here to challenge that viewpoint,” she said.
What’s perhaps more in question is whether political dysfunction would lead the US to be unwilling to pay what it owes. The US came within days of defaulting on its debt in June, and at least some Republicans seemed willing to allow a default to happen in order to extract various political concessions from the White House. Should that sentiment spread, that could cause serious problems for all the countries and institutions who took on that debt, expecting to be repaid.
But if that’s the agency’s argument, it seems to have muddied the waters a bit by also saying it has concerns about the US’s solvency. There seems to be some subtext that Fitch doesn’t believe US lawmakers can get their act together to fix looming issues like rising Medicare costs and the mass retirement of baby boomers, and that it doesn’t trust Congress to always avoid a default. But Kelton said it’s frustrating that Fitch didn’t say that in plain language.
“If you want to just be explicit and say, ‘We have grave concerns about the direction of US politics, or we think that there’s a chance Congress is turning into a banana republic,’” said Kelton, “fine.”
“But they didn’t do that,” she said.
History repeating is sometimes good
It’s unclear what the downstream effects of this downgrade will be. In the short term, markets can overreact, said Kelton — and indeed, this morning, US and global stock markets fell.
It’s much less clear what the long-term effects will be. Theoretically, a ding to the US’s creditworthiness means a ding to the creditworthiness of the financial institutions that invest heavily in US Treasury bonds. Downstream effects of that could hypothetically include higher interest rates and increased costs to US taxpayers.
But that doesn’t seem likely to happen. Although analysts have concerns that the downgrade would do a bit of damage to the country’s reputation, many still expect the actual impact on confidence and investment in US government-backed securities to be limited, according to reporting from Reuters.
This isn’t the first time the US credit rating has taken a hit — and Fitch isn’t the first agency to ding the country’s creditworthiness. In 2011, after the US government engaged in a debt ceiling standoff, Standard & Poor’s downgraded the US rating from AAA to AA+.
The consequences were underwhelming: “Nothing happened,” said Kelton. In fact, she recalls that the day after the 2011 downgrade, the appetite for US Treasury bonds — a key measure of investor confidence in the American government’s solvency — was up, not down. (That generally seems to have remained true yesterday and today.)
That’s because sophisticated investors understood that the global financial system is built on the US’s ability to follow through on its financial promises, said Kelton. They bet that even if political troubles were putting debt in jeopardy at the time, things would normalize soon. If history is any indication, investors still have confidence in the US.
Other experts seemed to have similar recollections of the event and its economic resonance. “Remember when S&P downgraded America in 2011?” tweeted Nobel Prize-winning economist Paul Krugman. “Neither do I.”
The move by Fitch makes sense.
No, it does not help that the US has a very high level of national debt, but here comes somebody to scold me about how debt is different when you’re the government and yadda yadda, so never mind that angle.
No, this is a direct reaction to yet another game of fucking chicken with the debt ceiling. The finance world moves both fast and slow, second by second but also quarter by quarter; for every day trade where microseconds count, there is another action where it takes, oh, 3 months for the relevant body to react to what just happened. This is one of those actions. They’ve spent the last couple of months running their numbers, and now here we are. They have delivered their verdict for the current fiscal quarter, after much deliberation.
It does not make any sense at all to go around talking about US Fed bonds as if they are “zero risk”, or even “effectively zero risk”, if every 8 years there will come a game of chicken slash pissing contest where the hostages are everyone who has been foolish enough to buy US Federal debt under the expectation that the interest rate will be paid on time. If somebody in the US government does not blink in this game of chicken, then fuck you, the US will default on its “zero risk” debt.
And so here is Fitch quite reasonably questioning that status quo, that US debt is “zero risk”.
Keep in mind that the entire damn globe is holding US Treasury Bonds, the debt in question. Just as importantly, the biggest holder of US debt is US citizens. You, somehow. That’s where the yields on a CD come from, and your money market account. US Bonds.
Typically, 10 year US Treasury Bonds provide the highest guaranteed interest rate -ignoring recent rate inversions because COVID black swan shitshow- because obviously if you are going to lock up your money for a decade, you would expect the best return at maturity.
But this debt ceiling BS happens every 8 years. This means that every truly serious investor who holds a 10-year T-Bill, from Wall Street funds to the Chinese government, is heavily exposed to the threat of complete default on this debt thanks to that entire debt ceiling thing, to say absolutely nothing about the solvency of the US government, in general.
That’s not fucking zero risk. And Fitch is tired of pretending that it is.
Fuck sake, they aren’t even trying to have a debate upon whether the US can sustain its frankly obscene debt level. No, it’s just that AAA rating means “zero effective risk, barring nuclear war or alien invasion or some unforeseeable shit” and all that clownfuckery with the debt ceiling is NOT “zero risk”, nor is it unforeseeable.
Is that zero risk? When the person who owes you money can watch the due date tick down from 5 years out and wait until the last fucking minute of the last damn day to decide they’re going to pass the law that will allow them to pay you? No, the fuck it ain’t.
Did they appear to care about the creditors? The bondholders who they owed interest to? No, that whole song and dance was about, I don’t know, probably abortion. The Republicans have been using the debt ceiling as a hostage for a decade or more, so if you’re the French government, for example, and hold a bunch of US Treasury bills, you can’t call that shit zero risk with a straight face, come on. It doesn’t even matter if the US can pay the debt, the question is, will they?
I need you to understand that literally everyone in the world is investing in US Federal debt, it’s not just you, US person. It’s kind of frightening how US Federal debt is the cinder blocks that many other nations are building their economic foundation on. That’s what being the reserve currency is about.
Fitch knows that, and they know it back to front, so when they issue a rating, the weight of it is upon them. Can we call it zero risk? Like zero, zero??
If you have any money in your brokerage money market account, or a CD, anywhere, you’re in this boat, wondering if US Bonds are zero risk. The whole world is in this boat, wondering if US Treasury Bonds, especially the 10-year ones, are really zero risk guaranteed money on maturity. Like, really really, tho? Maybe there’s a smidge of risk? Even the 30 year bonds??? 30 fuckin years on the bond, my dude, zero risk on that?
We’ve all been on American social media, they all talk like they’re going to have another Civil War; probably not, but still. Zero risk on the 30-year US Treasury Bond? That’s a long time. Shit can go nuclear. Zero risk?
Could you look your best fucking friend in the face and say, “oh, yeah, buy a US 30 year Treasury Bond, there is absolutely no risk of any sort on that, you will get your interest even if Florida slips under the sea, taking Disney World with it.” Could you? No.
So pretend that there you are, some team of analysts at Fitch, knowing all of this, knowing more than I do because it’s your job, and looking at each other like, “Can we call this zero risk? Because that’s what AAA means. We all know that. So can we?” And nobody wants to, because it isn’t, and we’re all tired of pretending like it is.
And Fitch looks at the obvious, it downgrades US Treasury debt from AAA - perfect, the best possible - to AA+ - still near perfect, but room for improvement.
Fitch is right. Fitch is right to shoot up the warning flare. We’re lucky that China’s situation is still a bit of a mess, and the United States Federal Reserve needed the wakeup call, not that they want it. We’re lucky that buying a bond from the Chinese Federal Government doesn’t quite make sense, because if the state owns all things, then what is a bond? It doesn’t matter what the answer is, it only matters that we have to discuss it. We all know what a US Treasury Bond is, that’s beyond debate. That certainty elevates it.
It’s not like Fitch are acting up to get attention, fuck that. Every other respectable bond rating house should have done this first. It’s not fair that Fitch has to be the odd ones to call the obvious. Fitch is right. The US needs to get its shit together.
Bravo. Spot on.
Perun tier, through and through. Thank you.