US debt rating downgrade may drive up interest rates

The Fitch Ratings logo is seen at their offices at Canary Wharf financial district in London, March 3, 2016. [Reuters]

The global ratings agency Fitch this week lowered its assessment of the creditworthiness of the U.S. government, announcing that it had downgraded U.S. Treasury securities from the agency's top AAA rating to a slightly lower AA+ designation.

In the long term, the change could have potentially serious consequences for the United States and the broader global economy. This is because debt issued by the U.S. Treasury is a global benchmark for interest rates and has long been considered one of the safest - if not the safest - interest-bearing investment in the world.

Fitch justified its change by pointing to longtime dysfunction in Washington. For years, the government has lurched from debt crisis to debt crisis, with congressional standoffs, including one earlier this year, repeatedly bringing the country to the brink of default, only for lawmakers to pull back at the last moment.

"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 resolution," Fitch said in an announcement of the change.

Distant echo

The business of rating countries' creditworthiness is dominated by three global companies: Fitch Ratings, S&P Global Ratings and Moody's. All three issue thousands of assessments of the risk of lending to countries and businesses every year.

Fitch's decision to cut the U.S. rating is a distant echo of one made by S&P 11 years ago, in the wake of an earlier debt limit standoff. S&P also lowered the rating of the U.S. to AA+, citing concerns very much like those expressed by Fitch this week.

Until Tuesday, S&P had appeared to be the outlier, with the other two major ratings firms maintaining the country's AAA rating. Now it is Moody's that appears to be out of step with its competitors.

Biden administration reacts

The administration of President Joe Biden seemed somewhat blindsided by the Fitch announcement Tuesday. Treasury Secretary Janet Yellen called the decision flawed during a public appearance the same day.

"Fitch's decision is puzzling in light of the economic strength we see in the United States," Yellen said. "I strongly disagree with Fitch's decision, and I believe it is entirely unwarranted."

Yellen referred to various economic indicators, including rising gross domestic product, extremely low unemployment and rapidly cooling inflation, as signs of the resilience and stability of the U.S. economy.

"At the end of the day, Fitch's decision does not change what all of us already know - that Treasury securities remain the world's preeminent safe and liquid asset, and that the American economy is fundamentally strong," Yellen said.

'Wake-up call'

Despite the administration's assurances, some experts say U.S. policymakers should take the Fitch downgrade seriously, both because of the underlying problems the agency identifies and the negative impact a lower credit rating could have on the economy.

According to the Congressional Budget office, the federal government's outstanding debt is now roughly equal to the nation's GDP, a ratio not seen since the end of World War II, and it is on track to continue rising. In recent years, neither of the two main political parties in the U.S. has taken serious steps to deal with the country's ballooning debt, even when each has enjoyed undivided control of Congress and the executive branch.

"This is a useful wakeup call to tell the political class that they need to get serious about the budget deficit issue," Desmond Lachman, a senior fellow at the American Enterprise Institute, told VOA.

Lachman pointed out that some of the largest purchasers of U.S. Treasury debt are foreign governments, and that continual budgetary dysfunction in Washington could cause them to rethink the wisdom of investing large amounts of money in a government that seems not just unable, but unwilling, to balance its books.

"We're already very indebted abroad," said Lachman. "The Chinese central bank is holding something like $3 trillion of Treasuries. They're not going to finance us indefinitely, you know."

Global impact

Andrew Lautz, a senior policy analyst with the Bipartisan Policy Center, told VOA that it was too soon to say how much of an impact the ratings' downgrade would have on the rates at which the U.S. is able to borrow in the future. However, he said, any increase would be felt far beyond the U.S. Treasury.

"U.S. government debt, in the form of Treasury securities, underpins not just the U.S. economy but the global economy," he said. "It's still considered the safe-haven asset of the world ... and the world's reserve currency."

Interest rates on consumer credit cards, home mortgages and business loans are based, either directly or indirectly, on the rates charged on Treasury debts.

"So, when Treasury's borrowing costs go up, and when that increase is sustained over the long term, that has a cascading effect on consumer and business credit," Lautz said.

Regardless of whether the ratings' change drives borrowing costs up, Lautz said, the Fitch downgrade sends a message that needs to be heard.

"It should be a powerful signal to policymakers that we need to get our fiscal house in order," he said. "We need to improve our budget process and we need to take steps to ensure that debt limit brinkmanship or government shutdowns can't happen again in the future."