Fitch was right: political dysfunction and reckless fiscal policy impair US debt

Fitch has a point. The widespread reluctance to admit it only proves the company’s case.

The reaction to Fitch Ratings’ recent downgrading of US government debt was more revealing than the announcement itself. Citing concerns about America’s long-term fiscal position and the risk that Washington’s political dysfunction could make matters worse, the company marked US debt down from AAA to AA+. The move was roundly attacked as “strange” and “completely absurd.” In an official response, Treasury Secretary Janet Yellen called it “arbitrary” and “outdated.”

True, the insight conveyed by any such assessment of US government debt is minimal. Investors and analysts have all the data they need to judge for themselves the risks attached to the world’s most widely traded assets. The new rating has no material regulatory implications and barely even registered with bond markets. In effect, Fitch was telling investors what they already knew.

If ever there was a case of protesting too much, though, the reaction to the downgrade qualifies. Yellen’s comments — claiming that the administration is “committed to fiscal sustainability” — veered into outright complacency. Her reassurance should cause more anxiety not less, because the issues that Fitch is pointing to are real: By 2025, the company points out, the US budget deficit will reach nearly 7% of gross domestic product, even as the country’s fiscal challenges (a rising debt-service burden, soaring health-care costs, dwindling Social Security funds) go mostly unaddressed. Changing course starts with recognizing the gravity of the problem.

Fitch’s critics say the US fiscal outlook has improved lately, leading them to ask why the downgrade is happening now. Fair enough: On Fitch’s own analysis, it should’ve happened earlier. But the underlying problem is in no way solved. The recent improvement is temporary, arising mainly from the effect of high inflation on the denominator in the ratio of debt to GDP. On current policy, this ratio is still on track to reach historically unprecedented levels. The Congressional Budget Office expects it to exceed 118% by 2033 — and to continue rising thereafter absent a major policy change. Crucially, this deterioration is happening just as Washington’s incapacity to address the issue gets ever more entrenched.

Nobody, least of all Fitch, thinks that the US might find itself forced to renege on its obligations. The bad outlook does portend some combination of higher interest rates, higher taxes and lower public spending — but this in itself doesn’t mean the US is heading toward insolvency. That danger arises thanks to some future mix of fiscal crisis, polarized politics and the astonishing willingness of the country’s leaders to occasionally flirt with a voluntary debt default for tactical purposes.

Yellen seems to regard the recent debt-ceiling deal, which lifted the imminent threat of self-inflicted default, as sufficient reassurance on this score. That would be absurd. The deal seriously worsened the longer-term fiscal outlook by taking essential reform of entitlements (mainly Social Security and Medicare) off the table. And it did nothing to improve the budgetary process. Addressing that challenge will require ambitious bipartisan cooperation. Right now that’s hard to imagine — and the problem could get worse before it gets better.

In short, Fitch has a point. The widespread reluctance to admit it only proves the company’s case.

Views are personal and do not represent the stand of this publication.

Credit: Bloomberg