The decision by Fitch to strip the US of its AAA credit rating, lowering it one level to AA+, means little in itself. There is next to zero chance the government won’t be able to pay its creditors and the Treasury Department’s access to funding is determined by forces far more fundamental than a few capital letters tied to a ratings report. That doesn’t mean the US’s rising debt burden isn’t a problem.
There are at least three ways in which increased federal borrowing could disrupt not jus the US economy and financial markets, but the global ones as well. The first and most worrying is the potential for a so-called debt bomb. Under this scenario, the government’s debt burden -which currently stands at $32.3 trillion - becomes so great that even a small increase in interest rates means the Treasury needs to borrow to just to cover the cost of servicing the debt. This leads to a vicious cycle, with the added borrowing discouraging buyers, driving interest rates higher and forcing even more borrowing. The resulting sky-high interest rates throws the economy into a deep recession.
What’s concerning is that the US may be getting uncomfortably close to such a scenario. The Treasury is on track to spend almost $1 trillion on interest payments alone in fiscal 2023, compared with less than $600 billion before the pandemic and around $425 billion in 2011 when S&P lowered its rating for the US from AAA to AA+.
The third potential crisis stemming from too much debt is political. Recall that when he was president, Donald Trump - who polls show is the frontrunner to win the Republican party’s presidential nomination for the 2024 election - publicly criticised Powell for raising interest rates in 2017 and 2018 in an effort to keep inflation under control. So, it stands to reason that if Trump had his way, inflation rates would probably have been even higher and more sustained than they’ve been. This is significant because if elected, Trump will be responsible for appointing not just the next head of the Fed but filling any vacant seat of on the central bank’s Board of Governors.
Large and sustained budget deficits create an enormous incentive for any politician to appoint officials to the Fed that would do their bidding in the short term while leaving the fallout to the next administration. If such a political dynamic were to prevail, it might only be a matter of time before a debt bomb and debt monetisation became a real possibility - ratifying Fitch’s decision.
Karl W. Smith is a Bloomberg Opinion columnist. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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