Wednesday, April 20, 2011

The National Debt “Downgrade”

Standard and Poor’s signaled that they might downgrade their rating of US debt.

S&P is the largest rater of government bonds in the world. They have rated the US, and about 20 other advanced economies as AAA — their highest rating.

But, about 20 years ago, they started also announcing a signal of where the rating may be going. This is what changed on Monday — the US was downgraded from “AAA Stable” to “AAA Negative”. That’s why I put "downgrade” in quotes, because we’re still AAA (sort of). Here’s a chart for comparison:

These ratings are used by buyers of government bonds (typically other countries, central banks, insurance and reinsurance companies and pension funds) to decide how much interest they need to justify the purchase. So this “downgrade” will result in our government having to pay higher rates.

This “downgrade” is purely in response to political moves; most likely Obama’s unprofessional speech last week that pilloried Republicans in Congress for supporting Representative Paul Ryan’s plan to reduce the national debt. The “downgrade” can be taken as a sign that S&P has interpreted Obama’s speech as indicating that he is unwilling to make a deal with House Republicans.

It would not be correct to interpret the “downgrade” as a response to economic fundamentals. These are not good, but they simply don’t change that rapidly. Here’s the story we already know:

This didn’t change last week. Politics did. The top chart also shows that we’re not out of the range of other countries — like Canada. The difference is that our political situation is not currently favorable to improving the numbers.

This all came from a piece in Tuesday’s issue of The Wall Street Journal called “U.S. Warned on Debt Load”.

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