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What Happened with the U.S. Ratings Downgrade Problem?

Was the U.S. Ratings Downgrade from AAA to AA in 2011 a Problem?

Before Standard & Poor’s cut the United States’ credit rating last summer, few economists or politicians believed that the United States could ever lose its gold-standard AAA rating. As a stable, vibrant democracy backed by a strong military, it was inconceivable that its government could show even the slightest hint of fiscal weakness.

Has the US Ratings Downgrade Affected the U.S. Economy?

U.S. Ratings DowngradeAlthough some prominent economists argued that the U.S. ratings downgrade would directly affect the  economy, its impact appears to have been muted. Today, S&P’s judgment remains a one-off aberration. In fact, little has changed since the downgrade. If anything, the American economy is stronger today than it was in the summer of 2011. The unemployment rate has improved since then and is now hovering below 8 percent. [Editor’s note: These numbers may not present the true picture, see Unemployment, Part-time Workers and Obamacare ]

Likewise, Treasury bond yields have failed to spike as anticipated. Today, 10-year T-bill rates are about 1 percent lower than they were immediately before the downgrade. This outcome has puzzled economists who were sure that the American economy would suffer as a result of the downgrade. “Worst-case” predictions that the rating change would spark another housing crisis or cause a spike in the interest rates on mortgage loans have so far proven unfounded. In fact, borrowing costs for the average American consumer are lower now than they have been in many years. By historical standards, inflation also remains low.

What’s the Difference between the Two Ratings?

Then again, the relative non-impact of the downgrade might not be surprising. By most standards, the country’s new AA+ credit rating is not weak. If the United States was an individual consumer, this rating would translate to a personal credit score of above 800. Consumers with such high credit ratings are fairly rare and are highly sought-after by credit card companies. These individuals can obtain credit cards with low interest rates and generous spending limits. They may also find it easier to procure low-interest mortgages that don’t require large down payments.

In much the same way, the ability of the United States government to borrow money has not been significantly impacted. Interest rates on government debt remain low, and the treasury has not yet had any difficulty finding buyers. Since the government’s rating remains extremely good both relative to other issuers and in absolute terms, investors have not been deterred by the fact that it is slightly lower than it was before. In the report that accompanied its downgrade, S&P indicated that the United States may well regain its AAA rating. Later in the same report, the agency also hinted at the possibility of further downgrades.

In other words, much uncertainty surrounds the credit outlook of the United States. However, it’s important to keep in mind that AA+ is still an excellent credit rating. An individual with an analogous credit score would still enjoy pleasantly low borrowing costs. Unless the country faces further downgrades, its borrowing costs are likely to remain low in the coming years. Just like the credit score of an everyday credit card user who makes a single late payment, the country’s credit rating is somewhat more tenuous than it was before the downgrade. Of course, private borrowers can improve their credit scores and lower their interest rates by making timely payments and using credit judiciously. The United States may be able to lower its own borrowing costs by renewing its top-notch AAA credit rating once more.

Editor’s Note:

One reason the U.S. ratings downgrade hasn’t affected the economy yet is that Europe is in a much worse situation so there aren’t many other alternatives but, the downgrade does hint of serious underlying problems and although the final reckoning day hasn’t arrived yet, issues like the “fiscal cliff” are on the horizon and could have an impact shortly.  The deficit continues to mushroom out of control with government debt nearing 100% of GDP compared to 80% of GDP in 2008. In other words, it now takes every cent made in the U.S. in one year to pay off the government debt. And the GDP includes in it’s calculation money “made” by the government pushing papers around, which really produces nothing but more red tape (and by extension less productivity).  This is unsustainable in the long run so saying things look fine so far is like a drug addict or drunk driver  saying “well it hasn’t killed me yet” … it is only a matter of time before the consequences of our government’s actions are felt in the economy.

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About the Author:

This article was written by Lindsey together with Alfonso. Alfonso has been covering the forex market for more than 10 years, working at trading desks and global research and analysis teams. He works with OANDA regularly as a market specialist in business dailies and online portals. You can read more of Alfonso’s work at http://forexblog.oanda.com/.

Image courtesy of domdeen / FreeDigitalPhotos.net

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