In a bold move, credit rating agency Standard & Poor’s has downgraded the United States one notch from AAA to AA+ with negative outlook.
The credit rating downgrade is the result of concerns about budget deficits and comes shortly after US politicians took a decision to raise their debt ceiling to the wire.
As part of negotiations to increase the debt ceiling, politicians in the US put in place a deficit reduction plan. Standard & Poor’s do not believe this went far enough towards dealing with budget deficits.
This credit rating downgrade is potentially very bad news for investors.
It is likely to further damage investor confidence in the world’s largest economy, following a week when lack of investor confidence resulted in around 10% being wiped off the value of global stock markets.
Whilst we hope that markets have priced in this credit rating downgrade, it seems likely that markets will now have further to fall when they reopen on Monday, as a result of this news.
In practical terms, losing the coveted AAA rating is likely to raise the cost of borrowing for the US government, resulting in higher interest rates for individuals in the US.
Standard & Poor’s have downgraded US debt for two reasons.
Firstly, the downgrade has occurred because US debt is forecast to reach 85% of Gross Domestic Product (GDP) in ten years time. This forecast initially contained an error of around $2tn which the US government claimed undermined the assessment made by Standard & Poor’s.
Secondly, and possibly more importantly, US debt was downgraded because Standard & Poor’s has lost confidence in the US government ability to make decisions around budget and fiscal policy.
Within their report, Standard & Poor’s said:
“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.”
It is this second point which has so undermined confidence amongst investors over the past week. The ‘Tea Party’ movement in the US may have scored a massive own-goal with their belligerent stance on negotiations to raise the debt ceiling.
The credit rating of US debt could have even further to fall. The current negative rating means that Standard & Poor’s could reduce the rating another notch to AA within the next two years if current deficit reduction measures were inadequate.
One important message this unprecedented credit rating downgrade should send to all Western economies is that the age of living beyond our means is over.
Borrowing huge amounts of money each year to pay our bills is an unsustainable strategy for both governments and individuals. Combined with lack of a clear strategy to manage debts, it is little surprise that the credit-worthiness of the US has been lowered.
Photo credit: Flickr/nn1776
