Fitch’s decision to downgrade US debt has a political rationale

The gods of finance can sometimes deliver choreography which will make future historians laugh. One such moment occurred in America this week.

Jack Smith, the Special Counsel for the United States announced on Tuesday a new indictment of former US President Donald Trump. He accused him of launching an “unprecedented assault on the seat American democracy”.

On the same day, Fitch, the credit ratings agency, stripped America of the AAA rating, echoing a similar move made by Standard & Poor in 2011. Two of the three major rating agencies have downgraded Treasury bonds — despite the fact that they are supposed to be the benchmark for “risk-free global finance”.

These two announcements may not appear to be linked at first — and they certainly weren’t coordinated. The coincidence is symbolic. They collectively indicate that America’s political economic is headed into uncharted water, with a wide range of possible outcomes. Investors need to take notice, regardless of whether they agree with the decision made by Smith or Fitch.

It is worth reading the announcement to understand why. Rating agencies used to assess the creditworthiness America by analyzing its financial and economic fundamentals. As any finance student knows, the difference between developed and emerging countries is that developed countries are less prone to political risks, while emerging markets tend to be more so.

Fitch analysts cited some statistics in their announcement on Tuesday. The analysts noted that they expect the deficit of the general government to increase to 6.3 percent of GDP by 2023 from 3.7 percent in 2022. This is due to weaker federal revenue, new spending programs and an increased interest burden.

The interest-to revenue ratio will reach 10% by 2025, compared to 2.8% for the median ‘AA’ and 1.0% for the median ‘AAA.’ Meanwhile the debt-to GDP ratio is expected to hit 118.4% by 2025. . . The debt of America is two-and-a half times greater than the median of the AAA countries, which is 39.3 percent of GDP. In plain English: America’s debt data are far worse than those of any other top-rated countries and will likely continue to worsen.

As many economists retorted with anger, America isn’t exactly a normal country. It can always pay its debts, since it has the (in)famous privilege of printing dollars.

Fitch also noted that certain debt statistics had improved in recent years: for example, the debt-to GDP ratio is expected to drop from 122.3 percent in 2020 to “only” 112 percent in 2023. Janet Yellen , Treasury Secretary, dismissed ‘s downgrade , calling it “arbitrary and based upon outdated data”.

Many critics have failed to realize that the downgrade is less about economics and more about politics, or “governance”, as the rating agency has repeatedly called it. Even if Washington is theoretically able to pay its bills and reduce its debt, this does not guarantee that it will. A new policy risk has emerged.

The fact that bitter Congressional fights continue to erupt over the debt limit is a sign. While the last standoff ended in June, may be back this fall when the negotiations over the budget for 2024 resume.

It is difficult to imagine Congress taking sensible steps to address America’s fiscal issues. The bipartisan reform of social security is one example. Another is reviewing the spending and reforming taxation. Since the Simpson-Bowles Commission in 2010 — which failed — there have been no serious initiatives on this line.

This week’s accidental choreography is important. If Smith’s legal onslaught knocks Trump from the 2024 race, allowing centrist forces to win, it’s possible to imagine future scenarios where bipartisan fiscal policies could emerge in Congress in order to deal with that debt.

Right now, Trump leads the Republican field in some respects, and his supporters are being energized by the indictments. This will at best ensure that 2024’s race is polarised and bipartisan initiatives are impossible. If Trump is re-elected (which is not to be discounted), it will lead to a period of policy uncertainty.

It is not surprising that this populist has promised to avenge his enemies by gutting civil service. Last time he held office, he had threatened the independence the Federal Reserve and delivered large unfunded tax reductions. He also failed to reduce spending. He has also pledged in recent years to oppose any reforms to social security and Medicare.

While it may seem reasonable to question the logic and timing of Fitch’s decision, its concerns about the rising risk of policy appear accurate. The loss of the AAA rating reveals that America’s status as a developed nation is changing. It is now viewed more like an emerging market. Uncle Sam should be weeping.