Episode 2
Episode summary
The ratings agency Fitch downgraded the U.S. debt rating from AAA to AA+ setting off a deluge of commentary. Is America destined for financial ruin? Is it really “arbitrary” as Treasury Secretary Janet Yellen suggests? Liz cuts through the noise to explain why you should care, but also why you can relax.
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Transcript
Liz Wilke (00:00:00) – Hi, I’m Liz Wilke, and this is the Gustonomics Podcast. Each week, I bring you about 10 minutes of economics knowledge so you can be more informed, use the information in your business or work, or just have a nice reminder that the power of the internet is being used for more than videos about cats and synchronized dancing in public spaces. Whatever brings you here, thanks for checking out the podcast. This week, I’m talking about credit scores, specifically the credit score for the United States of America.
Liz Wilke (00:00:32) – First off, yes, the US has a credit score, and it’s a lot like a personal credit score. Governments around the world have credit ratings like people do. These ratings are created by lots of companies that do research on how able a government is to pay back its loans, and then they assign a score, which people use to judge how safe it is to lend money to them.
Liz Wilke (00:00:56) – The best score is a triple A rating, which means that this professional agency with many smart people who do this kind of assessment for a living think that it’s completely safe for you to lend your money to this government. Those ratings go all the way down to a C or D rating, depending on which scoring scale is being used. The lowest rating basically means, we think you should lend at your own risk. This government is the least reliable government for paying back loans.
Liz Wilke (00:01:33) – There used to be 10 countries in the world with the top triple A rating. Now there are nine. One of the three major credit ratings companies, Fitch Ratings, downgraded the United States from its highest rating to the one just below it, which is double A plus. Two of the three major credit rating agencies, Fitch Ratings and Standard & Poor’s, currently rate the United States credit at a double A plus. Only Moody’s, the largest of the three largest, maintain the US in its highest rating category.
Liz Wilke (00:02:10) – So why did the United States get this downgrade? Well, Fitch says that the amount of the US debt, without strong indicators that the US can manage its financial situation over the long term, is the reason for their downgrade. Oddly, instead of downgrading the US over the summer’s debt ceiling standoff, it actually did so after the Treasury announced it would borrow $1 trillion in the third quarter of this year, which was way above estimates. So what’s the impact of this downgrade? Investors and the stock market have largely shrugged off the news so far.
Liz Wilke (00:02:47) – There was a dip in the stock market, but the stock market also dips during the summer months and when there’s a full moon, and sometimes on the third Thursday of the month. The Dow dropped about 1% after the downgrade, which can be categorized as a large-ish but also completely typical dip. The stock market regularly dips or grows by that much throughout the year.
Liz Wilke (00:03:08) – But also, this has already happened to us. You might remember that during the debt ceiling standoff of 2011, Standard & Poor’s, one of the other credit ratings agencies, downgraded the US from AAA to AA-plus status, and we’ve been there ever since. During the month after that news, the stock market fell 15% because investors thought borrowing would get more expensive for the US government, and that would spell economic trouble. But that didn’t materialize. Lenders seemed largely happy to continue to lend money to the US government at low rates, so we kind of forgot about it.
Liz Wilke (00:03:47) – The Secretary of the Treasury and former Chair of the Federal Reserve, Janet Yellen, shrugged off the news, saying it was based on outdated information and arbitrary. It may be true that this is based on outdated information. It’s also true that Fitch Ratings exists entirely to provide these kinds of ratings, so they probably know at least a little bit about it. And it’s also true that it is in Janet Yellen’s best interests as the lead of the government body that is responsible for US borrowing to calm investors by essentially telling them, nothing to see here, folks.
Liz Wilke (00:04:24) – By and large, this single event isn’t a big deal, actually. The US dollar is still the preferred currency of safe storage around the world, which enormously benefits the United States. And people believe that the US is a very safe place to put their money.
Liz Wilke (00:04:41) – It might become a big deal if the last and largest credit rating agency follows suit, or we get an even further downgrade by Fitch or Standard & Poor’s. Although, given the lukewarm reaction to this news and the lack of a big fallout from 2011, this might not be enough to spell trouble for the United States’ ability to borrow.
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Liz Wilke (00:05:36) – Welcome back. We’re talking about the recent downgrade to the US credit rating. And you might be wondering, Liz, if this isn’t a big deal, what would be a big deal?
Liz Wilke (00:05:49) – The US government currently benefits for being such a trusted, safe government to borrow money from. It basically means there’s no risk of default. So investors are willing to lend to the US government at the lowest possible rate. So what would be a big deal is if the government were to default on any of its debt.
Liz Wilke (00:06:09) – This came close to happening in the debt ceiling negotiations over the summer. If it were ever to happen, that could have a much more damaging effect on the United States’ ability to borrow because, well, everyone would then know that the US isn’t entirely reliable rather than some credit agencies speculating that that’s the case. If this were to happen, it would make borrowing more expensive for the US government, which it has to do whenever it runs a deficit in order to fund all its programs.
Liz Wilke (00:06:39) – And the US government has run a deficit in 79 out of the last 92 years. Side note here, both political parties tend to run deficits when they are in power. Deficits are definitely a bipartisan issue. If this were to happen, or it seemed much more likely to happen, then it would signal to people who would be lenders to the government that the government might not be totally able to honor all the outstanding debt. So those investors might be less willing to lend at the low safe rate.
Liz Wilke (00:07:10) – So say people think the US is riskier and they might say, I could put my money elsewhere. So I’m gonna need a better deal from the government. I’m gonna need a higher return. Most economists agree that there’s nothing inherently wrong with government debt. Debt finances a lot of things that are important to people. And the same is true of governments.
Liz Wilke (00:07:32) – As long as the government can continue to borrow money when it needs to, that itself isn’t really an issue, especially because it’s been cheap for the US government to raise money by taking on debt because interest rates are low and the US government is so safe.
Liz Wilke (00:07:46) – There’s a lot more debate about how much debt is too much. For the purposes of this episode, I think the most important issue is what happens when the government has to pay more for debt at any level.
Liz Wilke (00:07:58) – About 10% of the US government’s budget last year went to interest payments on current debt. If borrowing costs rise, that means more tax dollars or more debt must be used to pay the interest and make payments, which means those dollars are not being invested in roads or schools or health and safety inspections or anything else that government does for its citizens and helps the country to be prosperous. So the more the government has to pay to borrow, the less money is available to spend on other things we value, no matter what the debt level is. Although, of course, the choices get more severe the higher those payments become.
Liz Wilke (00:08:39) – One final note here, beyond the question of how risky the US government is as a borrower, interest rates used to be near zero, which means the US government could borrow money almost for free because it was so safe. As interest rates are rising, the US government is going to pay more to borrow money anyway, even if it is 100% safe. The less safe investors think it is, the more they’ll pay on top of that.
Liz Wilke (00:09:03) – And there’s the crux. The credit rating itself isn’t the issue to pay attention to. Pay attention to what people think the credit rating says about the true trustworthiness of the United States government to pay its bills in full and on time. This time, investors don’t seem to think that this downgrade is a strong indicator that the US government is any less able to do that than before. But over time, this could change.
Liz Wilke (00:09:30) – If the government ever fails to reach a deal on the debt ceiling when it needs to, or the burden of making payments on the debt becomes so high that we start having conversations about whether or not to pay the debt or for education or Medicare, then investors will almost certainly react negatively. This is the kind of future that Fitch Ratings currently believes is possible and why it downgraded its rating. To be clear, we are not in that position now, and there is plenty of opportunity to avoid that situation.
Liz Wilke (00:10:01) – The good news is that investor confidence, not a ratings agency, is the real determinant of the cost to the United States to borrow money. Remember, the economy is a bunch of people doing people stuff with other people. And so far, investors believe that the US remains about as reliable as ever. That’s it for this week’s episode. I hope you learned something new and useful. Please let us know what you think of the podcast by leaving a review or share it with a friend or colleague who might enjoy it. I’m Liz Wilke, and thanks for listening.
Liz Wilke (00:10:34) – See you next week.
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