On Friday, May 16th, the international credit rating institute Moody’s downgraded the U.S. government from Aaa to Aa+. They gave two main reasons:
- Congress is doing nothing to stop the deficits, which are now averaging 25% of the federal government’s annual spending.
- At $1.2 trillion per year, interest payments on the government debt are now the second-largest item in the federal budget.
The downgrade is a serious signal to U.S. lawmakers and to President Trump that time is running out on America’s cheap credit line. The credit downgrade was small on a scale that runs from Aaa (virtually risk-free credit) down to C (as bad as it gets), but for the U.S. government, it is a big loss.
Inevitably, a lower credit score means higher borrowing costs. The $36 trillion U.S. government debt is going to cost taxpayers even more in interest payments. Investors will balk at buying U.S. Treasury securities unless they get some risk premium in return.
All this points in one scary direction: a debt crisis. Although Moody’s does not give a timeline in its report, they hint rather boldly that the American economy will face a debt crisis in the near future.
I agree with that assessment: unless Congress takes drastic action very soon, I predict that the U.S. economy will be hit by a debt crisis before President Trump leaves office.
This means, bluntly, that without urgent response from Congress, we are two years, three at the most, away from a Greek-style event in the U.S. economy.
In Greece, the crisis exploded in 2009 when the government’s creditors lost faith in the ability of the Greek Treasury to meet its debt obligations. While interest rates soared past 20 percent, the EU and the European Central Bank, ECB, took help from the International Monetary Fund, IMF, to prop up the ailing Greek government with fresh loans. In return, the three organizations demanded harsh budget cuts and crippling tax increases.
The end result for Greece was devastating. The only silver lining with the Greek crisis was that its ramifications for the global economy, or even the European economy, were limited. A debt crisis in the United States would in all likelihood not stay contained in the same way, simply because of the globally dominant size of the U.S. economy.
One of the immediate consequences for Europe of an American debt crisis would be a drastic upheaval of investment portfolio management. European investors love American Treasury securities because they are virtually risk-free. In fact, the market for U.S. government debt has for decades served as a risk-free foundation for investors from all over the world. So far, the United States Treasury has never missed an interest payment, which puts U.S. sovereign debt in the highest class of financial reliability.
When European investors have to look elsewhere for assets with very low risk, they will pull their money out of the U.S. economy. This will have a depressing effect on the U.S. dollar vs. the euro, which can add to the sense of crisis urgency. European investors will want to pull their money out as soon as possible so as not to leave anything to be crushed by a falling dollar.
It is this type of crisis that Moody’s sees coming. It is not of any urgent concern to them—yet—but as Europe’s debt crises have demonstrated, the situation can deteriorate rapidly. A debt crisis raises interest rates, sharply and quickly, to levels unseen under ‘normal’ economic conditions. Business investments grind to a halt, unemployment skyrockets, private consumption plummets—and it all happens within a few weeks of the outbreak of the crisis.
As the Greeks and others can testify, a debt crisis is a brutal experience. It would take America a decade, perhaps even longer, to recover from it, with livelihoods, futures, even lives lost in the process.
This is why America in general, and America’s political leadership in particular, needs to take the threat of a debt crisis very seriously.
Unfortunately, that does not seem to be the case. President Trump has not commented on the credit downgrade, but comments from Treasury Secretary Scott Bessent explained that
the downgrade was related to the Biden administration’s spending policies
Kevin Hassett, Director of the National Economic Council under the White House, more or less ignores the threat of a debt crisis.
Economist Steve Moore, co-founder of The Committee to Unleash Prosperity and visiting fellow with the Heritage Foundation, goes on an all-out attack on Moody’s. In an op-ed for Fox Business, Moore does not mince words:
I’ve got to wonder if there possibly could be a more incompetent and biased credit rater than Moody’s—the agency that just downgraded federal bonds from AAA rating.
I am not going to go into the facts regarding Moody’s and the subprime crisis in 2007-2008—I have addressed that issue elsewhere. Instead, let me just note that the unison tone from the Trump administration and its influential friends (of which Moore is one) is really worrying. It focuses on the messenger, not the problem.
