Discover more from Monday Morning Economist
What Does It Mean When AA+ Isn’t the Best Grade You Can Earn?
Exploring the impact of the United States's latest credit rating downgrade and what it means for investor confidence at home and abroad
Credit ratings serve as signals, guiding investors through the choppy seas of borrowing and lending. They're like a financial GPS, telling us how likely a country or a company is to pay back its debts. These ratings can impact borrowing costs, interest rates, and even investor confidence. But what happens when one of the most trusted assets in the world because just a smidge less trustworthy?
Picture this: the United States, often seen as the poster child of economic stability, recently witnessed a significant event. In a decision partly motivated by concerns over the government's handling of the debt crisis, Fitch Ratings lowered the U.S. credit rating from AAA to AA+. Credit ratings might seem like just a bunch of letters, but they carry immense weight. The U.S. previously held a prestigious AAA rating from Fitch for decades. Top credit ratings are a status symbol for the world’s largest and safest economy, one that has never defaulted on its debt obligations.
You might wonder, what's the big deal? The markets didn't exactly go haywire after the downgrade. The Dow Jones Industrial Average dipped around 300 points. While that might not sound like a catastrophe, there's more beneath the surface. The U.S. dollar, a global reserve currency, still maintained its safe-haven status. S&P downgraded the U.S. back in 2011 during a different debt negotiation debacle and hasn’t adjusted the rating since then. There are only a handful of countries with top-notch ratings from all major agencies, but Fitch’s downgrade moves the U.S. just a bit further from this group.
Credit ratings are based on a sliding scale, from AAA to D for default, with slight differences between agencies. A move from AAA to AA+ might not sound drastic, but it signals increased perceived risk to credit rating agencies. It's a bit like going from an A+ grade to an A- on a report card. The downgrade pushes the U.S. from the top-rated investment grade to a slightly lower category. Some economists believe the change is absurd and bizarre, while JPMorgan’s CEO said the change was ridiculous and doesn’t really matter.
So, why do these credit ratings matter beyond the financial ticker tapes? Let's break it down. Credit ratings aren't just letters and numbers; they're critical factors in investment decisions. Think of it like your personal credit score but on a national scale. Countries with higher credit ratings get better terms on their debt, just like people with high credit scores get lower interest rates on loans. And this downgrade might cause a few investors to rethink their portfolios and appetite for risk.
This isn't just a U.S. story; it's a global one. The downgrade resonates worldwide, as U.S. debt is held by investors ranging from central banks to pension funds across the globe. The event raises questions about how changes in one economy's credit rating can ripple through others and amplify the impact across global financial markets.
Now, let's look at the companies behind these credit ratings. You've probably heard of S&P, Moody's, and Fitch. They're the ones assigning the all-important ratings. But it hasn’t always been smooth sailing for them. Remember the 2008 Global Financial Crisis? Some highly-rated subprime mortgage bonds went bust, exposing flaws in the rating process. Despite post-crisis regulatory tightening, credit ratings remain subjective, leaving room for debate on their accuracy and reliability.
But why should you care? If the markets didn't react much to the downgrade, what does it really tell us about the fiscal challenges facing the U.S.? It's like peeling back the curtain on the government's struggles. Funding programs like Social Security and Medicare while managing other contributors to the deficit isn't a walk in the park. For many of us, it sounds like a broken record. For Fitch, the current issues have raised enough concern about the country's ability to govern. The growing political divisions over how to address the issue aren’t helping matters
.Beyond the markets, credit ratings play a crucial role in a country's macroeconomic stability. A downgrade highlights underlying economic weaknesses and challenges in managing government debt. For the U.S., this downgrade was intended to emphasize the importance of addressing fiscal imbalances and promoting sound economic policies for the long haul.
History teaches us plenty. We can’t forget about Greece, Argentina, and Venezuela. They faced credit rating downgrades during economic downturns, leading to high borrowing costs and limited access to global financial markets. These real-world examples should serve as valuable reminders about the potential consequences of a credit rating downgrade on a nation's economic prospects.
As we near the end, let's pause to consider the resilience of the global financial system. Despite the downgrade, the U.S. dollar remains a safe haven. Investors worldwide hold substantial amounts of U.S. government debt, showcasing their ongoing confidence in the U.S. economy amidst challenges and uncertainties. The downgrade is more of a warning that things need to change in Washington rather than a sign that the U.S. isn’t a good investment.
Think of the downgrade more like a wake-up call. It should raise crucial questions about the path ahead for the U.S. economy and emphasize the need for responsible fiscal policies. Credit ratings, while a valuable tool, are not infallible. As the global economy evolves, so does our understanding of credit ratings and their far-reaching implications.
Fitch Ratings, Moody's, and Standard & Poor's (S&P) control approximately 93% of the rating business [European Securities & Market Authority]
The only remaining countries with AAA ratings from the three major rating agencies are Germany, Denmark, Netherlands, Sweden, Norway, Switzerland, Luxembourg, Singapore, and Australia [Fortune]
There are only two companies in the S&P 500, Johnson & Johnson and Microsoft, with AAA credit ratings from S&P [Investor’s Business Daily]
As of August 10, 2023, the total outstanding public debt for the United States was $32,658,063,006,610.50 [U.S. Treasury]
Fitch Rating is wholly owned by Hearst Communications, Inc. as of April 2018 [Hearst Communications]