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In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.
According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.
Is Losing AAA Rating that Big of a Deal?
But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.
How Real is the Risk?
Now with the risk in mind, I think that ratings agencies talk a good game but they will problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.
With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.