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The Boring Invstr - Your Simple & Digestible Weekly Investing & Finance Newsletter
America Has a Money Management Problem and It Isn’t Good
Trey Woolley
August 20, 2023
Welcome Back to The Twentieth Edition of The Boring Invstr!
Hello Boring Invstrs,
America Has a Money Management Problem and It Isn’t Good
On August 1st, Fitch downgraded the U.S. government's credit rating from AAA to AA+. This marks the first time the U.S.’s credit rating was downgraded since 2011.
Fitch Ratings Logo - Getty Images
To preface, the dominance of the US economy isn’t likely to go anywhere. The U.S. is the world's largest economy, accounting for a quarter of global GDP. It is a significant trading partner, the largest financial market, and a major consumer and producer of commodities like oil and gas.
On top of its dominance in trade and financial systems, many of the world’s top economies rely on the U.S. China (2nd largest economy) and Japan (3rd largest economy) are two of the largest buyers of U.S. debt. Many countries with large economies buy U.S. debt thanks to a historically strong reputation to be able to pay off their debt. The US dollar also happens to account for 59% of foreign exchange reserves dollars. Despite countries attempting to “de-dollarize” their dependence on the dollar, these countries continue to buy U.S. debt. There are too many factors that would have to stray away for the U.S. economy to free fall from its dominance.
The Downgrade
The downgrade is a result of the "chicken game" with the debt ceiling, a decade of unlimited spending, and no repercussions for spending more and more. Although, the downgrade does not mean that the U.S. is close to defaulting on its debt. Fitch cited these reasons for their downgrade:
The highest debt in U.S. history, with a higher debt-to-GDP ratio in the coming years (2.5 times greater than the median Aaa ratings).
Several medium-term problems, such as rising healthcare costs and challenges over the federal budget.
Social security will run out by 2035, and an increase in spending by 1.5% of GDP is necessary to continue these programs.
Fitch projects a mild recession towards the end of 2023 and into 2024.
US Credit Rating Status Timeline - Reuters
Despite many being surprised by the downgrade, it should not be shocking. Rising debt and poor government management of a known debt crisis is the true reason to blame. There are steps that could have been taken years ago to avoid another downgrade but instead, a decade of historically low-interest rates and politicians playing chicken with each other until the last hours of a deadline prompt a long-coming downgrade. It should have come earlier.
Unfortunately, the US also experienced a downgrade by Standard and Poor (S&P) in 2011. S&P also downgraded U.S. debt in 2011 for very similar reasons, including the debt ceiling. S&P stated a similar reason in 2011 about politicians playing chicken with each other until last-minute agreements.
The downgrade will make it harder for the U.S. to borrow money and could lead to reduced investment in the U.S. economy. It also makes it riskier to hold U.S. debt. It will also affect the US consumer due to higher borrowing costs.
The downgrade is not merely a warning sign for default, but a wake-up call to the government to fix their shenanigans. Until large actions are taken to fix the debt crisis, the U.S. likely won’t experience AAA credit rating status for long period of time.
That’s all for this week!
Wishing you fruitful investing and a great week!
Trey
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