The Debt Downgrade Dilemma

In the latest wave of sensationalist headlines regarding the United States’ economy, Moody became the last major credit agency to downgrade the U.S. credit rating from a pristine Aaa to an Aa1. This move follows S&P’s debt downgrade in 2011 and Fitch’s in 2023, solidifying a call to action to address the persisting government deficit as well as political gridlock surrounding it. 

The first major reason Moody downgraded the U.S. credit rating was the continuous spike in national debt. The U.S. debt currently stands at $36.22 trillion, which is 124% of the GDP, and the highest ever recorded since World War II. Recent analyses estimate that the U.S. debt will reach 156% of the annual GDP by 2055 if current policies do not change. What’s even more troubling is the huge amount of interest the U.S. has to pay on just its debt alone. In fact, interest costs will approach $1.8 trillion by 2035 as it is currently the second-largest federal expense, even exceeding military spending. As rising interest rates and debt make it more costly for the government to sustain itself, it will increasingly have less to spend on Social Security, healthcare, defense, and other public goods. 

Moody also cited political stalemates as a reason for downgrading the U.S. credit rating. As debt reaches record highs, lawmakers have always struggled to come to a consensus. Republicans reject tax increases, while Democrats are weary of cutting federal spending. Either way, these political stalemates have made little progress when it comes to bringing in more revenue or reducing spending. 

Further adding to the political turmoil is President Donald Trump’s push to pass a bill in Congress to extend the 2017 Tax Cuts and Jobs Act. These tax cuts would increase the debt even more, and make it harder for consumers to borrow. To that end, Moody estimated that the proposed tax cuts would add an extra $4 trillion to the national debt, not accounting for interest rates. Thus, this downgrading of debt means that every action taken by policymakers from now on will impact the ability for the U.S. to sustain its leadership on a global scale. 

The downgrading of the U.S. credit rating has already started affecting everyday individuals. When a country is now viewed as a bigger credit risk due to a lower credit rating, investors will demand higher interest rates, thus resulting in significantly higher borrowing costs for the U.S. These higher borrowing costs raise the interest rates on mortgage, car loans, student loans, credit card debt, and more. The ripple effect has already been evident as the average 30-year fixed mortgage rate rose above 7% and the amount of interest the U.S. has to pay in order to borrow money for 10 years has already risen above 4.55%. Furthermore, the value of the U.S. dollar fell against numerous other types of currencies in the foreign currency market. These trends illustrate the fact that the time window to enact meaningful reforms is slowly closing. 

Despite this, Moody changed its outlook on the U.S. from “negative” to “stable,” citing some of its credit strengths, such as the dollar’s size and resilience. While a one notch downgrade does not mean imminent debt default, it is still clear that this dollar dilemma will continue to persist as the downgrading of debt means the U.S. will face a more constrained lending environment in the near future, and will ultimately have to change some of its policies. 

Read More Here: 

• Philip Luck, Center for Strategic & International Studies 

• Adam Hayes, Investopedia 

• Paul Wiseman, AP News

• Staff, Al Jazeera

• Tony Romn, Andrew Duehren, & Joe Rennison, New York Times