Credit Rating Drop Likely Linked To Congressional Differences

Fitch Rating dropped U.S. credit rating from AAA to AA+. For perspective, Standard and Poor’s (S&P) dropped the US credit rating one notch from AAA to AA+ on August 5, 2011, almost exactly twelve years ago.

While the S&P 500 fell 6.65 percent the next trading day, between the twelve years spanning S&P’s and Fitch’s downgrades, the S&P 500 is up 421 percent. Debt downgrade did not usher in poor returns.

In principle, a lower debt rating for corporate or government bonds should lead to higher borrowing rates. Spirit Airlines (rated B+ by Fitch) will pay a higher rate of interest on its bonds than will Microsoft (rates AAA by Fitch).

Similarly, Jamaica (B+) will pay more than South Korea (AA-). Also, high and rising levels of government debt can lead to crowding out within credit markets, leading to higher rates for all borrowers.

Yet, the yield on the US 10-year treasury fell from over 2.5 percent at the time of the S&P downgrade in 2011 to 1.6 percent one year later, and the less-than-perfect US credit rating didn’t prevent the yield on the 10-year reaching 0.5 percent in August of 2020. Markets set interest rates, not rating agencies.

What are the alternatives to debt issued by the US Treasury? No sovereign credit market is as large or liquid as the US. And, does anyone really believe Germany (rated AAA) is a better credit than the now lower-rated US? European countries depend on the US for subsidized military protection.

The AA+ balance sheet of the US is subsidizing the AAA balance sheet of Germany. Maybe some other sovereign downgrades are in order. In reality, the distinction of the credit ratings is probably meaningless and reflects the serious differences within the US Congress regarding the future of spending more so than the ability to pay.

Finally, this may once again raise questions about the dollar as the world’s reserve currency. That question should be put quickly to rest. What are the alternatives?

The Chinese yuan from much lower-rated communist China (A+, same as Estonia and Malta)? China would have to relinquish far too much control and countries need to hold their reserves in a currency with open and transparent financial markets. That is not China.

The Euro would be the only possible alternative, but Europe remains fractured with national sovereign debt issued across a host of countries with few prospects for economic growth and rapidly aging and needy elderly populations.

Even the ability of Europe to keep itself warm during the winter has recently been brought into question. Not the setting for a future reserve currency. Expect no change in US dollar reserve status.

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