In a major setback for the United States, Fitch Ratings, one of the leading credit rating agencies, has downgraded the nation's long-term credit rating from AAA to AA+. This downgrade comes as a result of the country's mounting debt and declining political stability, which Fitch identified as the key factors behind the decision. The agency expressed concerns over the deterioration of governance standards, particularly in fiscal and debt-related matters, that have taken place over the past twenty years. Furthermore, Fitch highlighted the complexities of the U.S. budgeting process and the lack of medium-term financial planning as contributing factors to the downgrade.
The timing of this downgrade is particularly unfavorable as the U.S. continues to grapple with the fiscal shocks caused by the ongoing pandemic, new spending initiatives, and tax cuts. These factors have led to the national debt reaching an alarming 113% of the country's economic output, a significant increase from pre-pandemic levels. However, Treasury Secretary Janet Yellen criticized Fitch's decision, labeling it arbitrary and based on outdated data. Yellen emphasized that despite the rating change, Treasury securities remain the world's preeminent safe and liquid asset, and she stressed that the American economy is fundamentally strong. She also highlighted the administration's plans to reduce the budget deficit and ensure a robust economic recovery from the coronavirus recession.
The downgrade could have potential consequences for the U.S., potentially resulting in higher interest rates on Treasury notes, bills, and bonds. The last time the country faced a debt downgrade was in 2011 when Standard & Poor's took similar action due to prolonged wrangling in Congress. However, Fitch did acknowledge a number of positive aspects about the U.S., including its large, advanced, well-diversified, and high-income economy. Additionally, the U.S. dollar's status as the world's reserve currency provides the government with extraordinary financing flexibility.
The Biden administration strongly refuted the downgrade, criticizing Fitch's methodology and arguing that it does not accurately reflect the true health of the U.S. economy. Yellen pointed out that Fitch's ratings model showed a deterioration in U.S. governance from 2018 to 2020, yet no changes were made to the rating until now. The administration believes that the U.S. economy has experienced a rapid recovery from the pandemic recession, with low unemployment rates and solid economic growth.
Although the downgrade is not expected to significantly impact the demand for U.S. debt, it does cast a shadow on the country's fiscal management record. The repeated political standoffs over spending and taxes, along with the escalating levels of debt, raise concerns about the long-term economic stability of the nation. The Biden administration's plans to address the rising costs of programs like Social Security and Medicare and reduce the budget deficit will be closely monitored as the country strives to regain its AAA rating. The success of these efforts will play a crucial role in restoring confidence in the U.S. economy and its ability to effectively manage its debt.
