Our Thoughts On US Debt Losing AAA Status
Last Friday, Moody's downgraded the US government's AAA credit rating, which is a big deal in the world of finance. While this is a notable change, it's not the first time it’s happened. Fitch Ratings already downgraded the US to AA+ back in 2011, showing that concerns about the country’s debt have been around for a while.
Historical Context: Early Warnings and Long-term Concerns
To understand why this downgrade is important, we need to look back in history. In the 1980s, President Ronald Reagan warned about the dangers of growing debt. Back then, the US Debt to GDP ratio was around 40-45%. Reagan was concerned that borrowing too much could hurt the country in the future, especially with things like higher taxes or fewer social programs.
Despite these early warnings, the US continued to borrow more money over the years. From the 1980s to the early 2000s, the debt grew slowly, and the economy was able to manage it. But things started to change in the mid-2000s, and the government’s borrowing began to increase more quickly.
The Rapid Increase in Debt Since 2008
After the 2008 financial crisis, US debt increased rapidly. The government passed a lot of stimulus programs to help the economy, including giving out bailouts to banks and automakers. These actions helped stabilize the financial system, but they also led to much higher government borrowing.
On top of this, tax cuts and more government spending in the following years kept increasing the debt. Then, in 2020, the COVID-19 pandemic caused even more borrowing as the government sent stimulus checks and helped businesses struggling from the lockdowns. As a result, the US Debt to GDP ratio shot up to around 122%, much higher than the 40-45% range Reagan warned about.
During this time, the US stock market grew rapidly too. The government’s stimulus efforts and low interest rates helped boost the economy, which led to higher corporate profits and more investor confidence. This caused the stock market to grow for a long period. But as the debt grew, the risks also increased, putting pressure on the country’s financial health.
Implications for Interest Rates and Inflation
The downgrade could mean higher borrowing costs for the US government, which could cause interest rates to rise for consumers and businesses. This could affect everything from mortgages to loans for businesses. For investors, it might signal a shift in the bond market, which could affect how you should manage your investments.
A downgrade could lead to higher interest rates on things like home loans and business financing. Investors will need to think carefully about how their portfolios might be impacted by these changes.
Understanding Credit Ratings
It's important to understand that even though the US government's rating was downgraded, US Treasury bonds are still considered safe investments. Historically, bonds with an AA+ rating have had a default rate of less than 1%. So, while the downgrade is something to pay attention to, it doesn’t mean that US debt is a high-risk investment.
Credit Risk: What Does It Mean for Investors?
Credit risk is the risk that someone who borrows money might not be able to pay it back. In the case of US government bonds, the risk of default is still very low, even with the downgrade. However, a change in credit ratings can affect how bonds perform in the market.
When a country’s rating is downgraded, investors might get nervous and sell bonds, which can cause prices to go up or down. This doesn’t mean the US will default on its debt soon, but it shows that there are some growing risks. For investors, it’s a reminder that it’s important to have a diversified portfolio so that you’re not overly exposed to any one type of risk, including US government bonds.
Global Implications for Investors
Even though this downgrade is mostly about the US, it can affect markets around the world. Since the US is the world’s largest economy and the US dollar is the global reserve currency, other countries might adjust their investments in US debt. However, US government bonds are still considered one of the safest places to invest, which means this downgrade may not cause massive changes in global markets right away.
Looking Forward: Policy Actions and Long-Term Strategy
While the downgrade is concerning, it doesn’t mean the US is in immediate danger of defaulting on its debt. The government has tools it can use to adjust fiscal policies and address debt. The most important thing for investors is to stay focused on long-term goals. This helps protect them from short-term market changes.
Looking Ahead
At Sevey Wealth, we believe it’s important to keep our clients informed and help them navigate changes like these. The recent downgrade shows how important it is to think ahead about your finances. Whether you’re looking to protect your investments or take advantage of new opportunities, we’re here to help you make informed decisions.
If you want to learn more about how these developments could impact your financial plan, feel free to reach out to us. We’re here to support you in making the best decisions for your future.
