Fisher Investments Editorial Staff
Deficits, US Economy

Not in the Mood

By, 03/16/2010

Story Highlights:

  • Credit rating agency Moody's announced the US—along with Germany, Britain, France, Spain, and Nordic countries—is closer to losing its AAA rating.
  • Moody's calculations projected US interest payments on government debt (including federal, state, and local) could rise from 7% of tax revenue in 2009 to 11% by 2013—14% under a more adverse scenario.
  • But a debt downgrade is far from a foregone conclusion.
  • The US has by far the largest, most diverse economy and deepest capital markets in the world—and the US government's debt servicing costs are well within or below historic norms.

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Credit rating agency Moody's announced Monday the US—along with Germany, Britain, France, Spain, and Nordic countries—is inching closer to losing its AAA rating. Though these countries are considered "stable" for now, the thought of losing that triple-A is a mood-killer—a lower rating could decrease investor confidence and increase governments' debt financing costs.  

Moody's calculations projected US interest payments on government debt (including federal, state, and local) could rise from 7% of tax revenue in 2009 to 11% by 2013—14% under a more adverse scenario. Debt servicing costs above 10% of revenues triggers a downgrade consideration, though it's not the only factor. Moody's also considers a government's ability to get too-high debt levels under control over a given period. 

But a debt downgrade is far from a foregone conclusion. Moody's assessment hinges on all sorts of assumptions and projections—including a meaningful increase in interest rates—but economies and the impact of fiscal and monetary policies are way too complicated to model and predict outcomes for. Current debt and deficit levels are elevated thanks to the economic downturn and government spending in response. Still, our debt servicing costs are well within or below historic norms thanks to low interest rates. Down the line, economic recovery (aided by said stimulus) produces higher tax receipts, making debt-servicing costs all the more manageable. Already, the US and other economies are showing substantial improvement, like the US's 5.9% GDP growth in Q4 2009.  

Even if the US did lose its triple-A halo, would investors suddenly see the US as being a more risky borrower? If so, compared to which country? None that we can think of—after all, Moody's announcement today covered countries comprising over 40% of the global economy. Not to mention the fact the US has by far the largest, most diverse economy and deepest capital markets in the world. Additionally, we have our own central bank (unlike countries in the European Economic and Monetary Union), so in an extreme scenario, we could create money to service our debt (though this could impact exchange and inflation rates).  

To investors, if the US were AA, then AA just becomes the new AAA, breaching some arbitrary debt-servicing cost level notwithstanding. Does it make sense Moody's rates Spain as AAA, even though it's one of the recently infamous PIIGS countries? And Japan—the world's second largest economy—has the lowest sovereign credit rating among major countries as well as the lowest borrowing costs. Italy and Spain both suffered downgrades in 1998, and their borrowing costs fell. 

Government spending no doubt helped ameliorate the financial blow to the US economy. Moreover, elevated deficit levels haven't sunk stocks historically. Though it may not get Moody's in the mood, higher debt levels for now aren't problematic.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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