Downgrade of American Debt Almost Inevitable

Despite an agreement to cut over a trillion dollars in government spending, the United States could lose their AAA status.

View of the Empire State Building in Manhattan from Queens, New York, September 1, 2010
View of the Empire State Building in Manhattan from Queens, New York, September 1, 2010 (Chris Goldberg)

Although lawmakers reached an agreement to lift their nation’s legal debt ceiling while reducing almost a trillion in projected federal spending over the next decade, rating agencies are still likely to downgrade America’s creditworthiness because the budget cuts fail to eventually balance the books.

After weeks of partisan procrastination, Democrats and Republicans in Congress this weekend agreed to a compromise that would extend the government’s legal ability to borrow by up to $2.8 trillion, alleviating legislators of the burden of having to debate deficit reduction again ahead of the 2012 elections. America’s debt now stands at over $14.3 trillion. Washington is projected to borrow trillions more over the years ahead.

The bipartisan debt ceiling agreement fails to fully mend the deficit over the long term. Instead, it cuts close to a trillion in discretionary spending or less than $100 billion a year over the next ten years while empowering a special congressional committee to identify an additional $1.5 trillion worth of spending cuts in defense and entitlement programs. This committee could also agree to revenue increases by eliminating tax deductions or raising tax rates or both.

If these cuts are fully implemented — some observers doubt whether future Congresses will maintain the budget reforms — the government is expected to be $20 instead of $23 trillion in debt by 2020.

The tentative austerity measures probably won’t persuade rating agencies that America still belongs to the most creditworthy of nations. Moody’s warned several times last month that lawmakers should agree to significant spending reductions over the next decade if they were to avert a downgrade. Standard and Poor’s similarly advocated some $4 trillion in cuts.

Economically, a downgrade would be far from disastrous. The United States are among few countries with an AAA rating anyway. As the largest economy in the world, its sovereign bonds would probably continue to be regarded as an exceptionally safe investment. During the past weeks of political turmoil, the government continued to be able to borrow at very low interest rates. For many international investors, there simply aren’t many alternatives outside the United States, whatever its credit rating.

Politically, a downgrade could be detrimental to President Barack Obama’s hopes for reelection. With unemployment officially over 9 percent but much higher in reality when counting the millions of Americans who have given up looking for work, it is not too difficult to imagine campaign ads from opposition Republicans that blame the president not only for a lackluster economic recovery but losing the nation’s prestigious AAA rating as well.

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