Time For Glasses? US Fiscal Management Looks to be Short-Sighted
August 14, 2023
By Michael Moreland
Retired Vice President of Investments
Last week Sam Richter discussed the market impact of the recent Fitch downgrade of U.S. government debt from AAA to AA+. Sam’s conclusion – the downgrade will have no near term impact on interest rates and thus the role of the dollar as the world’s reserve currency – was absolutely correct. The American economy is the world’s strongest, most diverse, productive, and trusted. This will not change anytime soon.
While unexpected, however, the downgrade was not a surprise. The ‘full faith and credit’ in the U.S. was demonstrated by financial markets’ muted response to the downgrade. Interest rates and stocks took the news in stride. The last downgrade (by Standard & Poor’s in 2011) was a bigger shock to the system. Investors took the Fitch action more or less in stride.
Will U.S. Remain the Global Leader it is Today?
The Biden Administration’s response, at the same time, was disappointing. Treasury Secretary Janet Yellen, a former Chair of the Federal Reserve, placed the bulk of the blame on the pandemic-related spending and economic chaos of the Trump Administration. Little, if nothing, was said about the financial challenges still facing the U.S. A close reading of the Fitch report, however, shows a more forward-looking view. Let’s review a few items:
The summary is all-inclusive:
“The ratings downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”
Deficit spending, along with higher interest rates, is expected to impose a further drag on federal finances:
“…The interest-to-revenue ratio is expected to reach 10% by 2025 (compared to 2.8% for the ‘AA’ median and 1% for the ‘AAA’ median) due to the higher debt level as well as sustained higher interest rates compared with pre-pandemic levels.”
“…Lower deficits and high nominal GDP growth reduced the debt-to-GDP ratio over the last two years from the pandemic high of 122.3% in 2020; however, at 112.9% this year it is still well above the pre-pandemic 2019 level of 100.1%. The GG (general government) debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025. The debt ratio is over two-and-a-half times higher than the ‘AAA’ median of 39.3% of GDP and ‘AA’ median of 44.7% of GDP. Fitch’s longer-term projections forecast additional debt/GDP rises, increasing the vulnerability of the U.S. fiscal position to future economic shocks.” (emphasis mine).
The report continues along these lines. While the report notes the underlying strengths and global leadership of the U.S., it is another clear warning that the fiscal management of the U.S. is out of control with no clear plan to resolve the longer term challenges we face. More and more, it is being noted that the ‘emperor has no clothes’ as it relates to addressing the country’s fiscal management.
Put On Your Glasses To Get the Long-Term View
This topic was the center of our Summer 2023 Economic & Market Commentary . Please review for a little deeper dive into our perspectives on the topic.
As your manager, we consider not only the short term but also the longer term environment as we make decisions on proper and prudent investment strategies. Learn how these factors affect you; talk to your Investment Manager and Advisor. Your success – and safety – matters to us.