Written by Mario Lettieri and Paolo Raimondi * –
When Fitch Ratings downgraded the US from AAA to AA+ in early August, the US government immediately responded harshly. Janet Yellen announced her complete disagreement and described the decision as “arbitrary”. And in 2011, Obama reacted even more violently when Standard & Poor’s made the same downgrade. Let European governments keep this in mind when US agencies talk about the direction of their economies.
The reason given by Fitch Ratings is too general and misses the point. It states that in the last 20 years there has been a continuous deterioration in the standards of managing the economy also with regard to issues of taxation and debt.
In fact, it was appropriate to go into the merits. The total US public debt (federal and regional) now stands at more than $32 billion, and was about $10 billion when the Great Financial Crisis of 2008 erupted. It is estimated that by the end of the decade it will reach $50 billion.
Moreover, for a long time each year US governments fail to keep spending within budget limits and traditionally have to breach the debt ceiling to avoid bankruptcy! This time, a bipartisan agreement decided to suspend the federal debt limit until January 2025, that is, for political expediency until a new president takes office after the November 2024 elections. After the debt is “run over,” it is estimated that this year’s budget deficit will rise to 6.3% of GDP last year was 3.7%.
A rating downgrade will inevitably increase the level of interest payable on public bonds, relative to well-known Treasury bonds. This will add to the increase caused by the Fed’s high interest rates, which have been justified as an indispensable step to contain inflation. To this we must add that the Fed has been trying for months to “dismantle” the quantitative easing program, and has avoided buying new government bonds or rolling over part of outstanding bonds.
The result is that public securities are going through a major tremor. Which not only reveals the problem of public debt management. As we have seen in the past weeks, the rise in interest rates on bonds has had very serious implications for the stability of some regional banks, even with real bankruptcies. Note that Moody’s recently downgraded some regional banks.
In fact, the US banking system is full of public bonds that are at a loss compared to today’s prices. Trying to replace it is not a linear process. Besides the losses they could incur in the midst of a sale, the overall effect on their market values could be very destabilizing to their holdings.
Meanwhile, it should be noted that from October 2022 to June 2023, after the interest rate hike wanted by the Fed, interest payments amounted to $652 billion, which is even higher than defense spending. The amount is 25% higher than the interest expense for the same period in the previous year. The Congressional Budget Office (Cbo) estimates the benefits to be paid at $745 billion in 2024 and more than $10,000 billion in the following decade.
The problem also lies in the fact that the US public debt is “surrounded” by countless debt and speculative bubbles. For example, a downgrade would also have strong implications for the interest rates applied to mortgages and the mortgages that citizens have to pay to buy their homes. The total debt for residential and commercial building mortgages is about $18 trillion. Another negative impact will appear on the debts deducted to finance the educational path, which is called “student debt”. This bubble is now worth more than $1.7 trillion. The interest and equity payments of these debts were suspended during the Covid period, but by government decision, they will start again from September.
Therefore, it is feared that public services will pay the price, in an attempt to contain public debt and the budget deficit, starting with health care and education. Unfortunately, this recipe is also known in Italy.
The very serious financial problems of Evergrande, the Chinese private construction and finance giant, in addition to creating serious problems for Beijing, threaten to affect the uncertain financial and debt trend also in the US and elsewhere.
* Mario Lettieri, former Deputy and Undersecretary for Economics; Paolo Raimondi, economist and university professor.
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