You might have missed it. Even investment professionals tasked with monitoring market events seemed to ignore it. The big news a few weeks ago was Moody’s downgrading the US sovereign debt rating from AAA to AA.
Maybe the headline fell flat because Moody’s is the last of the three main credit agencies to downgrade the US? (Hence, a fait accompli.) Maybe the ebb and flow of tariff headlines garnered much of Wall Street’s attention? Maybe it was because, at the end of the day, the downgrade is immaterial to investors? In fact, the credit default swaps (CDS), the instrument that acts as insurance against defaults, barely budged.
My bet is on the latter. In the investing world, comparisons, challengers, and alternatives provide a relevant yardstick. Comparisons between Ford and GM, or between Microsoft and Apple, or between Coke and Pepsi help investors evaluate investing opportunities. When evaluating the US dollar, a proxy for US credit rating, there is no other currency that can take on the role of the US dollar. There is no other currency that comes close to the breadth, heft, or clout of the US economy, the historical stability, or the earned trust from foreign sovereigns or investors. So, at the end of the day, the US downgrade is effectively immaterial… at least in the near term. There is no substitute.
Having said that, Moody’s reasoning for the downgrade should not fall on deaf ears. Moody’s cited a rise in US government debt as the basis for the downgrade. US debt levels are not exactly breaking news, but they are worthy of attention. Moody’s shot across the bow was a warning that spending levels are unsustainable.
The US spent $6.75 Trillion1 in fiscal 2024, yet only had receipts of $4.92 Trillion1. The resulting $1.83 Trillion deficit1 should not come as a surprise. Deficits have been going on for decades, accumulating into total debt. The US debt is 123% of GDP1. In other words, the US owes more than it receives. The last and only period in which debt levels were this high was World War II. Much of that spending was dialed down once war gave way to peace.
Our current situation is different. 58% of federal spending goes to mandatory transfer payments (Social Security, Medicare/Medicaid, and welfare payments), with 13% to mandatory interest payments and 13% to defense. Interest payments will go down as the Federal Reserve (Fed) lowers interest rates, yet the Fed does not review the nation’s debt service when making interest rate policy. However, merely cutting the remaining 16% (veteran’s affairs, education, transportation, policing, national parks, etc.) would still fall short of trimming the annual deficit. Solving the deficit problem will take a combination of economic growth, higher taxes, and unpleasant discussions about transfer payments and defense spending.
For decades, politicians have kicked the can down the road. Moody’s is saying the road is coming to an end and significant change is necessary. Our Washington representative will be making arguments in public and private, some inflammatory and some conciliatory. As with most negotiations, the interim arguments are rarely the final outcome.
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