SYLVIE DOUGLIS, BYLINE: NPR.
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DARIAN WOODS, HOST:
Today, the financial world is feeling a little unsettled. That's because the United States' stellar credit worthiness is being questioned by one of the three main ratings agencies. So when banks or investors weigh up whether or not they want to buy government's debt, they turn to these rating agencies, which essentially give a credit score to governments around the world. And late on Tuesday afternoon, Fitch unleashed a financial earthquake. It downgraded American government debt from AAA to AA+. Now, that is still very low default risk. And these ratings arguably matter less for a huge, widely traded market as the one for U.S. Treasurys. But because U.S. government debt, U.S. Treasurys, are held all around the world, the implications could be worrying.
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WOODS: This is THE INDICATOR FROM PLANET MONEY. I'm Darian Woods. Today on the show, the U.S. credit rating downgrade - what's behind it, what it could mean for the economy and why now?
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WOODS: Our expert to guide us through the U.S. credit rating downgrade is Carola Binder. Carola is an associate professor of economics at Haverford College. And to be honest, the big credit rating downgrade was only the second-biggest news in her household.
CAROLA BINDER: Yeah, I'm good. I actually just had a baby two days ago on Milton Friedman's birthday, so it's an exciting time over here.
WOODS: Oh, my gosh.
But Carola, ever the macroeconomist, had been following all the drama from her hospital bed.
BINDER: I'm feeling a little bit surprised about the timing of the downgrade. It seems like lately we've been getting mostly good economic news coming in, especially about inflation falling, the labor market still staying strong. And it seems like there's more and more of a chance that we're going to be able to get inflation back to target without a recession like people were worried about, myself included, even a couple of months ago.
WOODS: Yeah, I mean, inflation's down to around 3%. Economic growth just came out - you know, that's running at around 2.5%. I don't know, like, the clouds were parting and then suddenly this rainstorm of a ratings downgrade comes in.
BINDER: Yeah, I mean, hopefully it's not going to be that big of a rainstorm. It sounds bad, but the downgrade was from AAA to AA+, which doesn't mean that a U.S. government debt default is imminent. It just means they think the possibility is - basically moved from 0% to some very, very, very small percent.
WOODS: What reasons did Fitch give for going from AAA to AA+?
BINDER: So when Fitch, you know, put out a report about this downgrade, a big one was just government debt is becoming increasingly a burden. Just to put it in a little bit of perspective - in the first quarter of 2023, total public debt as a percent of GDP was 119%. And that's been falling a little bit, but it was about 106% before the pandemic. So government debt to GDP is, you know, still relatively high.
WOODS: A lot of people have different opinions over how worrying the U.S. government debt is. I mean, defenders might point to France's debt that's a little over 100%, similar to the U.S.'s, or even Japan's, which is about 240%. But it sounds like Fitch does see this as quite a concern.
BINDER: They see it as a concern, yes, because I think it's sort of hard to fathom how it's going to get much lower given how just partisan the budget process is in the United States.
WOODS: Yeah, and that brings us to reason No. 2 which is around governance.
BINDER: Right. They're worried about governance issues in the United States - the really intense partisanship, the difficulty of making bipartisan agreements, the way that the debt limit itself has been so politicized and is kind of used as, like, a political football, which adds a lot of uncertainty. And when we have all these standoffs and these governance issues, that chance becomes something more than zero, even if it's still very small.
WOODS: What other reasons do they give?
BINDER: Another reason would be the rising interest rates. So because of the high inflation we've had over the last couple of years, the Fed has been doing this really aggressive tightening. The federal funds rate was raised from basically 0% to around 5.5%, which of course make the government's debt burden greater. They have more interest to pay on their debt. The fourth reason is their prediction of a recession that could still occur. And luckily, we haven't seen that materialize yet. And the more that inflation keeps falling without signs of, like, labor market slowing down, the more I think we're, like, more nearly in the clear - that we not only will have a soft landing, but - well, a very soft landing in the sense of, like, we don't need a big recession or maybe even any recession to get inflation back down to target. But, you know, these things are really hard to predict, and we're not totally in the clear yet. And interest rates are so high that I think they're still working in this possibility, again, even if it's small, that we could have a recession. And a recession, you know, is never good for the government's debt. They get less tax revenue, more spending. So that's going to increase debt to GDP.
WOODS: Some economists have called this a bizarre decision. Why are they saying that? And do you agree?
BINDER: I think they're calling it a bizarre decision because the timing seems bizarre in the sense that we don't have any new information at the moment that's, like, really, you know, clearly pointing to the need for a downgrade. There was no big change for the worse since the last time they gave the U.S. a AAA rating. So the question is kind of like, why now? We've been having these debt limit standoffs for years. And actually one of the other rating agencies, Standard & Poor's, downgraded the U.S. from AAA to AA+ back in 2011 after a different debt limit standoff and has kept it at AA+ ever since then. You know, it's like, why didn't Fitch's downgrade after one of the other debt limit standoffs or maybe when inflation was really rising a couple of years ago? Why are they doing it now when things look like they're getting better?
The big thing is that these rating agencies aren't really focusing on these short run movements and macroeconomic statistics that come out every month or every quarter, and they're really thinking about the very, very long term. So I think that's how we reconcile this kind of surprising news about the Fitch downgrade at the same time that we're getting good macroeconomic news coming in. And then, you know, within the administration - within any administration - right? - if your sovereign debt gets downgraded, your insiders in the administration are going to oppose it. And now we have Treasury Secretary Janet Yellen disagreeing vocally with this downgrading decision right now. If this downgrade makes it more costly for the U.S. to finance their debt, then that's obviously not good for the administration.
WOODS: No, no, it's not the good news at all. And I'm wondering about the wider implications. I mean, let's say for somebody's 401(k), what might they expect?
BINDER: One thing is to look at what happened in 2011 and back then, the stock market declined quite a lot with the downgrade that big, and the impact on the Treasury market hasn't either. I think this is because this move doesn't really reflect, like, any new, bad information. So to the extent that markets realize that, you know, they're not going to suddenly think that Treasurys got a lot more risky. I mean, hopefully this doesn't have too big of an effect on things like people's 401(k)s. But I think it is really hard to predict.
WOODS: So overall, what I'm hearing is that this is certainly a blow to U.S. pride, but I'm not hearing economic Armageddon right now.
BINDER: Right. I mean, that's always subject to change. But right now that's my view.
WOODS: And I won't hold you any longer. I hope that your new baby grows up in a world where the U.S. does not default on its debts.
BINDER: I hope so.
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WOODS: This episode was produced by Corey Bridges with engineering by Josh Newell. It was fact-checked by Sierra Juarez. Kate Concannon edits the show. And THE INDICATOR is a production of NPR.
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