US credit rating could drop within 10 years

Wednesday, June 28th, 2006
Categorized as: Savings Bond newsUS Credit Rating

According to a recent report by the credit rating agency Standard & Poor’s, the credit rating of the US Treasury could drop from its current AAA rating to A by 2015. A further decline to BBB could occur by 2020.

There is another grade, AA, between AAA and A, but the press release about the report doesn’t say when a drop to AA might occur.

The report, Global Graying Country Report: United States of America, is one of a series of reports on the potential impact of aging societies on the credit ratings of sovereign national governments. Standard & Poor’s began releasing the series of reports to its RatingsDirect subcribers on May 31, 2006. The report on the US was issued on June 5.

The press release from Standard & Poor’s annoucing the US report says:

Without concerted policy and fiscal reforms, the aging U.S. population will lead to intense pressure on the public finances and the ratings on the sovereign, Standard & Poor’s Ratings Services said in a report published today.

“Absent further reforms, total age related public expenditures in the U.S. will rise to 20% of GDP in 2050, up from 10% in 2005,” said David Wyss, Standard & Poor’s Chief Economist for the U.S. “In this scenario, general government deficits and net debt would rise sharply from the mid-2020s to
reach 29% and 350% of GDP, respectively, by 2050.”

A fiscal deterioration of that magnitude would not be compatible with the current ‘AAA’ long-term sovereign rating on the U.S. After 2015 it would fall into the ‘A’ category, and would then drop further into the ‘BBB’ category by 2020. In 2025, U.S. fiscal indicators would have weakened to an extent that they would be more typical of performances currently associated with speculative-grade sovereigns.

This scenario is not a prediction by Standard & Poor’s. It is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In reality, it is highly unlikely that governments will allow debt and deficit burdens to spiral out of control. Once governments are confronted with unsustainably rising debt burdens they do react, however reluctantly, by tightening the fiscal stance and/or reforming expenditure programs.

The scenario analysis therefore gives some valuable insights about the power of policy choices. If the U.S. were to embark on a radical structural reform preventing age-related spending from rising, fiscal indicators would hold up much better. Following such a concentrated policy approach, the U.S. net debt ratio would be only 40% of the ratio under the no-policy-change base-case. The theoretical sovereign rating would not fall below the ‘BBB’ category even by the middle of the current century.

“The U.S. position has worsened since 2003, because of the new drug benefit added to Medicare, which increases estimated health care costs by nearly 2% of GDP in 2050, and accounts for one-quarter of the rise in spending on the elderly,” said Mr. Wyss. “Even without that new program, however, the U.S. fiscal position would slip to speculative-grade characteristics by 2030.”

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3 Comments

On June 29th, 2006 Mario said:

I was under the impression that the government cannot default on its loans by definition? Because they can always raise taxes and/or print more money? Or is this view too simplistic?

On June 30th, 2006 Dan said:

Possible bright side – maybe this will mean higher interest on Treasury securities to go along with the higher credit risk? (not holding my breath…)

On June 30th, 2006 Tom Adams said:

Mario – What you thought is what I thought. It’s what we all learned in Economics 101. That’s why the S&P report is such a shocker.

To be fair, the report does say: “In reality, it is highly unlikely that governments will allow debt and deficit burdens to spiral out of control. Once governments are confronted with unsustainably rising debt burdens they do react, however reluctantly, by tightening the fiscal stance and/or reforming expenditure programs.”

Nonetheless, fiscal responsiblity is a rational issue and we elect leaders for emotional, not rational, reasons. So the news from Washington is all about emotional issues like flag-burning instead of rational issues like fiscal responsibility.

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June 1, 2010

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Tom Adams

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