The US Deserves Its Credit Downgrade

While Jack Smith was busy indicting Donald Trump on Tuesday afternoon in connection with the former president’s efforts to remain in power following the 2020 election, Fitch was busy pulling the trigger on a US debt downgrade.

The timing was obviously a coincidence, but the two events weren’t entirely unrelated. Fitch cited an “erosion of governance” in Washington, echoing language from a warning shot fired in May, just prior to the debt ceiling deal that averted a technical US default — and whatever might’ve gone along with it.

As I put it two months ago while warning readers that a downgrade was likely irrespective of any resolution to the standoff, a decision by Fitch to go ahead with the controversial move would be predicated not just on America’s fiscal trajectory, but also on the read-through of the nation’s multi-faceted credibility crisis, which recently engulfed the Supreme Court.

Although Fitch didn’t venture a critique of America’s fraying democracy, they didn’t exactly mince words either. “In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters,” the agency remarked. “The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”

The “deterioration” Fitch discussed on Tuesday was the subject of May’s monthly letter+. Here are a few relevant excerpts:

It’s worth noting that among the incumbent lawmakers who initially objected to Kevin McCarthy’s bid to become House speaker in January, 14 of 15 voted to overturn the 2020 presidential election. All of those lawmakers favored sustaining at least one objection to states’ 2020 results even after witnessing the riot. Voting with them on that day in 2021 was McCarthy who, two years later, was compelled to prostrate himself at the feet of Trumpism to secure the House gavel in what I described as “a feat of self-abasement with almost no modern historical precedent.”

As everyone with even a passing interest in markets pointed out, the leverage the House’s far-right flank secured over McCarthy in January virtually ensured that the forthcoming debt ceiling debate would be more perilous than previous standoffs.

That’s why this time was different. In no uncertain terms: There was a link between the violent attempt to usurp America’s democratic process and 2023’s debt limit deadlock.

Suffice to say anyone feeling nervous about the future of American democracy won’t be blamed for their trepidation, including Fitch if that’s what they’re concerned about.

Of course, Fitch’s rationale mostly focused on the fiscal trajectory. “Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms,” they went on. Fitch predicted a recession starting in Q4, and anemic growth next year.

With apologies, Fitch’s macro projections are no better than anyone else’s, which is to say they’re just guesses. The fiscal color was boilerplate, and anyway irrelevant. It’s the same set of talking points you’ve heard over and over again — social security and Medicare costs are an issue and although debt-to-GDP has receded from the COVID stimulus peak of 122%, it’s still above pre-pandemic levels and poised to rise going forward.

Again, none of that’s especially relevant. The US can just print money to pay for entitlements, and the debt-to-GDP ratio is meaningless. Fitch would call those assertions of mine preposterous and I wouldn’t care. Not even a little bit.

But that’s not to say the US didn’t deserve to be Fitch-slapped (sorry). It did! Fitch is spot on in describing a deterioration in governance, and they’d have done well to spend more time editorializing around that and less time fretting over budget figures that don’t make any difference for the issuer of the world’s reserve currency.

America’s problem isn’t fiscal recklessness, it’s institutional decay. America can’t go broke financially, but it can be bankrupt in social capital terms. And it can succumb to autocracy.

Needless to say, the Biden administration wasn’t amused with Fitch’s decision, which Janet Yellen said “does not change what Americans, investors and people all around the world already know: That Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong.”

The downgrade exacerbated the very partisan rancor Fitch cited in the rationale. Chuck Schumer blamed House Republicans, and Republicans blamed Biden’s economic policies.

For his part, Larry Summers called the decision “bizarre and inept.” Mohamed El-Erian said he was “very puzzled by many aspects of this announcement, as well as by the timing.”

To reiterate: I don’t know why anyone was surprised. Yes, the debt ceiling standoff was ultimately resolved, but the gridlock in D.C. certainly isn’t, and the downgrade was arguably a foregone conclusion when Fitch put America on watch in May. At least one bank said as much.

Do note: In the May notice, Fitch specifically mentioned the “contested” 2020 election. Fast forward two months, and we have an indictment related to that episode. What does it say about the state of America’s union when the last president was just charged with plotting against the country in a conspiracy with the former mayor of New York City? (Rudy Giuliani wasn’t named, but an attorney said that, “It appears Mayor Giuliani is alleged to be co-conspirator No. 1” in the indictment.)

I suppose you could argue that’s a sign that justice works if you give it time — and that no one is above the law. But that’s a bit like saying the Biden-McCarthy debt ceiling deal was a sign of bipartisan compromise. Maybe it’s true, but it’s small comfort, if it’s any at all.

Oh well, at least the US still has currency hegemony going for it. As Fitch put it, “the US dollar gives the government extraordinary financing flexibility.”