US ignores Fitch credit rating downgrade at its own peril

South China Morning Post has published an article arguing that Washington policymakers and Wall Street traders are choosing to shrug off the growing concern over management of federal government debt. Caliber.Az reprints the article.

Pride comes before a fall, it is said, and the mixture of arrogance and complacency which the United States is displaying at present with regard to the state of its public finances suggests that it could trip up badly before long. It almost seems to be courting disaster wilfully.

To shrug off a government debt downgrade just when many other countries are anxious to lessen their dependence on the massive US government securities market and on the US dollar seems perverse in the extreme. Even so, that is what Washington and New York seem to think they can do with impunity.

Putting it more bluntly, when those who resent your attitude go to work not only on undermining your foundations but also on building their own fortresses, it is not wise to ignore such threats or simply disparage others’ efforts. You need to be on the lookout.

This month, Fitch Ratings announced its decision to downgrade the US long-term credit rating to AA+ from AAA. It cited expected fiscal deterioration during the next three years and repeated down-to-the-wire debt ceiling negotiations that threaten the government’s ability to pay its bills.

Instead of acknowledging a growing problem of market discomfort or credibility with the management of federal government debt, US Treasury Secretary Janet Yellen disagreed with Fitch’s downgrade, calling it “arbitrary and based on outdated data”.

The White House also said it strongly disagreed with the decision. “It defies reality to downgrade the United States at a moment when President [Joe] Biden has delivered the strongest recovery of any major economy in the world,” press secretary Karine Jean-Pierre said, according to Reuters.

This was disingenuous to the point of evasion. The Fitch statement noted a “steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025”.

Twenty years is a long time, and if fingers are being pointed now it is not only at the Biden administration but also, by implication, at a series of previous US administrations. Rating agency S&P, for example, stripped the US of its AAA rating no less than 12 years ago.

So much for Washington’s reaction. Meanwhile, market participants in New York were content to dismiss the Fitch downgrade as having already been “priced in” by the market. In their view, the impact of the rating move was negligible, as Atlantic Council senior fellow Hung Tran observed in a commentary.

“With a touch of complacency, many observers also claimed that the rating decisions effects [would] be limited as the rest of the world does not have many alternatives to US Treasury securities as high quality liquid assets for their reserves, collateral and investment needs,” he wrote.

There is, in fact, more than a touch of complacency involved. There is an apparent inability on the part of some Washington policymakers and New York stock traders and investors to grasp the fact that, while the supremacy of US financial markets remains a fact, it is not an immutable one.

Both S&P and Fitch used similar reasoning to support their decisions on changing the US credit rating. Fiscal decision-making in the US has become increasingly dysfunctional as the Republican Party has repeatedly used the debt ceiling as a political tool to hold the sovereign credit quality hostage to its agenda.

Repeated use of debt ceiling stalemates and threats of a default have turned a dysfunctional and irresponsible governance practice into a “new normal” not consistent with the prudent conduct expected of a AAA sovereign borrower, Tran argues.

Another round of budget-wrangling with threats of a government shutdown is looming, he suggests. Republicans are again looking to use debt-limit tactics when Congress has to pass annual appropriation bills for the government to function in the financial year starting October 1.

Small wonder, then, that bond markets are beginning to look nervous against this background. As my former colleague John Plender wrote in the Financial Times, this nervousness has many causes, ranging from the Fitch downgrade to worries about endemic budget deficits.

Washington cannot afford to be complacent about the stability and integrity of the market for US Treasuries. Japan is the biggest foreign holder of these “risk-free” assets, but as interest rates in Japan rise after recent Bank of Japan policy changes, that situation could change soon.

As the second-biggest holder of Treasuries, China is anxious to lessen its dependence on US government securities as a safe haven for its reserves. Alongside its fellow Brics nations of Brazil, Russia, India and South Africa, it is promoting the use of other assets as potential alternatives to the US financial system.

If Washington can show greater fiscal discipline from here on and learn to take seriously the warnings implicit in some countries’ actions that indicate their desire to find at least partial alternatives to US Treasuries and other dollar securities, it can perhaps stave off impending trouble. But this is a big if.