If Legislators Don’t Push Us Off the Cliff, Will Our Credit Rating?

Originally published by Politic365 here. If you haven’t already shifted your portfolio from riskier equities to commodities, you might be behind the curve.  However, there is a new commodity that […]

Originally published by Politic365 here.

If you haven’t already shifted your portfolio from riskier equities to commodities, you might be behind the curve.  However, there is a new commodity that lacks the volatility of Gold, has been used across the free world for decades, and has a consistently rising demand and a positive future outlook: the Band-Aid (NYSE: JNJ).

Lawmakers have been applying economic Band-Aids around the world from Europe to Asia and the Americas.  Although the surgically precise application of the Band-Aid has done well enough to stave off even the Mayans’ Apocalypse, credit rating agencies are now beginning to look for a tourniquet, before giving their usual Pontifical blessing.

Last year, Standard & Poor’s delivered a Hassan Chop to the federal government by downgrading the U.S. credit rating for the first time in history.  Moody’s and Fitch have maintained their “negative outlook” on U.S. creditworthiness since that time.  Given our current trends, many analysts think it’s only a matter of time before the other agencies deliver their own warning shots to the U.S.

“Who cares about ratings?  Why does it even matter?”  I’ve heard the question more than a few times from my economic students.  So here’s a quick summary:  if ratings go down, so do we.

Ok, that’s a bit simplistic.  But, it really is simple.  If our country’s credit rating drops, our interest rates—on basically everything—are going to go up.  Think of our country as a person.  If Uncle Sam wants to get a new credit card (Sam has a big shopping addiction) and Sam’s credit score goes down, that credit card lender is going to want him to pay them a higher interest rate in order for them to take on an increased risk of not getting their money back.  It’s quite the same for countries as well.

As our nation’s interest rate rises, it will only amplify the value of our current debt.  We currently spend $30 billion per month on interest alone.  (We could give every poor person in the country $700 per month if we didn’t have to pay just the interest on our debt.)  If our credit rating decreases and our borrowing costs increase, our monthly deficit could increase irrespective of spending increases.  Even if our legislators get serious about curtailing debt, this situation creates a Catch-22 that Joseph Heller couldn’t have thought up.

In addition to debt costs increasing, it creates a security risk as our “less-than-amiable” economic allies (e.g. China, Russia, etc.) increase the pressure to exaggerate the cost of our debt.  More and more of the U.S. GDP will shift to other countries, who can, in turn, spend more money on their defense—as well as offense—than we can afford to.

Our ability to borrow as much as we need to cover our legislators’ promises and our country’s obligations may also be slowed.  Institutional investors often lend money to the U.S. Treasury (through U.S. Bonds) based on the guarantee the U.S. offers.  Eliminate the guarantee and those lenders may divest altogether.

And it trickles down to you and me quite rapidly.  If you live in the metropolitan Washington D.C. area, local municipalities cost to borrow may also increase immediately, costing taxpayers more for schools and roads.  Interest rates for mortgages, businesses, and credit cards will also feel the cascading effect.

In the end, it really may not even matter if Washington buys an economic Band-Aid big enough to cover our current obligations.  If credit agencies are honest and call the plans to kick the can down the road what they are, we may see serious economic ramifications from U.S. credit rating downgrades.

Don’t be too excited if you don’t get to see us walk the fiscal plank in January.  It will still be there, just a little longer and a little higher.

JUSTIN VELEZ-HAGAN is Senior Contributing Writer and Commentator for Politic365.com.  He is also an Adjunct Instructor of Economics at the University of Maryland-University College and the National Executive Director of The National Puerto Rican Chamber of Commerce.  He can be reached at Justin@Politic365.com.