What Does the U.S. Credit Rating Downgrade Really Mean?

The negative economic impacts of the U.S. credit rating downgrade

Some economists and financial experts believe S&P’s downgrade will have significant negative impacts to the U.S. and world financial markets that ripple through the U.S. and global economy in both the short term and long-term. They argue the downgrade will have the following effects.

  • Increases the possibility of a double-dip recession and a larger fiscal deficit.
  • Degrades the confidence of investors, making the fragile financial market even worse. Provokes panic selling in global stock markets.
  • Intensifies emerging trend of investors avoiding U.S. treasury securities and increases market turbulence.
  • Increases the global risk premium level by making the global market more sensitive to the European debt crisis and making the bad-credit economies of the European Union more fragile.

  • Diminishes global economic recovery by dampening people’s optimism for U.S. economic growth, increasing U.S. costs to issue treasury securities, and negating economic development through large scale debt funding and printing more U.S. currency. In this scenario, the U.S. falls into a vicious cycle where borrowing money becomes harder, economic development is encumbered and credit worsens.
  • Exposes U.S. citizens to higher borrowing costs and lower purchasing power thus reducing U.S. consumer demand and exposing countries relying on U.S. import orders to significant losses and economic slow down.
  • Damages the interests of U.S. debt holders such as China, Japan and Russia as U.S. treasury bonds loose their superior international status and the U.S. dollar depreciates.

Why the downgrade in the U.S. credit rating doesn’t matter

Other economic experts note that the downgrade of the U.S. credit rating may have little effect and point to the following reasons.

  • The U.S. still has AAA ratings from two rating agencies, Moody’s and Fitch.
  • The debt limit agreement reached by Congress in August 2011 showed U.S. politicians can reach political solutions to address the nation’s debt problems.
  • The U.S. credit rating is underpinned by the flexible, diversified and wealthy economy that provides the country’s revenue base.
  • U.S. monetary and exchange rate flexibility enhance the capacity of the economy to absorb and adjust to shocks.
  • Most U.S. debt is held by big institutions like pension funds and central banks that do their own research on sovereign debt and aren’t heavily influenced by rating agencies, and Treasury yields may experience little impact as a result.
  • Nearly all financial-industry regulations and internal policies at financial institutions treat the AA+ rating the same as an AAA rating, so forced selling is unlikely.
  • The effect on other countries that were downgraded was minimal in most cases. For example, Canada’s interest rates went up briefly in 1994 when it was downgraded, but rebounded within two months and Canada later regained the AAA rating it holds today.