Will the US lose its AAA rating?
This is a guest post from Lee Murray a Financial Advisor for Edward Jones in Fredericksburg, VA. You can contact Lee at Lee.Murray (at) edwardjones.com.
There are a lot of variables that go into determining whether or not the US will lose its AAA rating. I will try to summarize the most likely possibilities. For starters, a country’s credit rating is similar to an individual’s credit score. If a person has a credit score of 790, for instance, they should have a relatively easy time borrowing money and they get it at a good, low rate. This is the equivalent of a AAA rating. However, if an individual has a credit rating of 450, then they have a much greater chance of having a loan application declined or should they get approved, they will have to pay a higher interest rate because it is deemed a “more risky loan”. This may be the equivalent of a C rating. There also 7 ratings inbetween AAA and C.
The concern is that if the United States were to have their credit downgraded from AAA to AA, we may not get as much credit extended to us as we have in the past and we may have to pay a higher interest rate to borrow the money. So what happens if the USA gets downgraded? As stated above, it would be more expensive and tougher to borrow money from other countries but taking it a step further, it would set off a series of economical events. More than likely, it would cause the value of the dollar to drop and thus pushing the value of gold and oil higher as people make what is commonly referred to as a “flight to safety”. It would cost more to borrow money and in turn cost US companies more money to operate, hence lowering their profit margins. Once profits are lowered, investor interest will decline, both domestic and foreign, and you will tend to see more sells than buys and a drop in stock price.
Is a downgrade likely to happen? In one word: no. This is simply my opinion but I firmly believe that there are too many reasons out there for the USA to keep it’s AAA rating. Talk of the US having a credit downgrade comes up everytime there is a recession or a downturn in the stock market. The fact of the matter is that we still have the healthiest economy in the World, even given the events of the past 18 months. This talk is often media-driven and as proof, the stock market has not built in a credit downgrade because they simply do not think it is going to happen. An entity is downgraded when it’s lenders have lost confidence in it’s ability to pay back it’s loans. In order for the United States’ ability to not pay back it’s loans to occur, we would need constant negative Gross Domestic Product (more than 2 or 3 quarters worth) and a significant decrease in Income Per Capita. All of this, possibily coupled with a significant drop in population, could lead to much lower tax revenue and thus hurting the federal government’s balance sheet, if you will. We do not see this realistically happening.
In addition, the rating companies are United States companies. The most commonly used credit rating companies are Standard & Poors and Moody’s Investors. I will be the first to admit that there is a conflict of interest in this but both of these companies realize that if they downgrade the country’s credit rating, it will effectively hurt their own companies. Even with that aside, all sovereign debt throughout the world is priced relative to US Bonds so downgrading the US credit rating would lower US bonds and essentially result in a downgrade of all sovereign debt.
This is a very interesting topic and I have tried to highlight the reasons why it is not foreseeable that the United States will have it’s AAA rating downgraded. I stress that it is not foreseeable but notice I did not say “impossible”. In investing and economics, the minute one believes something will never happen, they had better watch out because that is when Murphy’s Law kicks in. I am of the opinion that we will not hear much more on this topic until maybe four or five years from now when we have the next correction.
Lee Murray
Financial Advisor
Edward Jones
43 Town & Country Dr Suite 113
Fredericksburg, VA 22405
(540) 373-1805
www.edwardjones.com
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