The credit rating for U.S. bonds was just downgraded again. Moody’s rating went from AAA to AA1, which sounds miniscule. In reality, it is significant. This is the first time in more than a century that U.S. government debt has no perfect rating from three major credit rating agencies—Moody’s, Fitch Ratings, and Standard & Poor’s.
The reason is obvious. U.S. debt is out of control. Congress shows few if any signs of willingness to cut spending and drop the debt. The legislature is even balking on writing DOGE budgetary savings into the budget they are sending to the White House to sign. That would essentially shred all the good work done by Elon Musk.
We are nowhere near resetting the budget back to pre-lockdown days. Instead, Congress seems thrilled to take the past five years of crazy spending and make it the new normal. Under these conditions, credit-rating agencies have all decided to announce a bit of caution. The United States is no longer a perfect credit risk. An element of worry is merited by investors worldwide.
To be sure, if the U.S. government’s balance sheet were evaluated like a private company, the rating would instantly and immediately hit rock bottom. It is not evaluated that way. This is in contrast to every state and municipal government, plus every private corporation.
Why does the U.S. debt not experience a rigorous and market-based credit rating? There is only one reason: the central bank. It stands ready to bail out the financial system and the government should anything go haywire. No state or city, much less any private debt issuer, enjoys such a privilege. The right to run a money-printing machine is possessed by the federal government alone.
That’s why there is no real risk premium attached to U.S. debt. There hasn’t been since 1913. That was the whole purpose of the Federal Reserve. Its job was to protect government debt and the financial system that sustains it from the wiles of the market. In this sense, it has done a great job. But it has come at great expense to the public in the form of massive devolution: the 1913 dollar is now worth about 3 cents. Pathetic!
Let’s back up and consider what a credit rating is. There is likely one that pertains to your own credit history. In the old days, you had to dig deep to find it and would never even bother to know it unless you were applying for a home loan, an auto loan, or maybe an apartment lease. It was not much of a big deal in our lives unless it really mattered.
That has all changed. My phone lights up from time to time with a big announcement: “Your new credit rating is here!”
I’m supposed to get all excited and see if it went up or down and why. Getting a new credit card will ding it down because this implies that you are planning to take on new debt with no change in income. Having an entity even check your rating will ding it too, because the implication is that you are shopping for debt.
Sometimes it changes for no apparent reason. Maybe I should care intensely, and I followed the game for a while the way people look for likes and clicks on social media posts. Then I got bored and even annoyed that my bank wants me focused on this for no apparent reason. Then I got paranoid: Maybe this incessant push to make me wild for my rating is preparing us for the rollout of a social credit system like in China!
Can’t rule it out. These days anything is possible. More likely, we are being pressed to become rating obsessives simply because it is now possible to shove it in our faces all the time.
That said, it’s not a bad thing. It inspires discipline and responsibility. It is also shockingly unforgiving. If you missed a payment five years ago, you might think bygones are bygones. But your credit rating app has still got you in sackcloth and ashes, saying 10 Hail Marys for penance. Even then, you seem doomed to a lower rung of heaven.
This imposes a kind of accountability on personal finance. One major mistake affects your ability to borrow at all. You will walk around as if wearing a leper’s bell around your neck. Note that no government is doing this. It is purely a product of private markets. It’s not coercive. No one is forcing you to take out a loan. If you do, you darn sure must pay up.
I find this entirely defensible even if it is annoying and shockingly severe.
The taskmaster role the agencies take for our personal finances entirely contrasts with the way they treat federal government debt. Here we find forgiveness 70 times 70 times 70. No matter that nonsense of the fiscal and monetary authorities, even bailouts, zero interest rates, and endless inflation, is brushed aside as a big nothing burger.
It’s been going on for a century. It’s a fair question to ask why the downgrade has happened now.
It’s possible that it is timed with the realization that Congress is utterly failing to take the situation with the debt seriously. But did anyone really believe that it would? Well, I admit that I became briefly hopeful when Musk was talking about cutting $2 trillion in one year. But that was soon reduced to $1 trillion. Then it kept falling all the way to $150 billion. Now it appears that nothing will actually be cut.
We will soon be back to the old Washington game of calling a cut a reduction in the rate of increases. The Republicans will proclaim victory while the Democrats and the media will scream in pain at the cruelty to widows, orphans, workers, and peasants. It’s the longest-running show on Broadway and is forever being revived and played again.
But what if there is another reason? Here is an interesting theory. The Fed has been rather uncooperative with the Trump administration. Trump keeps calling for lower rates while the Fed keeps not lowering them. Indeed, the Fed has pushed back on the executive department probably more than any time in the history of the central bank.
The Fed is simply not going to accommodate Trump, probably for political reasons and also because the Trump administration is widely seen in Washington as the biggest enemy that the administrative state has ever faced. You might say that is an exaggeration, but it doesn’t take that much to flip the psychology of the financial markets.
The creditworthiness of federal government debt is wholly dependent on the power of the central bank. What the rating would be absent the Fed we cannot know; it would need to be tested by the ferocious judgment of the ratings agencies. Would it be A, triple B, or lower, maybe even D for default?
Illinois has a debt of $10,915 per capita and earns the low rating of BBB, the lowest of any state. The federal government has a debt of $106,200 per capita, or 10 times the worst other ratio in a state that has no central bank. And yet Treasury notes are rated AA1. This alone is revealing.
Would that every member of Congress have an app on his or her phone that would disclose a genuine market-based credit rating for federal debt, one that would slide up and down based on spending bills, public statements, and debt-limit increases. Even better would be a system whereby the capacity to borrow would undergo a hard freeze if the credit rating went too low.
In other words, if the federal government faced the same fiscal discipline as every American borrower, we could get the state of the nation’s finances in tip-top shape in no time. There is a sure path toward making that happen. Abolish the central bank.
