Opinion
The US just paid a heavy price for Washington’s poison
Stephen Bartholomeusz
Senior business columnistIt speaks volumes about the extent of the dysfunction in US politics that, for the second time in history, the poisonous politics and the brinkmanship over America’s debt ceiling earlier this year has led to a downgrading of its credit rating.
The decision by Fitch Ratings to lower the rating from AAA to AA+ wasn’t only about “the erosion of governance” in the US that had the US days away from a default on its debts earlier this year, but the dysfunction it revealed as the key contributor to America’s deteriorating financial position.
Washington’s bitter divide means that any resolution is heavily compromised and, if made, is made at the eleventh hour.Credit: Bloomberg
With ideology, some of it lunatic, dominating politics in Congress, every policy issue is bitterly contested and any resolution is heavily compromised and, if made, is done at the eleventh hour. Democrats and Republicans are poles apart on both fiscal and social policies.
It may be, as US Treasury secretary Janet Yellen said, that the Fitch decision is “arbitrary and based on outdated data”, but, even though America’s fiscal position has improved since its nadir during the pandemic, it is deteriorating and the likelihood that this Congress will do anything to address it is slim.
The downgrade is also, it should be said, more symbolic than likely to have any practical effects, although there may be some near-term impact on financial markets; the dollar dipped and bond yields edged up on the news.
When Standard and Poor’s cut its rating from AAA in 2011 during the Obama presidency (amid a confrontation over the introduction of Obamacare) there was a similar ripple effect in markets but no lasting damage.
Regardless of the rating, the US government debt market is the largest and deepest in the world. Indeed, the downgrading could have the perverse effect of seeing capital flow into it because its status as the world’s financial haven makes it the go-to place for investors globally during any moment of stress – even when that stress is home-grown.
At face value it might appear an odd moment for a lowering of America’s credit rating.
The debt ceiling standoff was resolved, albeit at the last minute, with House leader Kevin McCarthy agreeing to a two-year suspension of the $US31.4 trillion ($47.4 trillion) limit in exchange for a pledge from Joe Biden that non-defence spending would remain flat next year and increase only one per cent in 2025.
As Yellen said, the budget deficit has shrunk (although it remains elevated by historical standards), Biden’s proposed budget would reduce the deficit further by an estimated $US2.6 trillion over the next decade, the economy is growing (June quarter GDP growth was 2.4 per cent), inflation is declining and unemployment is at record lows.
Speaker of the House Kevin McCarthy during the debt ceiling standoff.Credit: AP
However, the deal McCarthy and Biden struck has infuriated the House Freedom Caucus and other hardline fiscal conservatives, along with the ultra-MAGA, Trumpist crew in the House who want to damage the Democrats and Biden’s re-election prospects.
They are already proposing a series of budget bills for the next financial year, which starts October 1, that contain big spending cuts that attack core Democrat policies on the environment, health and aged care, abortion and diversity and which are completely at odds with the deal McCarthy agreed on their behalf.
Now, of course, McCarthy, who needs the support of the hard right to maintain his position, is characterising that deal as a ceiling on spending rather than a floor.
Biden will not accept the spending bills the Republicans are tabling, which raises the prospect of a shutdown of the US government before the end of the year.
If there is no funding legislation passed by Congress, government agencies will cease non-essential operations, employees will be stood down and national parks and institutions will close.
While there have been plenty of shutdowns in the past – the last and longest was a 35-day shutdown in the 2018-19 financial year caused by a fight over the funding for Trump’s proposed wall along the Mexican border – they disrupt and damage the economy and, in the current circumstances, would underscore the point Fitch is making about US governance.
While it could be argued that Fitch has strayed beyond its brief in citing standards of governance as a major influence on its downgrade, it’s on sounder ground when it comes to America’s finances.
The US government debt-to-GDP ratio, at 112.9 per cent, may have come down from its pandemic peak of 122.3 per cent in 2020, but it is significantly higher than its pre-pandemic level of 100.1 per cent. Fitch believes it will rise to 118.4 per cent by 2025.
Fitch’s decision will probably change nothing of any note. It does, however say a lot about the less-than-united United States of America.
The forecast budget deficit of $US1.5 trillion for this financial year, or about 5.8 per cent of GDP, is forecast by Fitch to blow out to 6.6 per cent next year and 6.9 per cent in 2025, driven by weaker economic growth and higher interest costs.
With interest rates higher than they were pre-pandemic as central banks have responded to outbreaks of inflation (US rates are at 22-year highs), interest costs have soared, running at an annualised rate approaching $US900 billion this financial year and compounding rapidly.
With revenue coming in below expectations, the cost of healthcare and social welfare programs rising inexorably as the population ages, and Trump’s 2017 tax cuts – set to expire in 2025 and likely to be renewed if either he or another Republican wins the presidency and/or have control of at least one of the chambers – America’s finances will become increasingly stressed.
That’s the more conventional case for the downgrading, with the governance dysfunction buttressing it because, without a change in the political context, nothing substantial will be done to address it and reverse the trends of increasing deficits and debt and interest bills that soak up an increased proportion of government spending.
Fitch’s decision will probably change nothing of any note. It does, however, say a lot about the less-than-united United States of America.
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