Paul Krugman, looking at Japan, says that today's S&P news is "no big deal," based on the fact that Japanese long-term interest rates stayed low even after the country was downgraded in 2002. But of course if the fate of the U.S. over the next nine years is remotely similar to the fate of Japan over the past nine years, that's going to be a very big deal indeed — for the U.S. economy, for its fiscal ratios, and for the entire world.
The potential global downside here is large, as Mohamed El-Erian explains:
The world looks to America for a range of "global public goods" — including the reserve currency, the deepest and most liquid government debt markets, and the "risk free" standard. With no other country able and willing to step into this role, the result would be global efficiency loses and a higher risk of economic and financial fragmentation.
That said, however, there is a silver lining if you look hard enough. "Efficiency," after all, is a nice way of saying "fragility." As a general rule, the more efficient something is, the easier it is to break. So if we want to move to a more robust world with fewer major crises, there will necessarily be a price to pay in terms of global efficiency loses.
A slow move away from the dollar's reserve-currency status might not be such a bad thing, seeing as how that status has allowed the U.S. twin deficits to grow to previously-unimaginable levels. Just as car traffic expands to fill the road space available, national debt ratios naturally tend to go up rather than down, unless and until some kind of external constraint is imposed by the markets and/or ratings agencies. In that sense, the news from S&P is simply a necessary part of how the U.S. is going to get its fiscal act together.
U.S. Treasury bonds are always going to be the most liquid government debt market, simply by dint of their sheer size. As such, they will always be the benchmark off which all other debt is priced. It's conceivable that one day a debt instrument somewhere will trade through treasuries. That's fine — there's no particular harm in that. Does it mean that U.S. debt is not risk-free? Yes, that's exactly what it means. But realistically no one has ever considered U.S. debt to be risk-free: there has always, for instance, been the very real risk of inflation.
El-Erian is absolutely right to worry about where the world's growth is going to come from as we move from a unipolar global market to something which looks more like a G-Zero world. But I suspect that transition is inevitable in any case, no matter what happens to the U.S. credit rating or its national debt. And there's precious little that the U.S. or its legislators can do about it.