The Debt Problem: Implications for the U.S. and Other Nations

by: Jerry Slusiewicz

Monday before the market opened, Standard & Poor’s reaffirmed the U.S. government's top credit rating of AAA but not before expressing concern that our legislators are not moving quickly enough to stop our growing budget deficit. S&P said there is a 33% chance it would lower the country's credit rating from AAA in the next two years if Washington fails act.

U.S. Treasury Bonds have historically been known as the safest investments on the planet. But now top money managers such as Pimco’s Bill Gross are calling our debt issuance a Ponzi scheme, where one arm of the government, the Federal Reserve Bank, is supporting the U.S. Treasury, by buying as much as 70% of the new debt that has been issued since last September.

Many pundits are stating that this move by the ratings agency to lower its outlook for U.S. paper from "stable" to "negative" caught investors off guard. While this is a first since it began rating the creditworthiness of government bonds back in 1860, this action should hardly be a surprise. Our debt has skyrocketed over the last few years to levels only achieved during major wars.

Today the total outstanding public debt in the U.S. is around $14 trillion. The debt to GDP ratio is among the highest in the world. The federal deficit has approached this echelon only a few times in U.S. history: During the Civil War, World War I, World War II, and today in aftermath of the financial crisis of 2008.

Should our government debt get downgraded in the future, we would have to pay a higher interest rate to attract new buyers. More problems would occur, as many institutions are banned from holding anything but AAA rated investments. That would force a sale of their holdings, which would result in lower prices and even higher interest rates.

As troubling as this may be for the U.S., the situation in parts of Europe are even more problematic. Greece and Ireland have already needed to be bailed out by the IMF and other eurozone countries and are still reeling. Both countries have had their credit rating downgraded again in the last month.

Portugal is now in need of a bailout. Also there is speculation that Spain and Italy will need help in the near future. Should Spain require a bailout, it is estimated that the money needed would amount to the sum of all three of the previous countries combined. It can be surmised that as bad as the situation is over here with our current debt warnings, the problems are even bigger in Europe.