2023-08-15 20:02:07
“Strange Timing”: America’s Credit Rating Downgraded by Fitch, the Wake-Up Call for 2023
In an unexpected move, the rating agency Fitch downgraded America’s credit rating, leaving senior Biden administration officials referring to it as “strange timing.” However, in hindsight, experts now see 2023 as a crucial year and view Fitch’s decision as a wake-up call. The Federal Reserve’s fight against inflation has increased the risk of a fiscal crisis, highlighting decades of dysfunction in Washington as contributing factors.
The ripple effects of this downgrade are far-reaching. China’s decision, which has upset global markets, has led to high unemployment rates among the youth and a frozen real estate market. Additionally, Fitch is considering downgrading US banks, putting the entire financial sector on alert.
Investors are now seeking shelter from the looming storm, and interestingly, the investments that hold the most promise are the ones considered attractive in the current climate.
Historically, investors have been willing to accept low returns on safe government securities, particularly for the short term. However, recent data demonstrates that this sentiment may be shifting. A professor of economics at New York University revealed that an initial investment of $100 in a three-month government bond in 1928, prior to the Great Depression, would have only grown to about $2,141 by the end of 2022. On the other hand, the same amount invested in mid-rated corporate bonds would have led to a loss of -$46,379, while investing in stocks would have resulted in a significant increase to $624,534. These findings indicate that short-term investments, once considered safe, are now producing minimal to zero returns.
Notably, Ray Dalio, the founder of Bridgewater Associates, the world’s largest hedge fund, has changed his position on cash investments. In a recent interview, he stated that “cash used to be trash, today it is quite attractive – in relation to bonds and stocks.”
One of the primary reasons cash is gaining value is the ever-growing debt pile of the US government. The ongoing war on terror, the global financial crisis, and the COVID-19 pandemic have led to an exponential increase in the national debt. While low interest rates and bond purchases by the Federal Reserve have masked these concerns, experts argue that the Treasury missed the opportunity to lock in these low rates by issuing promissory notes and long-term bonds.
The Congressional Budget Office predicts that the American debt held by the public will surpass the GDP this year, with interest payments on this debt accounting for about three-quarters of non-defense spending. By 2031, these interest payments are projected to match the size of the debt.
The forecast by the Congressional Budget Office seems optimistic as the net interest paid on the debt is predicted to barely exceed 3% in the upcoming years. Meanwhile, medium- and short-term bonds are currently yielding more than 5%. With approximately 70% of the US government’s stock maturing within the next five years, the replacement of these bonds at higher interest rates could lead to a potential increase of $3.5 trillion in federal debt by 2033, resulting in annual interest expenses of approximately $2 trillion. This amount is expected to surpass the revenue generated by the personal income tax, which stands at $2.5 trillion.
Compound interest has the potential to exacerbate an already precarious situation. The situation may resemble past crises in Argentina and Russia, where investors fled due to a vicious circle of debt. While the global reserve currency and the ability to print money provide some stability, the risks for the US are not negligible.
As the Federal Reserve contemplates interest rate hikes, which could lead to increased savings withdrawals, the stock and housing markets risk crashing. Alternatively, the Federal Reserve may intervene by purchasing enough bonds to lower interest rates, reigniting inflation, and reducing real bond yields.
Looking ahead, the Biden administration’s ability to maneuver will be limited due to the ongoing burden of interest costs. This may result in reduced capacity to bail out banks during crises, secure life-saving vaccines, subsidize advanced technologies, or combat terrorism. The fear is that the US will be left with limited resources, undermining the strength of the economy and its international prestige, thereby reducing the attractiveness of its properties.
Predicting when the markets will truly start to worry about this scenario remains challenging, as budget warnings have triggered numerous false alarms in the past. Nevertheless, it is clear that safe cash investments have become increasingly attractive in the current economic climate.
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