U.S. Credit Rating Downgraded: How Will It Impact Your Investments?
Are we back in 2011 or what?
After the US debt ceiling drama earlier this year, we just witnessed arating agency downgrading the US exactly like in 2011 – back then S&P, this time Fitch.
Today you are likely to read plenty of scary and fear-mongering headlines.
In this piece instead, we’ll take a step back and rationally assess what the US downgrade means for investors and markets out there.
A few words on the reasons behind the downgrade: Fitch pointed out the prolonged discussions on debt ceiling show ‘’deterioration in the standards of governance’’ and the rating agency also sees an economic downturn ahead which is likely to weaken government finances further.
The chart below shows the US spending on interest payments nearing an annualized $1 trillion: a scary chart…if you think the US government has a constrained budget like a household.
But that’s not how it works.
The government doesn’t ‘’need to find money’’ before delivering deficit spending: the government is the very issuer of the money the private sector uses, so its balance sheet doesn’t work like ours.
Deficit spending creates a hole in the government’s balance sheets and increases our net wealth (it’s nice when they cut your taxes or throw cheques at you, right?) – this increases bank deposits in the system.
More bank deposits (liability for a bank) imply more bank reserves (assets for a bank) in the system too, and when the government issues bonds to ‘’fund’’ its deficit spending, primary dealers can swap these reserves (or use the repo market) for newly auctioned Treasuries.
There are more steps and versions of how this could work, but this stylized example should help you understand the main concept: deficit spending creates money for the private sector,
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