Moody's Downgrades the U.S.
Moody's recently became the last of the credit rating agencies to strip the U.S. of its Aaa rating. Before I get into the question of whether this action was justified, some personal considerations. I was the sole Managing Director for Sovereign Ratings at Moody's from 1986 to 1996. In that year, it was decided that, due to growth in the number of rated countries, the number of analysts responsible for their ratings had become too large for the management span of a single MD, so my colleague Vincent Truglia and I became co-Managing Directors. Vincent was responsible for teams covering the Americas and E. Asia and I for Europe, Middle East, Africa, and S. Asia. So the U.S. fell under his purview, but I remained involved as a voting member of all sovereign rating committees.
Until the Great Recession (GR) of 2008-9, the U.S. rating was unquestioned. The U.S. Treasury, The Federal Reserve, and the private U.S. financial system were at the center of the global economic order, the dollar was the dominant currency for trade and reserve holdings, and the U.S. government debt (using the most appropriate concept, "Federal Debt in the Hands of the Public", which excludes intragovernmental debt and debt held by the Federal Reserve) was, in 2008, a modest 36% of GDP.
That key debt ratio took a noticeable jump in response to the GR, almost doubling to 65% by 2011, when S&P , our chief rival in the ratings business, downgraded the U.S. to (in their notation) AA1. I had left Moody's several years before but chose to comment online that I did not agree with S&P's action. The $US was still dominant in international transactions. In fact, the global financial panic accompanying the GR had caused a run into the dollar as a safe haven, even though the crisis had originated within the U.S. I did not feel that the outlook for government debt, although starting to show signs of its later ascent, was dire enough to offset that monetary advantage. And, in fact, as the graph shows, the debt/GDP ratio pretty much stabilized between that time and the advent of COVID. For rating bonds, we generally tried to think of default risk over a medium-term horizon (8-15) years. No U.S. Treasury security issued at that point in time seemed to me to have any risk of default.
https://fred.stlouisfed.org/series/FYGFGDQ188S
What has changed? Is the recent Moody's action justified? I would say yes, but keep in mind that the difference between the risk of default associated with Aaa and Aa1 is tiny. Both are ultra-safe ratings. The downgrade is essentially a signal that the trajectory of debt expected for the U.S. has reached explosive levels, primarily because of the rising costs of entitlement programs for seniors caused by population aging, as well as the rising interest costs added on as the debt grows. In my view, Moody's is correct to conclude that, from today's vantage point, the debt burden has finally reached the point of more than offsetting the continuing special attractiveness of U.S. Treasuries as the world's premier "safe asset."
The debt ratio is already nearly100% and forecasts from official sources, like the CBO and The JCT, as well as from non-official fiscal experts, predict levels going to 200% by 2055, if the provisions of the Tax Act of 2017 become permanent, and even higher, if the new cuts proposed in the budget bill go into effect. Here, for example, is the excellent summary from the Yale Budget Lab.
https://budgetlab.yale.edu/research/budgetary-effects-may-2025-tax-bill-preliminary
It would be incorrect, however, to conclude that the primary cause of rising deficits and debt is found on the taxation side of the budget. Federal tax receipts have fluctuated within a very narrow range, 16% to 19% of GDP, for many decades. There seems to be, in effect, a political cap on how much of their incomes Americans are willing to pay in taxes. Periodic tax-cutting exercises have done little more than offset the normal upward push from nominal income growth -- "bracket creep."
https://fred.stlouisfed.org/series/FYFRGDA188S
The debt explosion will evidently not be cured by major new tax programs, but will require significant reform of entitlement programs, but that is a topic for another post.