The United States is drawing closer to the kind of debt crisis plaguing some European countries, where a financial emergency forces political leaders to make draconian spending cuts and tax increases to maintain the confidence of international investors.
Moody’s, a top Wall Street credit agency, brought the U.S. closer to such a point this week by, for the first time, warning that the U.S. could lose its gold-plated AAA credit rating in coming years unless it quickly puts into place plans to curb budget deficits of more than $1 trillion that have the potential to destabilize government finances and the financial markets.
“Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in [President Obama’s Feb. 1 budget] will at some point put pressure on the AAA-government bond rating,” Moody’s said in a report Tuesday.
Mr. Obama and Senate leaders, during negotiations last month over a $1.9 trillion increase in the government’s debt limit, had hoped to put into place a process for coming up with major budget reductions by creating a bipartisan commission to recommend ways of reducing the debt that Congress could consider by the end of the year.
But the commission proposal failed to pass, and Republicans immediately dismissed a back-up plan for the president to create a commission by executive order with the same mission.
Mr. Obama’s budget includes the commission plan for tackling the deficit, while offering one major concrete stab at deficit control: a three-year freeze on non-security discretionary spending expected to save $250 billion over 10 years.
Moody’s senior credit officer, Steven Hess, called the freeze a “positive step,” but said that it won’t bring deficits down to a level where they no longer pose the threat of a fiscal crisis.
That would occur when the debt gets so large that interest payments on the debt are growing faster than the economy and government revenues, and the Treasury can no longer keep up with the debt payments while trying to fund the rest of the government.
“The debt trajectory is clearly continuously upward if further measures are not implemented,” Mr. Hess said.
Moody’s understands that “the government is constrained for the time being by the high unemployment rate,” and that “a big fiscal adjustment right now would be politically difficult and could slow the economic recovery,” he said.
But he cautioned that “extra spending for employment creation in the current fiscal year adds to the long-term debt” problem.
Some private watchdog groups have sounded the same warning as Moody’s, though none of them has the power of the Wall Street rating agency to help bring about the budget crunch that they are predicting.
Similar, though less veiled, warnings by Moody’s and other credit agencies triggered financial turmoil and played a critical role in forcing Ireland, Greece, Portugal and other European countries to take drastic measures to grapple with their huge debt problems in recent months.
Former Sen. Pete V. Domenici, New Mexico Republican and a major player in drafting bipartisan deficit reduction plans in the 1980s and 1990s, said today’s political leaders need to focus on how serious the debt problem has become.
“For the first time in our nations history, we risk undermining U.S. economic and military strength and becoming a second-rate power,” he said, adding that he is particularly “concerned about the unprecedented level of U.S. debt held by foreign creditors,” which leaves the U.S. vulnerable to the whiplash of sentiment changes in international financial markets.
It doesn’t matter whether the debt was created by Republicans or Democrats, he added, “the severity of this problem will require members of both parties to come together to find a solution.”
Jerry Jasinowski, former president of the National Association of Manufacturers, credits Mr. Obama for trying to get bipartisan action on the economy and deficits.
Republicans should “see if common ground can be found,” he said. “Historically, the Democrats resist spending cuts, especially for entitlement programs, and the Republicans have hissy fits at the mere mention of tax increases. But leadership demands tough decisions. We must have some combination of spending cuts and tax increases. There is no other way.”
Mr. Jasinowski said that while the current economic challenges are the most “daunting” since the Great Depression, a crisis can be averted.
He noted that bipartisan cooperation between the Clinton administration and the Republican-led Congress in the 1990s produced three years of budget surpluses and a dynamically growing economy.
While no one knows for sure what would happen if U.S. Treasury bonds - once considered the safest haven for investment in the world - were to lose their AAA status from Moody’s or other credit-rating agencies, cash-strapped countries in Europe who have lost their AAA ratings are providing a clue about the consequences.
Ireland, which lost its AAA rating last summer as it financed unprecedented large bank bailouts and recession-related spending, was forced to make drastic cuts in spending and raise taxes to ensure it can continue to borrow at affordable rates. Other European countries, including Greece, Italy and Portugal, have faced similar or worse pressures, and their struggles have cast a cloud over the economic outlook for the entire European Union.
Japan’s sovereign debt was downgraded from AAA status last year without major consequences. But Japan’s savings rate is high enough to finance its own deficits, something not true of the U.S.
On the other hand, a U.S. downgrade could have greater consequences than elsewhere because of the dollar’s status as the world’s reserve currency and Treasury’s status as the world’s leading safe haven for investors.