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US Public Debt Could Put Democracy at Stake

Public Debt
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EDITOR NOTE: Economist and former S&P executive David Beers writes that the U.S. credit rating is now endangered with the debt ceiling fight in Congress and that the health of the U.S. democracy is also in limbo. Beers should know, he led the S&P team that downgraded the U.S.’s credit rating during the last debt ceiling fight in 2011. In his Barron’s op-ed, he walks through all the reasons that downgrading the U.S. was the right thing to do in 2011. These reasons include the trajectory and expectations around public debt and the “political dimensions” of the time. He also draws parallels to what is happening 10 years later, in 2021. Finally, he predicts that the “big three credit-rating firms” will be downgrading America’s credit once again in the near future.

In August 2011, S&P became the first major credit-rating firm to downgrade U.S. debt, following a political crisis over debt and spending. Ten years on, S&P’s decision is still controversial. My fellow rating-committee members and I expected criticism when we made the decision. We got plenty. We were attacked by officials in Washington and around the country, by sections of the banking and investment communities, and even by ordinary U.S. citizens.

It was a challenging time for all the S&P analysts listed on the press release. After the furore faded, I travelled to Europe, Canada, and East Asia for meetings I had previously postponed. Everywhere, I was struck that the people I met were far less critical of S&P’s downgrade than people in the U.S. Many even told me that they agreed with us. 

With more perspective, I still believe that the downgrade was the right decision, and one supported by events since then. 

First, consider S&P’s assumptions behind the rating downgrade highlighted in its press releases. Essentially, there were two. One was about the trajectory of public debt. The committee’s preferred measure, net general government debt, combines U.S. federal government obligations with those of state and local governments, net of their financial assets. We viewed (and I still view) this metric as the best one for comparing the debt of sovereigns because of their varied, and often more centralized, budgetary arrangements compared with those in the U.S. 

What were S&P’s expectations on public debt, and how did they pan out? In fact, the ex-post trajectory of the United States’s net general government debt to GDP ratio is very much in line with what S&P assumed back then, which, in turn, was based on analysis from the independent Congressional Budget Office. These projections showed net debt reaching 79% of GDP by 2015; the actual outturn was 80.7%. Over a ten-year horizon, S&P expected net debt to reach 85% of GDP by 2021. This was well under last year’s 103% outturn, which was heavily affected by the onset of Covid-19. However, by 2019 net debt already had reached 83% of GDP and clearly would have risen higher since then, absent the pandemic. So, leaving aside Covid’s extraordinary fiscal impact, S&P got the underlying public debt dynamics right in 2011.

What about the political dimensions of U.S. fiscal policy? In line with its ratings criteria, S&P’s ratings also reflect its opinion about a sovereign’s political stability. There should be no great controversy about this, at least among credit analysts. After all, political dynamics influence fiscal policy. At the time of the 2011 downgrade, S&P highlighted the deadlock over fiscal policy between the Democratic Obama administration and the Republican majority in the House of Representatives. S&P cited the fight over raising the federal debt ceiling, a feature of fiscal policy unique to the U.S., but its broader point was the absence of bipartisan consensus about fiscal priorities.

How does the gridlock in 2011 compare with what we see now? By any reasonable standard, political polarization in the U.S. is much worse. On a range of key issues, it is harder to cobble together cross-party Congressional majorities than ever before in my lifetime, which spans 13 presidencies. And it’s no coincidence that we also have the most polarized electorate in modern times. How else can one describe a state of affairs where as many as 70% of Republicans do not accept the certified results of the 2020 presidential election, and the main political parties are in thrall of extremes on the right or on the left? Today, the center ground is a lonelier place in American politics than it was a decade ago. So, S&P’s concerns on this issue resonate today, too.

Finally, let’s look at a snapshot of current financial market views of U.S. creditworthiness. A good measure, distinct from (though not necessarily uninfluenced by) credit ratings, is the market for five-year credit default swapsThe CDS market prices the perceived credit risks of participating investors. As of last Friday, for 5-year CDS swaps the U.S. ranked 10th in basis points terms, behind nine European sovereigns. This includes one (the U.K.) with a lower S&P rating and the rest, mainly eurozone sovereigns, with credit ratings lower, the same, or (like Germany’s) higher.

I remain convinced that the downgrade of the U.S. credit rating in 2011 was the right call. Fiscal and political developments since then confirm S&P’s judgment, as does the view of investors in the CDS market. On current trends, we should expect further downgrades from the big three credit-rating firms. One to watch is Fitch Ratings, which assigned a negative outlook to its AAA rating of the U.S. last year. But there is a bigger worry here: the health of U.S. democracy. For all of us, far more turns on America’s faltering political experiment than just its credit ratings. 

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