Economic Forecasts

Downgrade in U.S. Debt Rating Could Have Grim Consequences

Corporations are doing a much better job of staying in the black than governments.

Editor's Note: This story has been updated since its original publication in the July issue of Kiplinger's Personal Finance magazine.

What if the unthinkable happens and U.S. government debt loses its coveted triple-A rating? After all, we're running trillion-dollar deficits without a plan in place to close the gap, entitlement spending is surging, and interest payments, much of it to foreign creditors, will balloon as rates rise. Voters say they want deficit reduction, but they also want low taxes and generally oppose cuts to expensive programs such as Medicare and Social Security. Of course, it's always possible that Congress will demonstrate courage, statesmanship and bipartisanship and agree on a dramatic budget deal. But how likely is that?

The effects of a downgrade could be dramatic. Stock markets could tumble, as they did briefly on April 18, when Standard & Poor's suggested that it might downgrade the U.S.'s debt rating (Moody’s Investors Service issued a similar waning on June 2). Interest rates would rise, both for government debt (ours and that of foreign countries) and for corporate bonds, which are generally priced in relation to Treasury yields. Bond prices, which move in the opposite direction of yields, would fall. In fact, a downgrade could negatively affect the prices of most assets, because financial models used to value everything from stocks to commodities and real estate use Treasuries as a proxy for the so-called risk-free rate of return. Downgraded Treasuries would no longer be seen as "risk-free."

Ironically, the health of corporate America is improving as the finances of U.S., European and Japanese governments deteriorate. "The balance sheets of U.S. multinationals are stronger than those of many governments," says Noah Blackstein, manager of Dynamic U.S. Growth Fund. "Fundamentally, corporations seem like much better investments than governments."

Most Popular

House Approves $3,000 Child Tax Credit for 2021
Coronavirus and Your Money

House Approves $3,000 Child Tax Credit for 2021

The proposal would temporarily increase the child tax credit to $3,000 or $3,600 per child for most families and have 50% of it paid in advance by the…
February 27, 2021
Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?
Coronavirus and Your Money

Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?

The House passed President Biden's $1.9 trillion stimulus package. While the bill faces hurdles in the Senate, the provisions authorizing another roun…
February 27, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

Flying This Summer? What to Expect
Travel

Flying This Summer? What to Expect

Depending on your destination, you may need to show a negative COVID test or even prove you’ve been vaccinated.
February 23, 2021
Biden Steers PPP Loans to Smallest Businesses
Coronavirus and Your Money

Biden Steers PPP Loans to Smallest Businesses

For two weeks, mom-and-pop businesses will move to the front of the line for Paycheck Protection Program loans.
February 22, 2021
President Biden's Tax Plans for the Next Few Years
Politics

President Biden's Tax Plans for the Next Few Years

With control of both the House and Senate in Democratic hands, President Biden will be able to get more of his tax policy proposals through Congress. …
February 3, 2021
What to Expect if You're Flying in 2021
Travel

What to Expect if You're Flying in 2021

Policies enacted by the airlines in 2020 may change air travel for the long haul.
January 24, 2021