Sometimes it takes the naive and innocent to tell the unvarnished truth. In the Hans Christian Andersen tale, “The Emperor’s New Clothes,” a child shouts out that the Emperor has no clothes; he is naked. As the story unfolded, a scurrilous group of weavers had convinced the Emperor that they were creating the most magnificent wardrobe ever worn by any monarch when the reality was that they had spun only an illusion out of thin air.
Not wanting to offend their ruler, all the people in the kingdom went along with this delusion until one small child stood up and shouted that the Emperor had “no clothes!” When the truth is finally revealed, all the assembled townsfolk feel ashamed and embarrassed. But such is the power of reality that it can cut through social conventions and accepted norms.
We experienced just such a moment this week when on Tuesday, Fitch Ratings, Incorporated announced that they were lowering the United States rating to just “AA+” from “AAA.” Technically this reduction applied to America’s “Long-Term Foreign-Currency” Issued Bonds and Notes, the type that this country sells to the rest of the World. Still, the odds are overwhelming that Fitch and the other two major rating agencies will likely include all of America’s Bond Ratings after this first step.
That’s because the underlying fundamentals are the same for all of America’s borrowings.
It’s a trend that began many years ago when America started to believe that the conventional rules of finance don’t apply to us. That we could spend and borrow, and the rest of the World, in particular, would continue to lend us money to support extravagant ways. After all, the US Dollar was the reserve currency, the foundation of all international trade and exchange. The Global Economy relied on those Dollars to do business, so they’d have to build Dollar reserves to do business worldwide.
It was an arrangement that worked reasonably well until that master “weaver,” Joseph R. Biden, came into power. He brought with him the most clever financial haberdashers this country has ever seen. They sold us on a massive program called Bidenomics and promised that it would be the most beautiful economic “garment” in the World. And like those weavers of old, these new economic clothes were spun out of nothing but air.
And Fitch called them on it.
Three weeks ago, amidst much wangling, Washington announced they had solved the “Debt Ceiling” issue. You see, the nation’s bills had caught up with us. This Government needed to borrow more after spending $5 to $6 trillion on Pandemic Relief and carrying a budget creating over $1 Trillion in deficits. Faster than anyone expected, the nation had run against its borrowing limits. If Congress did not act, the country would be unable to pay its obligations. Don’t worry, said the President and his merry financial “weaver” along with the US Congress; we’ve got the solution: the “Fiscal Responsibility Act.”
Everyone breathed a sigh of relief. It was the most beautiful Budget “Clothes” we had ever seen. After all, it was called the “Fiscal Responsibility Act,” so it must be truly remarkable. At last, Washington was taking responsibility for its wayward spending.
And then came Fitch.
On July 10, the day after the debt ceiling crisis was supposedly solved, Fitch shouted that nothing had changed. That the “Fiscal Responsibility Act” was just an empty suit. There was nothing to it. Government spending would continue to increase. Fitch reported that General Government Debt would rise to 118% of the nation’s GDP in the next three years.
The FRA suspended all Debt limits until 2025. Those “weavers” in Washington are now free to spend as much as they like without worrying about that bothersome increase to the Debt Ceiling. Spend as much as you like, says the new Act. Where’s the Fiscal Responsibility? You may ask.
Fitch provides the numbers that paint the future. Last year, 2022, the General Government Deficit equaled 3.7% of GDP. By 2025, when the FRA Deb Ceiling suspension expires, General Government Deficit will reach 6.9% of GDP, nearly double last year’s deficit.
The Dollar During President Biden’s Term: Dollar Index (blue, left scale) Government Debt (red, right scale).
Fitch sees a convergence of three significant factors that will contribute to this continuing debt crisis. First, Fitch expects the economy to experience slowing growth and a likely recession later this year. Next, Fitch expects that these “Weavers in Washington” will continue to increase their spending, thereby making things even worse. And finally, Fitch has factored in these higher interest rates. Rates that will mean as older debt (bonds and notes) mature, they will need to be refinanced at these new higher interest rates, thereby increasing the Government’s interest expense automatically (and raising the GG Deficit).
The timing of all this couldn’t be worse. The BRICS Nations will hold their 15th Summit Meeting in Johannesburg, South Africa, in just two weeks. The chief topic among the delegation will be the production of a new BRICS Currency that could replace the Dollar as an international Reserve. Fitch has just provided the reasons that the Dollar, while not entirely naked, is certainly threadbare.