Staring down a AA-rating

August 2, 2011, 7:13 PM UTC
Fortune


Riskier?

FORTUNE — The U.S. might have avoided a debt default and a government shutdown, but the deal Congress reached to raise the nation’s $14.3 trillion debt limit does little to improve its long-term fiscal position. After weeks of political wrangling that culminated in a rushed deal with a temporary fix, the faith in America’s debt likely will fall in the eyes of global investors.

It’s only a matter of time before the U.S. loses its stellar triple A-rating – a coveted status the nation has managed to hold since 1941. A downgrade of our sovereign debt would not likely be financially disastrous, but it underscores just how deep the nation’s debt problems have become.

Technically, the debt deal calls for less than $1 trillion in spending cuts over the next 10 years. Lawmakers have essentially given themselves a back-door extension to fixing America’s fiscal problems by delaying bigger budget cuts. The plan includes a second round of reductions totaling $1.5 trillion, which will kick in if lawmakers can’t agree on recommendations by a bipartisan commission tasked to come up with such savings by the end of the year.

Members of Congress might be applauding themselves today, but Standard & Poor’s and other rating agencies likely won’t be fooled by the backslapping.

In a way, however grudgingly Democrats and Republicans nodded to the deficit-reduction plan, both sides essentially got what they wanted: President Obama got the debt ceiling raised through the end of his first term, and Republicans avoided tax increases.

S&P, meanwhile, got much less than what it asked for. Combined, the reductions of $2.1 trillion still fall short of the $4 trillion minimum that the rating agency implied was needed for the U.S. to avoid a downgrade. But who knows what S&P really wants – as Politico’s Ben White points out, the agency had already been back-pedaling its initial target. S&P did not immediately return a request for comment.

The $2.1 trillion in cuts would reduce the debt as a percentage to GDP by 10 percentage points over the next 10 years. However, that would still leave it at a very high 67% by 2021 – at best, according to Senior Chief Economist Paul Dales at Capital Economics, citing a scenario by the Congressional Budget Office. Dales believes the figure would fall closer to 95%.

Though some believe that a downgrade could happen as early as this week, it isn’t likely to shock bond markets. Yields on U.S. Treasuries would typically rise on worries over higher risks on such investments. However, yields on the 10-year Treasuries are still below 3%.

Nevertheless, a downgrade is a serious warning that worse things will surely be on the horizon. Losing triple-A status will likely add pressure on lawmakers to do more to reduce the deficit — any such moves would surely stall economic growth in the coming years.