“The numbers speak for themselves,” Richard Francis, the co-head of Americas sovereign ratings at Fitch, told CNN on Wednesday. By his count, U.S. debt as a share of gross domestic product soared to 113% of the U.S. annual economic output from below 60% in 2007.

For Fitch, this accelerated deterioration of the U.S. government balance sheet, combined with rising interest burdens from higher rates and a political class largely unwilling or unable to take concerted action, all mean the country can no longer serve as the gold standard for creditworthiness.

“Yes, debt to GDP peaked during the pandemic at 120% and has come down,” Francis explained to Bloomberg TV, citing as the cause the end of COVID-era stimulus last year. “But now we’re seeing debt levels starting to rise again and we do not see them stabilizing in the next three years and probably over the medium term.”

Arguments that the downgrade was not justified because the economy has outperformed economists’ expectations didn’t hold water for Fitch either, not least because the credit rating agency currently predicts a recession beginning in the fourth quarter.

Even if the U.S. were to engineer a soft landing, it would not be enough to offset the country’s ongoing precipitous fiscal and governance decline. 

“Honestly, it doesn’t really move the needle in terms of the underlying analysis,” Francis argued. 

Fitch has downgraded the U.S. long-term credit rating to AA+ from AAA. Why the cut, and why now? Fitch's Richard Francis explains. https://t.co/WxsLvg128N pic.twitter.com/pWppW4xPSl

— CNBC (@CNBC) August 2, 2023

Indeed, he said some of the U.S. government’s financial metrics had already long dropped below even double-AA rating, implying a downgrade would have come earlier had it not been for the U.S.’s biggest strategic asset over other triple-A peers like Germany: the dollar’s coveted global reserve currency status. This cements the country’s ability to borrow cheaply from investors abroad that need U.S. dollars just to participate in international trade and commerce.

Pushback

Naturally, the Biden administration disagreed with Fitch’s assessment. With the downgrade happening on her watch, Treasury Secretary Janet Yellen called the decision to question her management of the purse strings “arbitrary,” later adding that it was “entirely unwarranted.”

It’s not just Yellen or even former top government officials like Larry Summers who dismissed the decision. Even independent economists like Mohammed El-Erian questioned the move by Fitch. 

“Why now? What Fitch put in its statement has been true for a while,” he told Yahoo Finance Live.

Francis countered by arguing that an imminent decision had been telegraphed to policymakers ever since it warned of a potential downgrade in late May.

“We indicated then that we would resolve the rating watch in the third quarter and we wanted to take our time,” he explained. 

No progress on entitlement reform

While Francis argued issues like the brinkmanship around the debt ceiling—the very existence of which he said was not compatible with governance at the U.S.’s triple-A peers—played a role in his decision, it was really the increasing failure of politicians to tackle pressing reforms that factored in more. 

“Both sides, Republicans and Democrats, haven’t been able to come up with meaningful long-term solutions to deal with growing fiscal issues, especially around entitlement programs like social security and Medicare,” Francis said in another interview, this time with CNBC.

El-Erian worried, however, that Fitch inadvertently would further worsen the very political divides that had the ratings agency alarmed in the first place.

At present the 2024 election risks being a rematch of 2020, a highly polarized campaign that saw the country attack itself over Trump’s unsubstantiated claims that the Democrats and opponent Joe Biden rigged the vote. 

The link to this morning's conversation on Yahoo Finance.

Thank you Diane and Julie for having me on your show.https://t.co/ymwGGh2Ho3#economy #markets @YahooFinance

— Mohamed A. El-Erian (@elerianm) August 3, 2023

“Domestically, this is likely to fuel more of the polarized conversations that are going on,” said El-Erian.

Meanwhile the downgrade, whether warranted or not, plays into the hands of rogue states like Russia that are trying to end the dollar’s hegemonic status in an attempt to weaken America.

“Internationally, for the adversaries of the U.S., they will point to that as yet another development in terms of the U.S. no longer being as powerful or influential,” the economist continued in his critique of Fitch’s move. 

Oddly enough, the decision to downgrade the U.S. is not unprecedented. In fact, Moody’s is now the lone holdout that still believes the United States federal government should retain its gold standard rating after Standard & Poor’s downgraded it by one notch in 2011. 

One reason why Fitch may struggle to be heard is that credit rating agencies in general have been on the back foot ever since they failed to see the global financial crisis coming. S&P viewed Lehman Brothers as investment grade suitable for pension funds all the way up to its 2008 bankruptcy. 

Worse, it emerged later that they had a financial incentive to not see it coming. Their most profitable business had been helping package opaque pools of high-risk debt. Through a kind of financial alchemy, rating agencies turned subprime mortgages and no-job, no-income “liar loans” into triple-A securities as safe on paper as U.S. government bonds in exchange for fees from Wall Street banks that sold these on to investors.

In his interview with Bloomberg TV, Francis attempted to assuage an alarmed market with perhaps his most unusual argument: that his downgrade was in fact not all that big of a deal.

“Double A plus is the second highest rating we have,” he offered. “We’re just saying we do not think the underlying fiscal story and the governance is compatible with triple A any more.”