The Fitch downgrade has been treated with derision in some quarters. But in the cold light of day, it was justified. In truth, it could have come a lot sooner. Under reasonable assumptions, the public sector debt burden in the US remains on an unsustainable trajectory. Entitlement spending will grow as the population ages. Debt interest payments will take up a larger share of revenues. Fiscal hawks have little influence these days. There is very little political will, from either Republicans or Democrats, to address the key fiscal challenges facing the US.
The deteriorating fiscal positions of the US and the UK, increasingly resemble self-fulfilling cycles, whereby higher deficits push up borrowing costs, which in turn increase deficits, and so on. The secular decline in real interest rates embedded the idea that r will never exceed g. But this may not always be the case. Perpetual deficits eventually increase the risks that r rises above g. This then has implications for equity risk premiums, and stock market valuations.
Since the turn of the century, governments have repeatedly stepped in as ‘insurers of last resort’. The emphatic response to the pandemic marked the apogee of macroeconomic demand management. If economies can deal with a fallout on the scale of a pandemic, there is no crisis, it would seem, that cannot be tackled. But risk cannot be fully eliminated from market economies. It simply gets transferred, from the private sphere to the state. This should imply a higher cost of borrowing for the government.
