Fitch recently downgraded the credit of the U.S., sparking controversy.
The recent Fitch credit ratings downgrade of the U.S., from AAA to AA+, citing erosion of governance, Federal Reserve tightening and rising government deficits, has raised questions regarding the bizarre timing of the downgrade. While markets have taken a small hit, some view the move as only symbolic. But, with the upcoming BRICS meeting on the horizon, it is essential to explore how this downgrade timing might be a warning sign for the status of the U.S. dollar as the world’s dominant reserve currency.
Fitch’s decision to downgrade the U.S. credit rating was driven by the ongoing political stalemates over the debt ceiling, eroding confidence in the country’s ability to manage its debt responsibly. This move echoes S&P’s U.S. credit downgrade in 2011, where the nation’s credit rating was lowered from AAA to AA+. Back then, S&P attributed the downgrade to “political brinksmanship” and its impact on federal policymaking effectiveness and predictability.
The recent credit downgrade serves as a wakeup call reminding us of the risks that manufacturers, distributors and retailers around the world are facing.
As borrowing costs increase, American companies may reduce their investments and capacity expansions, which can disrupt production and distribution. One concern is how interconnected global supply chains are. Even stable companies need to be cautious about the viability of entities when it becomes expensive or even impossible for them to obtain capital. With access to credit and interest rates small businesses face significantly higher capital costs negatively impacting their financial performance and hindering job growth.
In the past, U.S. Treasury bonds were considered an investment option that attracted investors from around the world and contributed to the dominance of the dollar as a reserve currency. However, this downgrade might cause investors to reassess their positions and diversify their portfolios away from U.S. Assets. A Wall Street Journal report indicates that overseas investors are already buying fewer homes in the U.S., possibly due to the strong dollar and near-record high housing prices. This could potentially lead to capital outflows and a decrease in demand for dollars at a time when the U.S. national debt approaches $33 trillion.
The U.S. dollar’s hegemonic status as the primary global reserve currency has been a cornerstone of the international monetary system.
It provides the U.S. with unique economic advantages, including lower borrowing costs and increased economic influence but the increase in U.S. debt issuance is likely to be met with structurally higher yields, leading to concerns about dollar depreciation.
The timing of the U.S. downgrade is significant, considering the upcoming BRICS (Brazil, Russia, India, China, South Africa) meeting in Johannesburg, SA, August 22-24th, 2023. As the BRICS nations continue to grow and assert their influence on the global stage, discussions about diversifying their foreign reserves and reducing reliance on the dollar are on the agenda. The downgrade could provide further impetus for these nations to strengthen their economic ties and promote the use of their own currencies in international trade, potentially challenging the dollar’s hegemony in the long term.
The recent credit downgrade serves as a warning sign, reminding us of the potential consequences of prolonged fiscal instability and political standoffs.
The downgrade can have far-reaching implications, as BRICS nations prepare to meet, discussions around diversification of reserves and the pursuit of alternative reserve currencies may gain traction. To mitigate the potential fallout, policymakers and market participants must work towards restoring fiscal stability and confidence in the U.S. economy.
