Moody's Downgrades U.S. Credit Rating
Cites $36.2 Trillion Federal Debt
Annual Treasury Interest Payments Exceed Defense Budget
Market Shock Expected to Be Limited
Warning of Cracks in U.S. Treasuries' Risk-Free Status
Besant Dismisses as "Lagging Indicator"... Will Tax Cuts Be Stymied?
The backdrop to global credit rating agency Moody's decision to downgrade the United States' sovereign credit rating from the highest "Triple A" status for the first time in 108 years is the unsustainable federal government debt problem. This serves as a warning that the vicious cycle of chronic fiscal deficits?where government spending consistently exceeds tax revenue and the gap is filled by issuing government bonds?will no longer work. The U.S. debt structure has reached an abnormal level, to the point where the country must borrow again just to pay interest payments that exceed its annual defense budget.
On Wall Street, the prevailing view is that the shock will be limited, as these risks have already been exposed. However, with all three major credit rating agencies having stripped the U.S. of its top credit rating, there is a growing warning that U.S. Treasury bonds?long considered the world's safest asset?can no longer be regarded as "risk-free assets."
"Interest Payment Superpower" U.S.: Debt Rising Faster Than Growth
On May 16 (local time), Moody's downgraded the U.S. sovereign credit rating from "Aaa" to "Aa1," citing the rapidly increasing federal government debt and chronic fiscal deficits as the main reasons. According to data from the U.S. Treasury, Congressional Budget Office (CBO), and Peterson Foundation, current federal government debt stands at approximately $36.2 trillion (about 5,700 trillion won), a 59% surge from the pre-pandemic 2019 level of $22.7 trillion. The debt-to-GDP ratio has also soared from 107% to 123% (as of last year) during the same period. While U.S. GDP has grown at an average annual rate of around 2%, debt has ballooned at a much faster pace of about 10% per year.
This surge in debt is rooted in structural fiscal deficits. Mandatory spending on social security and healthcare services has increased, and massive monetary stimulus during the COVID-19 pandemic further worsened fiscal soundness. The U.S. Congress has repeatedly raised the "debt ceiling," which limits the federal government's borrowing, to avoid default or a so-called national bankruptcy. The enormous interest payments automatically generated by this massive debt are also a serious problem. For the 2024 fiscal year, federal government interest expenses reached about $949 billion (about 1,330 trillion won), surpassing defense spending ($826 billion) for the first time in history and accounting for 14% of the federal budget. Since these interest payments provide no tangible benefit to Americans and are incurred annually as a fixed cost, they are considered the most inefficient budget item.
The fiscal outlook going forward is even bleaker. Moody's projects that the federal deficit-to-GDP ratio will rise from 6.4% in 2024 to 9% in 2035, and the debt-to-GDP ratio will surge from 98% to 134% over the same period. In addition, experts predict that fiscal deficits will worsen further as President Donald Trump pursues income and corporate tax cuts. President Trump argues that tariff hikes can offset the resulting revenue shortfall, but critics point out that tariffs account for only 2% of total tax revenue, making this claim unrealistic.
Limited Market Shock Expected... Warning of Cracks in U.S. Treasuries' Risk-Free Asset Status
Regarding Moody's downgrade of the U.S. credit rating, most on Wall Street believe the market shock will be limited because the federal debt problem is already a known risk. Kim Forrest, Chief Investment Officer (CIO) at Bokeh Capital Partners, said, "Bond investors are already aware of the debt problem," and predicted that the rating downgrade would have little market impact. Previously, Fitch downgraded the U.S. credit rating by one notch from the top level in 2023, and Standard & Poor's (S&P) did the same in 2011.
However, there are warnings that, combined with President Trump's tariff policy, this move could trigger selling of U.S. Treasuries and even undermine the "risk-free asset" status of dollar-denominated assets. In theory, a downgrade of the U.S. sovereign credit rating increases the risk of default, forcing investors to demand higher yields on U.S. Treasuries.
Max Gokhman, Vice President and CIO at Franklin Templeton, warned, "The (tax cut) plans currently being discussed in Congress will further accelerate the fiscal deficit," adding, "As investors gradually shift from Treasuries to other safe assets, this will lead to a decline in Treasury prices, further depreciation of the dollar, and reduced attractiveness of U.S. stocks." Yesha Yadav, professor at Vanderbilt Law School, said, "To maintain its status as a fundamentally risk-free asset, the U.S. must heed Moody's warning and policymakers must urgently pursue fundamental reforms."
China, once the largest holder of U.S. Treasuries, continues to sell off its holdings. According to the U.S. Treasury, China's holdings of U.S. Treasuries stood at $765.4 billion as of March, down $18.9 billion from the previous month. Until February this year, China was the second-largest holder, but as it reduced its share of dollar assets, it dropped to third place behind Japan ($1.1308 trillion) and the United Kingdom ($779.3 billion). Analysts suggest that this is both a strategic move to pressure the U.S. ahead of the U.S.-China tariff war and a reflection of declining confidence in the U.S. economy, which is weighed down by chronic fiscal deficits and debt, given that China has been consistently selling U.S. Treasuries for several years.
Besant Dismisses as "Lagging Indicator"... Will Trump's Tax Cuts Be Stymied?
The Trump administration has blamed the latest credit downgrade on former President Joe Biden's administration. U.S. Treasury Secretary Scott Besant said in an interview with NBC News on May 18 that "Moody's action is a lagging indicator," and argued that the move was related to spending policies such as climate change response and expanded healthcare coverage under the Biden administration. He stated, "The most important metric is the debt-to-GDP ratio," and added, "If we grow GDP faster than the debt increases, the debt-to-GDP ratio will stabilize." He also pledged to address the debt problem by reducing government spending and promoting economic growth.
Some observers predict that if the downgrade leads to turmoil in financial markets, such as rising Treasury yields, it could put the brakes on President Trump's tax cut policies. In fact, after hardline Republicans voted down the tax cut bill in the House Budget Committee on May 16 (16 in favor, 21 against), the Moody's downgrade has further increased the political burden on President Trump in pushing forward his tax cut agenda.
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