U.S. must heed S&P warning

Standard & Poor’s revised its outlook on U.S. sovereign debt to negative from stable, warning the world’s largest economy that it could lose its Triple AAA rating in the next two years if it does not fix the federal deficit and debt problem. S&P is skeptical that the country will be able to come to grips over its colossal fiscal deficit and government debt in near future.

A downgrade from its current Triple AAA rating, the highest, could result in higher interest rates higher and more expensive loans, while plunging the economy into a further mess. Such consequences would not only affect its own economy but cause ripples through global markets.

The U.S. government has been using up its ammunition to contain the financial meltdown from two years ago. It veered away from a major depression but is now fighting the backlash from its debt-financed stimulus measures. The government is expected to run a record $1.5 trillion deficit this year and is trying desperately to cajole Congress to raise the nation’s debt ceiling of $14.3 trillion in order to pay its bills and avoid defaulting on its debt.

Record low interest rates and quantitative easing are also side effects. A weaker dollar has fanned inflationary pressure around the globe, and dollars are flowing into emerging markets. The unprecedented revision of its outlook on U.S. creditworthiness by S&P should serve as a wake-up call on the health of the economy.

It remains doubtful the political impasse over fixing the federal deficit will be resolved soon. Washington is poles apart when it comes to addressing debt and the deficit. Without a breakthrough, the country is in danger of a European-style credit crisis.

The U.S. has for decades enjoyed the benefits of being the issuer of the world’s largest circulating currency. The dollar’s status made U.S. Treasuries the safest investment despite the weight of the country’s mushrooming debt. The confidence from having the world’s currency has led the U.S. to discount the latest warning from the ratings agency.

Washington dismissed the S&P action as a political judgment. But the current expansionary fiscal and monetary policy is a poor recipe for the troubled U.S. economy and can be fatal. Fiscal austerity and gradual interest rate hikes would be inevitable. The U.S. must pay heed to the S&P warning and not rely on its dollar status alone. It can’t bet on always finding buyers for its Treasuries. Asian central banks are already nervous about holding them.