United States in a division with Italy

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At first glance, America and Italy have little in common. However, in one respect, they are very similar.

At least that’s how the rating agencies see it. Italy lost its AAA rating as it defaulted on US-like debt. No wonder, then, that many American politicians and investment banks were duped after the downgrade. Unlike Italy, America has some advantages.

For one thing, America has an economic advantage. This results not only from better demographic conditions but also from greater competitiveness and innovative strength. Unlike Italy, which does not have its own currency alongside the Euro, the USA has the dollar, which is still the undisputed number 1 reserve currency. Last but not least, America has a central bank that can print money in an emergency. Italy can only do this in harmony with the entire euro system.

So it is significant that rating agencies treat the US like Italy. This says a lot about how rating agencies assess the state of government finances and the quality of policies. Personally, I sympathize with Fitz’s decision. Despite high inflation and high nominal economic growth, the US has been unable to reduce the debt built up by the pandemic. The entire economy, including the state, has succeeded in doing this (Figure 1).

Even in the best of times, if debt cannot be managed with the support of high inflation, something is wrong. Henceforth, the debt should not decline from the high of 2020, but should rise again. According to projections by the Congressional Budget Office (CBO), annual deficits will never be less than 5% of economic output.

CBO’s projections are always over-optimistic. In 2009, 57% debt was expected by 2022. Actually it was 95%. In 2015, a value of 75% was expected by 2022. It was 20 percentage points too low (Figure 2). Long-term, CBO underestimates the annual deficit by 2.35 percentage points.

Taking this systematic error into account, a new long-term forecast results (Figure 3). Portugal’s current level of debt will increase within the next five years. Italy will be overtaken in 10 to 15 years, and after ten years even Greece’s debt will only be visible in the rearview mirror.

With politicians showing no signs of spending discipline and the current administration exploring whether to suspend the debt ceiling without Congress, expect all dams to break soon on fiscal policy. If these trends continue, not only the AAA rating will decline, but the A rating in general.