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In U.K. Downgrade, a Warning for America

Danielle Kurtzleben

Moody's has downgraded the Brits' credit rating. Here's why America should take note

Credit-rating agency Moody's downgraded the U.K. on Friday, cutting it from its coveted Aaa status to Aa1. The reason? A slow economic recovery and high debt levels.

Across the pond, those problems sound awfully familiar. And lawmakers should take note if they want the United State to avoid yet another downgrade of its own.

"Of course the U.S. could get downgraded again," writes Nigel Gault, chief U.S. economist at IHS Global Insight, in an e-mail to U.S. News. "If the ratings agencies lose confidence in the government's ability to stabilize the ratio of debt to GDP, they will downgrade the U.S. again."

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Another downgrade could be very bad news for the United States. When major rating agencies like Moody's, Standard & Poor's, and Fitch change their official ratings of a country's trustworthiness, people take notice. Designating a country's debt as risky could push interest rates up on debt, making it more expensive for the federal government to borrow. It would also make borrowing costs higher for American consumers, on everything from homes to business loans. Borrowing is exactly what the Federal Reserve has been trying to encourage with its recent policies, which would make a downgrade a potentially major setback. S&P gave the United States its first downgrade, in August 2011, after that summer's debt ceiling fight.

Higher interest payments on America's sovereign debt would also mean an even tougher time bringing the nation's fiscal house into order.

It's true that prospects look good for stabilizing the nation's debt-to-GDP ratio: under current law, the Congressional Budget Office projects that debt-to-GDP will remain in the mid-to-upper 70 percent range for the next decade.

However, those are the highest levels since immediately after World War II. And as Moody's noted in a January note, debt would have to be put on a downward trajectory "to support the government's creditworthiness."

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Then there's the continued uncertainty of a permanently deadlocked Congress with a nasty habit of only making new fiscal policy at the 11th hour--and even then, often choosing to kick the can down the road, setting up yet more last-minute decisions. Given the coming sequestration cuts, plus uncertainty over continuing to fund the government and raising the debt ceiling, plenty more political fights over government spending are lined up for the first half of this year.

The fights themselves, not just their outcomes, could threaten the economy. Political brinksmanship was a key reason the country suffered its first major downgrade, when Congress' failure to come to a deal on budget policy threatened a national default. At the time, the agency characterized American governance as "less stable, less effective, and less predictable than what we previously believed."

Now, other agencies are willing to follow suit. In addition to Moody's' warning earlier this year, Fitch warned in January that it would put the U.S. rating under review if there was a repeat of the debt ceiling crisis. That could easily happen, given that the federal government will approach its borrowing limit in May.

Still, Gault notes that it matters more what markets think than a credit rating agency. Proof of that came after the 2011 downgrade, when the market for U.S. Treasuries remained unrattled--meaning that investors continued buying U.S. debt, despite the warning.

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But there's no guarantee that the same thing will happen again. According to one analyst, another downgrade could trigger a blow to the U.S. economy.

"I think the second downgrade is more important than the first," says Jason Pride, director of investment strategy at investment firm Glenmede. While he doesn't think the likelihood of the United States paying its debts has lessened, he does think investors could be spooked if two of the three rating agencies, rather than one, give the U.S. a less-than-perfect rating.

The message for lawmakers from the U.K. appears simple: get the debt under control, but don't derail the economy. But within that deceptively simple message is a complex economic challenge.

"In the U.K., part of the reason for their downgrade is they've gone through with austerity, they've tried bringing debt levels down, but now they have a shrinking economy," says Pride. "That's the fine line we have to skirt in the U.S.: we have to maintain economic growth, and we have to show fiscal discipline at the same time."

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