UK Debt Trouble Moves Soveign Borrowing Problem Closer To US

No one in the US worried much when S&P downgraded the sovereign debt of The Ukraine or the Republic of Kazakhstan. Now, the trouble has moved much closer to home as the credit agency lowered its credit rating outlook for the UK from “stable” to “negative.” The agency is concerned about the increase in government debt and decrease in GDP. The action may make it more difficult for the British government to raise money or, alternatively, it may force the country to pay higher interest rates.

The UK’s problem brings the trouble of rising deficits and falling GDP and tax collections closer to the US. The largest purchaser of American Treasuries, China, has already voiced concern about the profligacy of spending that is part of the plan to pull the US out of a deep recession. If China cuts back its purchases of Treasuries, even a bit, interest rates on paper issued in the future could move up substantially.

The US faces two problems and they each compound the government deficit troubles. The IRS is collected much less than the current federal budget forecasts as individual and business taxpayers experience drops in their incomes. On the spending side of the ledger, the costs of stimulating the economy and bailing out businesses from car companies to GMAC rises each week.

There is a small market in credit default swaps for US debt. The fact that there is one at all should be troubling to the Treasury and the Fed. While the chances of American defaulting on any portion of its debt are small, if the recession drags on the odds that the government will have trouble raising money to finance the deficit will rise. To keep its credit rating, the American government will be faced with curtailing many of its stimulus programs or sharply raising the tax burden.  Either action could slow any recovery making a burgeoning deficit a “Catch 22” in which no alternative is acceptable.

The US plans to auction off hundreds of billions of dollars in Treasuries between now and the end of the year. The level of interest that will be paid on this paper will be a litmus test of the market’s appetite for debt in the country that has the largest GDP in the world but is well on its way to owing a record sum to its creditors.

Douglas A. McIntyre