Moody’s (NYSE:MCO) made comments about its ratings on US and UK sovereign debt that were meant to calm the markets. Early in the week the credit agency said that one or both countries could lose their “Triple A” ratings if the increase in their national debts began to tax their abilities to raise money in the global capital markets at reasonable interest rates.

The new Moody’s view is that, “The rise in debt and higher interest costs could test the ratings under some scenarios, but not right away.”

Simply stated, the US could face a downgrade of its rating if national deficits grow and the Treasury has to become more aggressive in its efforts to raise money to fund the American debt. It is easy to see how that might happen.

The economic recovery looks like it will continue in the early part of 2010, but then it begins to hit “headwinds.” The first of these is that unemployment will stay high. The federal government will need to spend money on jobs programs. At the same time, the consumer tax base will continue to erode as more people lose wages for longer periods of time. The number of jobs available for each out-of-work person is still falling.

The global capital markets do not have an infinite capacity to finance debt. A number of sovereign nations will continue to borrow to fund their rising deficits. Countries like Dubai may have to go back  market to refinance debt that cannot be repaid under current circumstances. Increases in corporate borrowing driven by rising equities markets that improve stock values and make issuing debt easier also reduces the capacity of the global pool of money available to purchase debt.

The Moody’s theory about how the US could lose its “Triple A” rating becomes more worrisome by the day as the likelihood that the Treasury will have to increase borrowing rapidly becomes more likely.

Douglas A McIntyre

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