How a Government Credit downgrade affects services

There is currently little awareness, or interest,  if and how a Government credit downgrade affects all services that the Government can provide.

In both the short and long term, a Government credit downgrade has a significant affect on the services Government can offer to society, mainly in a reduction of those services.    One need only look at Greece to see the nightmarish affects of many downgrades in credit, to the point where Government issued bonds going into junk status.

When the Government suffers a down grade in it’s credit rating,  it may be foreced to offer a higher rate of interest on the securities it issues to attract capital investors.   Currently, the Government pays approximately 12% of the revenues it takes in to investors through the Government Treasury bonds it has issued.    This means that the Government is now using approximately $300 billion per year to pay interest owed.   The public receives no benefit from this money.   It is, in essence, completely wasted money.  If there is another credit downgrade, or several downgrades, it may force the Government to pay a higher rate of interest on the same Treasury bonds to attract the same investors.

If an extra 1% in interest is paid, this is very significant because it is likely to be a permanent increase rather than a temporary or fluctuating  increase.    In order for the interest payment on bonds to go down, the credit rating issued by Moody’s and Standard and Poor’s would have to be upgraded.    Considering the Government’s large and consistent budget deficits, this scenario is unlikely, especially in the short term.    The extra 1% paid in  interest will represent approximately $10 billion dollars per year, each year, ongoing for those Treasuries issue in that 1 year.   If this is done each year, with a budget deficit of $1 trillion, this is approximately and extra $10 billion every year, on top of the previous year’s trillion.

So how does this affect or decrease services?

This is money that the Government cannot now use, that is previously did use, to fund any services or benefits, including Medicare, Social Security, Education, Military, Highway, unemployment, job training, or any other areas of the budget.   Every year that the Government says it has to reduce the benefits to Medicare and Social Security because of limited funds, those funds that are now being paid in interest could have been used to fund these programs, rather than cut them.    A future post will focus specifically on the dollar amounts per year.

If more credit downgrades force the Government to raise interest rates

Ensuing is an instruction review of whether further credit downgrades will force the Government to significantly raise interest rates, and other consequences.

If there is another, or more than one credit downgrade by Moody’s and Standard and Poors in the next year or two, there is an elevated risk investors of Government treasuries will demand higher interest rates.   If this very real prospect occurs, the consequences are enormous.

Once higher rates are demanded, the government will be forced to spend a greater percentage of it’s revenues on interest, causing it to spend less on other normal budget items.    Further, the longer the government continues to deficit spend at this point, the percent the government spends on interest on debt will accelerate more quickly.

There will be much greater pressure at this point to reduce deficit spending because of higher rates.   In order to accomplish lower spending, Government will be under intense pressure to cut spending.

The problem at this point is that due to the size of the deficit, spending cuts will not be enough & if the government even attempted to solve the problem with spending cuts,  the cuts would be so massive, they would likely cause a severe recession.    Therefore, significant revenue increases would have to occur.

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