The recent downgrade of United States’ sovereign credit rating from the highest level of AAA to AA+ by Fitch Ratings does not come as a surprise. The rating agency had warned the US government about an impending downgrade in May, placing the country rating under negative watch. But the downgrade helps to shine light once again on the reckless way in which the US is using its position as the issuer of the most used reserve currency to pile up enormous debt which threatens to jeopardise the global financial system.

One of the reasons cited by Fitch for the downgrade — erosion of governance in the US due to repeated stand-offs between political parties on increasing the debt limit — reflects the ad-hoc way the national debt of $32.5 trillion is being managed and the heightened risk being faced by the lenders. Of concern is that US treasury securities are held widely by most countries as part of their reserves. India’s holding of US treasury instruments amounts to $232 billion. The ratings report has flagged that US general government deficit will increase to 6.3 per cent of GDP in 2023 from 3.7 per cent in 2022 due to weakness in revenue collection, new spending initiatives and higher interest burden. Interest cost is expected to increase to 10 per cent of revenue and debt to GDP is expected to increase to 118.4 per cent by 2025. The official holdings of US treasury securities could be at risk if the US fiscal situation continues to push the limits.

The consequences of the US’ large debt are not limited to official reserves alone. The money printed by the US Federal Reserve to service its debt has inflated the prices of a bevy of asset classes with asset price bubbles being formed in many pockets including tech stocks, commodities, private cryptocurrencies and non-fungible tokens over the last 15 years. The nervousness caused in equity and debt markets after the Fitch rating downgrade reflects the fear of disruption if the repayment of US debt comes under a cloud. These concerns lead foreign portfolio investors to pull money out of riskier assets such as emerging market equity and debt, as witnessed this week.

The reason why the US continues to enjoy top ratings from Moody’s, Standard and Poor and Fitch, despite these fiscal slip-ups, is the high-income level in the country and the pole position of US dollar. As the report notes, “the US dollar is the world’s preeminent reserve currency, which gives the government extraordinary financing flexibility.” But if the US does not show the responsibility required of a country in this position, then it will lose this status eventually. This is already evident in the share of US dollar in global forex reserves declining from 71 per cent in 1999 to 59 per cent in 2023. Cross-border dollar credit, which had ballooned in the aftermath of the global financial crisis, is declining and countries are beginning to consider settlement of bilateral non-US trade in local currencies. The Americans need to heed these red flags.