I don’t understand the role of Fitch on a global scale. I’ve never previously heard of the US or other countries having a credit rating. How does Fitch “have power” over the credit rating of entire countries.
In: 21
It’s not so much that they have power as it is that they have influence.
First of all lets talk about the relationship between risk and interest rate. When one person lends another person money they charge interest. The riskier they think that lending is, the higher interest rate they need to charge in order to make it worth wile.
For example. 2 people want to borrow money from me. The first is my brother, he’s always been unreliable and kind of a dick head. He’s my parents favorite despite this and as a result they’ve never really taught him proper responsibility. He’s a flake and while he’s mostly a good guy there’s a 20% chance that he fails to pay me back.
The second person is my sister. She’s very reliable and true to her word. If I lend her money, there’s only a 1% chance she won’t pay it back.
Both Brother and Sister want to borrow $100 and I’ve got to charge them interest. I don’t want to make a big profit off this since they’re family but I want to cover my own risk.
I figure there’s a 1 in 100 chance my sister fails to pay me back. So if I loan her $100 on 100 occasions, I’ll lose $100 one of those times. This means that in the other 99 loans I’ll need to make $100 unorder to offset that loss. So that’s an interest rate of like 1.0101% If I charge her that on the 99 loans she pays back, I’ll make enough to offset the 1 time she dosent. Now, she’s only asking for 1 loan, but the same basic idea applies. The interest rate I charge must include enough profit to offset the risk of non-payment, plus a little profit for me (that part I’m skipping because she’s my sister).
My brother on the other hand will fail to pay me back 1 in 5 times. So If I make him 5 loans for $100, I’ll need to make $100 in interest on 4 of those loans in order to offset the $100 he’s going to fail to repay on the 5th. That’s a 25% interest rate for dear old brother.
So my Good Sister gets an interest rate of 1.01% while my nasty brother gets an interest rate of 25%. All because he’s a higher risk than she is.
Now back to your question. The US borrows a lot of money, and the people it borrows money from often wonder what interest rate they should be charging. They seek the advice of a company that does lots of risk analysis and that company is known as a credit rating agency.
The credit agency had previously concluded that the USA is 99.99% likely to pay its debts, therefore it gets the best “tipple A” rating. But the recent debt shenanigans that congress has pulled, it’s upset the credit rating agency. Now they think it’s not a 99.99% chance, it’s just a 99% chance. Still very likely, but a far ways from 99.99%. That’s what a downgrade to AA+ means, that the us is more likely not to repay it’s debt.
That likelihood change means an interest rate change. People out there that lend the USA money are going to want a higher profit because they are taking a higher risk. This means that the US interest payments will go up even when their total debt has not gone up and that means that interest payments become a higher percentage of the total government spend.
Not, a change from AAA to AA+ is actually really small, but if congress keeps fucking around on debt repayment the credit rating change could become a lot larger, and therefore the US interest payments could become a lot more money.
Latest Answers