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May 20, 2025

Moody’s Downgrade: Minor Event but Useful Reminder

The American economy is not only the largest in the world, it is also the most innovative and dynamic. The country’s physical resources, intellectual capital and financial wealth are powerful competitive advantages.

The U.S. represents only 4% of the global population, yet American stocks represent about 64% of the total value of all stocks in the world (based on the MSCI ACWI Index, which encompasses 23 developed market and 24 emerging market countries).

This proportion has actually grown in recent years, thanks largely to U.S. dominance in technology.

A decade ago, the U.S represented less than 52% of global market cap. There were only two tech stocks among the MSCI ACWI top 10 holdings: Apple (AAPL) and Microsoft (MSFT).

Now, nine of the top 10 most highly valued stocks within the global index are U.S. tech or tech platform companies. The tenth ranked stock is U.S. health care company Eli Lilly (ELY).

Unfortunately, the U.S. federal government’s fiscal situation is a much less impressive story.

Like a rock star or professional athlete who has earned millions of dollars yet somehow found his way to personal bankruptcy, our government’s finances have been badly mismanaged.

Last Friday afternoon, Moody’s became the last of the three major credit rating agencies to downgrade the United States from top-tier status. Standard & Poors and Fitch had previously downgraded the U.S. in 2011 and 2023 respectively.

The U.S. fiscal situation is a problem that has been decades in the making. There are solutions—but these require political will and a degree of political coordination that may never materialize.

The key risk, in our view, is not that the U.S. will default on its debt obligations, in the sense of not making bond payments. The key risk is monetary debasement.

The U.S. will in all likelihood continue to pay its bills… but this will require a lot of additional money printing by the Federal Reserve along the way to make the math work.

The best way for investors to address this risk is through ownership of assets that can survive—if not benefit from—such a scenario.

Why Moody’s moved

The concerns that Moody’s expressed are nothing new.

We have been writing about this topic for some time, including just over a year ago after the Congressional Budget Office (CBO) forecasted unsustainable future debt (What If We Don’t Fix Entitlements?).

The core problem is simple. The U.S. government is spending too much money relative to how much it collects.

Running persistent deficits is not inherently dangerous. As long as there is real economic growth, a government can actually run small deficits (typically low single digit percentage of GDP) without creating an unsustainable dynamic.

But we are well past that point, as Moody’s notes. The fiscal deficit was 6.4% of GDP in 2024. Moody’s anticipates that it will rise to “nearly 9%” by 2035.

Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs…. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government's debt and interest burden higher. - Moody’s (5/16/2025)

Debt spiral math

A government runs a fiscal deficit when it spends more than it takes in over the course of the year. The difference must be borrowed, so that deficit then gets added to the total amount of debt.

As the debt level rises, it becomes more expensive to service the debt.

As Moody’s explained, in 2021, interest payments only represented 9% of tax revenue. Interest payments as a percentage of tax receipts then rose to approximately 18% in 2024.

By 2035, Moody’s currently anticipates interest payments will get as high as 30% of tax revenue.

The problem is exacerbated by rising interest rates, which are linked to rising debt levels. Back in 2021, long-term interest rates were below 2%.

In part because the U.S. fiscal situation has deteriorated, yields on 10-year Treasuries are now closer to 4.5%, around the highest levels since the Global Financial Crisis of 2008.

10 Year Treasury Yields

(Last 10 Years)

Just as a consumer with growing credit card balances faces escalating interest rates, further deterioration in the U.S. fiscal situation should put more upward pressure on rates.

More debt means more capital is needed to refinance bonds as they mature. Meanwhile, the perceived ability of the government to repay investors is weakened.

Investors will therefore need to see higher interest rates as an inducement to buy U.S. government bonds. Higher rates are needed to compensate them for the increased risk of not getting paid back or, more realistically, getting paid back with dollars that have less real value.

Real rates versus real growth

The debt spiral dynamic starts to happen when real interest rates (interest rates above and beyond inflation rates) exceed real economic growth rates.

If real rates are higher than real growth rates, then debt rises faster than the economy. This is when the concept of fiscal dominance comes into play.

Fiscal dominance is the predicament in which fiscal challenges dominate the decision-making of the central bank. In fiscal dominance, the Federal Reserve will need to hold down nominal interest rates just so the U.S. can manage through its debt load.

Technical phrases like financial repression, quantitative easing and yield curve control also describe this economic scenario.

While the mechanics behind these strategies may vary, the main thrust is that the Fed will be printing money to buy the bonds of the U.S. government to make sure interest rates do not get too high.

Because the U.S. prints its own money, it will (most likely) never default on its obligations. But the U.S. can engage in debt monetization to prevent a scenario where nominal interest rates rise to levels that will swallow all tax revenues.

Potential solutions

The Trump administration came into this problem with eyes wide open. Treasury Secretary Scott Bessent is particularly motivated to get the country back on solid footing.

We described his strategy shortly after the election in The Next Treasury Secretary’s Plan to Secure America’s Future.

His objective is to try to steer the country back towards deficits that are 3% of GDP—a level that aligns with his 3% target for long-term economic growth. This would in theory put the U.S. back on a sustainable trajectory.

Trish Addresses Moody’s Downgrade

The administration has also discussed various creative options to bring down our deficits and total indebtedness. These include strategies to unlock the “asset side” of the U.S. government balance sheet.

Among the options that have been discussed and will likely be pursued are monetizing some of the vast federal land holdings, selling concessions for energy and other natural resources, and even offering citizenship programs for high net worth foreigners (“gold cards”).

Uphill battle

The Trump administration will do its best to work with Congress to restrain spending and generate economic growth, which should help drive tax revenues. But it also wants to cut tax rates in various areas, which reduces tax receipts.

Entitlements like Medicare and Social Security are another problem altogether.

These entitlement programs are the primary driver of long-term debt forecasts, largely because of demographic trends. Baby boomers are in the process of retiring, which means these workers are transitioning from contributors into these programs to recipients.

Entitlements are an extremely difficult matter to tackle politically.

Programs like Social Security and Medicare are top priorities for older voters, who have a greater propensity to vote versus younger voters. Any proposed adjustments at all to these programs raises alarm bells within this key constituency.

There is limited political momentum behind entitlement reform at the moment, which contributed to the Moody’s downgrade.

Portfolio positioning

Reaction to the Moody’s downgrade was muted. Stocks opened lower on Monday, the first trading day since the news broke, but closed basically flat on the day. Gold and Bitcoin did show some strength and traded up marginally from Friday levels.

The Moody’s rating drop brings the rating into alignment with the other two agencies and does not appear to have any direct impact on investor behavior. To a large extent, it simply reflects what the market already knows: the U.S. is now a fiscal mess.

It is hard not to share in Moody’s skepticism when it comes to the U.S. government bringing its fiscal house in order.

We have more confidence in the U.S. private sector, however. As the pandemic experience showed us, corporate earnings and asset prices are able to keep pace with growth in the money supply.

The losers in a debt monetization scenario tend to be individuals whose savings are largely comprised of money in the bank or some form of government bonds.

The winners tend to be households with exposure to real assets like ownership of business (stocks), commodities, or real estate.

As hard money alternatives, gold and Bitcoin are natural homes for investors concerned about long-term fiat currency debasement. Both are now trading just below all-time highs and should continue to see strong demand.

The Moody’s downgrade may have had limited market impact but should be viewed as a reminder: America’s long-term fiscal problems are not going away.

The path of least resistance is for America’s fiscal problems to get papered over through monetary policy in the years and decades ahead. Investors who want to preserve and grow their wealth should prioritize investments that will tend to appreciate as the money supply expands.

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