NOTE: This post is part of an ongoing education series. This information is for educational purposes only. This information does not constitute investment advice. No rational person would make investment decisions based on a blog post. Please consult with your financial advisor before taking any action.
Standard & Poor's threatened Monday to downgrade the United States' prized AAA credit rating unless the Obama administration and Congress find a way to slash the yawning federal budget deficit within two years.
"Because the U.S. has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable," S&P said.
Almost everyone now accepts that the budget deficit is too large. The big problem is how does one bring it down? Cutting "small" $200 million programs like NPR and Planned Parenthood are not going to do it. Here are the five things that need to be done:
1) Get out of Iraq.
2) Close loopholes that allow companies to make billions in profit and pay $0 in taxes. (I'm talking to you GE!)
3) Tax increase on people making over $250,000 per year.
4) Get out of Afghanistan.
5) Start making serious adjustment to large parts of the budget.
The potential upside is that our government gets serious and makes some of these changes. However....
A downgrade, which would leave Germany and France with a higher rating, would erode the status of the United States as the world's most powerful economy and the dollar's role as the dominant global currency.
If investors start demanding higher returns for holding riskier U.S. debt, the rise in bond yields would crank up borrowing costs for consumers and businesses. That would threaten to hurt the economy as it recovers from the worst recession since World War II.
If this is not clear to you - it would be very bad. The US does have a lot of debt. It has not been a problem because the interest rate is very low. If the rate goes up - the problem get a whole lot worse.