How the US Could Lose Its AAA

03/15/2010 4:08 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

The good news, according to Moody’s, is that the US government will spend about 7% of its total revenue in 2010 servicing the huge US debt. That will rise to 11% of total revenue in 2013.

That’s the good news?

Well, sure.

Moody’s, one of the three major debt rating companies in the United States, says that if the economy grows 0.5 percentage points more slowly than its baseline forecast of moderate growth, if the government doesn’t cut spending as much as it now thinks is likely, and if interest rates climb faster than expected, US spending on debt service (that’s the interest the government pays on its debt) could climb to 15% of government revenue. (Moody’s is also worried about the United Kingdom. For more on that front in the global sovereign debt crisis, see this related post.)

And that would be bad news indeed because it would probably cost the US its AAA credit rating. And that would push US interest rates yet higher and economic growth lower.

Here’s how Moody’s will do the math to determine if the US should lose its AAA rating.

If an AAA-rated country spends more than 10% of its revenue on servicing its debt, Moody’s doesn’t downgrade it immediately. The country gets a bit of time to get its fiscal act together. That time amounts to what Moody’s calls a “debt reversibility band.” The size of that band depends on Moody’s assessment of how willing and likely a country is to reduce the size of its debt. For the United States, Moody’s has set a four-percentage-point band.

Which is why the possibility that lower growth, fewer spending cuts, and higher interest rates could push debt service to about 15% of total revenue is so scary.

Last time I did the math, 15% was more than 10% plus 4%. And that would probably earn the US a downgrade from AAA.

The US doesn’t have to start cutting spending immediately. That’s fortunate, because immediate spending cuts could stall this still very fragile recovery.

But the window isn’t very large—less than three years—and it gets narrower every day.

Full disclosure: I don’t own shares of any company mentioned in this post.

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