Like many Americans, I’m wondering how a U.S. credit downgrade would impact me personally. The drop from AAA to AA rating will force the government to pay higher interest on its debt, but what will be the consequences to hard-working Americans? From my financial experience both professionally and privately, here is the impact I foresee to my credit card debts, mortgage, taxes, savings and cost of living resulting from a U.S. credit downgrade.
1) Higher Interest Rates on Loans
A downgrade in the U.S. credit rating will make the U.S. less attractive to investors. The government will have to pay more for borrowing money, and the Federal Reserve will likely charge banks more for the money it lends them. Like a snowball effect, interest rates will rise throughout the economy. The standard APR on my credit cards will go up as will the interest on future loans, such as payday loans for unemployed borrowers, car loans, adjustable rate mortgages, student loans or personal loans. This will affect the economy as a whole as people spend less and companies borrow less for the purpose of growing their business.
2) Higher Interest Rates on Mortgages
Now that our son left for college, my husband and I want to exchange our home for a smaller one. But with over 11% of U.S. homes empty and 25% of U.S. mortgages underwater, selling a home and getting a new mortgage is difficult. A downgrade in the U.S. credit rating will only make matters worse. As the U.S. government will offer higher yields on its 30-year bonds (due to a lower credit rating), mortgages will have to offer equally higher returns to attract investors. This will mean higher interest rates on mortgages for new home purchases or refinancing of existing ones.
3) Higher Federal Taxes
Currently, the U.S. government is borrowing $0.41 of every $1 it spends. In 2011 the interest on these loans totaled $386 Billion. A downgrade in the U.S. credit rating will force the Federal Reserve to increase the yield on long term U.S. treasury bonds because higher returns will attract buyers despite the higher risk attributed by the lower credit rating. To pay for this, the U.S. government will need higher revenues, which in the past typically led to higher taxes.
4) Higher Local Taxes
With the downgrade in the U.S. credit rating, municipal bonds of nearly 7,000 U.S. cities will also be downgraded. As a result, many major U.S. cities will find it more expensive to borrow money. To meet their fiscal obligations, they are likely to turn to higher taxes. In the Seattle area where I live, the local government is planning to increase revenue by implementing tolls on all major highways, increasing parking fees and adding traffic patrolling cameras for the purpose of issuing tickets automatically.
After twice infusing the economy by printing more money, the Federal Reserve has signaled its intention to proceed with QE3. The U.S. credit downgrade will increase the government’s need to raise money, which quantitative easing makes readily available. But adding the number of notes circulated in the economy decreases the value of the dollar. Food and gas prices are rising, while the income of many Americans remains the same or is cut through unemployment or the inability to find a comparable job to the one they lost. When living without jobs, more and more people are likely to turn to loans for unemployed. Inflation is raising the cost of living and decreasing the quality of life for many of us.
6) Higher U.S. Production Costs
As the U.S. credit rating downgrade weakens the dollar, the price of commodities is likely to go up. This will not only mean higher prices at the pump for working families but higher production costs for U.S. manufacturer’s, who will be forced to pay more for raw materials. This will increase the cost of their products above and beyond the higher costs already imposed by inflation. Buying American will become a lot more expensive.
7) Higher Costs of Imported Goods
A former colleague of mine who manufactures goods in China is experiencing a drastic rise in his overseas production costs due to the loss in purchasing power of the U.S. currency. As a result, he is forced to raise the retail sale price of his imported goods. A downgrade in the U.S. credit rating is likely to weaken the dollar further and increase the relative cost of imported goods even more. Every American family will be affected, even when buying Made-in-America goods because often raw materials are imported.
8) Uncertainty in Long Term Savings
I have already emptied my savings account because the 2% return could not compete with the 3.6% rate of inflation. Many of my colleagues and friends have pulled their money out of CDs and low yield savings accounts. The U.S. credit downgrade will decrease the safety factor associated with long term U.S. Treasury bonds, making it more difficult for investors to find a safe haven for their money.