S&P Ratings: Why the U.S. Government Is Still Rated AAA

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) and that both countries will endure a period of subpar growth as the private sector deleverages.

Still, we believe that the fiscal outturn in the U.S. will be somewhat better than that in the U.K. because of what we view as the greater diversity and, consequently, resiliency of its economy. We expect that the U.S.'s net general government debt will rise to about 90% of GDP by 2013; we expect that of the U.K. to rise to nearly 100%.

More important, however, in Standard & Poor's opinion, the key international role of the U.S. dollar gives the U.S. government substantially greater fiscal flexibility than the U.K. government, owing to the more modest global role of the U.K. pound sterling. We believe this flexibility would even enable the U.S. general government to carry debt in excess of annual GDP without a widening of credit risk premiums in its borrowing costs, as long as the market viewed its plan for fiscal consolidation as credible.

How serious are the medium-term fiscal pressures the U.S. government faces?

We believe that fiscal pressures in the U.S. are, in relation to GDP, the highest since World War II and, absent steps by the government to counter them, would likely persist over the longer term. Consistent with our sovereign ratings criteria, we focus on the general government fiscal balance and the trend in net general government debt, two measures that consolidate the operations of local, state, and federal governments.

However, most of the fiscal deterioration we expect in both the near term and the longer term is in the budget of the federal U.S. government. In the U.S. government's own words, increasing health costs and the aging of the population will place the budget on an unsustainable course without changes in policy to address these challenges. Recent projections by the Office of Management & Budget show deficits remaining at high levels, in comparison with the past 15 years, for the next 10 years.

We expect the U.S. government to rein in its fiscal accounts by implementing fiscal spending rules (pay-as-you-go), by achieving some real expenditure cuts in military and health spending, and by raising revenues. Apart from sales of allowances under carbon tax and trade permits and the reform of taxation on unrepatriated international earnings, the new U.S. Administration has not announced any significant revenue-raising measures. Although there will likely be challenges to achieving a sufficient level of political support, particularly in the midst of recession, we believe that bond investor sentiment will compel the Obama Administration to take steps, including raising revenues, to enable the government debt to fall as a percentage of GDP over time.

All revenue measures would probably be unpalatable to the U.S. public; letting sunset provisions take effect on previous tax cuts or raising contributions on Medicare might be the least distasteful of the government's options. Absent a robust policy response, Standard & Poor's projects that U.S. net general government (all levels) debt will approach 90% of GDP by 2013.

What are the main contingent fiscal risks to the U.S.?

In our view, the main contingent risk to the U.S. government emanates from its financial system. Some of these risks have already crystallized, which accounts for much of the jump in net debt in 2009. Other risks stem from public enterprises, particularly Fannie Mae and Freddie Mac.

The Federal Reserve also incurs credit risk on its direct and secured lending. We expect any losses in a given year on these programs to be well less than its average earnings of US$27 billion during the past five years.

Is the U.S. dollar's role as the key international currency at risk?

No, not for the foreseeable future, in our opinion, for four main reasons:

• The dollar has a long track record as a reliable store of value.

• The dollar is the most widely accepted medium of exchange for international payments, especially in quickly growing Asia.

• Large, deep, liquid, and 24-hour financial markets exist for currency trading, which is principally conducted against the dollar, and for trading in securities denominated in U.S. dollars.

• The dollar's long dominance has allowed it to become an integral part of the international financial trading architecture, and no other currency can readily replicate the advantages that come from these network effects.

Swann is a credit analyst for Standard & Poor's Ratings Services.

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