The United States recently hit a critical milestone: for the first time, its Federal Government spent more on interest payments than on defense. This shift echoes a pattern noted by historian Niall Ferguson—when a leading nation spends more on debt servicing than on military defense, it may signal the start of a period of geopolitical decline. The pressing question now is whether this shift marks the beginning of a similar downturn for the US.

As American public finances become increasingly strained, the idea of the issuer of the world’s primary reserve currency being burdened by unsustainable debt is no longer far-fetched. According to the Congressional Budget Office, US debt could exceed 160% of GDP by mid-century, with annual net Treasury debt issuance potentially reaching $2 trillion over the next decade. Complicating matters, key buyers such as the Federal Reserve and Foreign Central Banks may no longer be reliable net buyers of US debt—a challenge also faced by some European nations.

For years, governments have argued that fiscal stimulus is essential for economic growth, leading to a continuous rise in debt. Now, as the era of near-zero interest rates fades, the cost of servicing that debt is set to climb. Factors such as a global economic slowdown, declining tax revenues, aging populations, rising defense budgets, and political gridlock all contribute to deepening fiscal challenges.

In this environment, the role of credit rating agencies is more crucial than ever. These agencies assess sovereign risk and provide investors with tools to evaluate the long-term sustainability of government finances. As fiscal pressures mount, a vital question emerges: will rating agencies maintain their independence and make the necessary tough calls, or will political pressure cause them to hesitate?

Recent trends show that rating agencies have become more cautious about downgrading developed nations compared to emerging markets. During the COVID-19 pandemic, while many developing countries saw swift downgrades, ratings for wealthier nations largely remained unchanged. Although there have been some recent downgrades for countries like the US, France, and the UK, the overall trend over the past decade has favored upgrades for advanced economies. In contrast, emerging markets have experienced more downgrades, reflecting their relatively weaker economic fundamentals.

This shift may partly be due to the broader economic context. For example, during the pandemic, some agencies even raised the US’s institutional strength rating to avoid a downgrade and prevent market instability amid uncertainty. This decision followed the 2011 US downgrade, which sparked lawsuits and significant political backlash.

Credit rating agencies are tasked with providing an unbiased assessment of a nation’s fiscal health, but they must also consider the wider economic and political landscape. The critical question now is: if the US fiscal situation worsens, will these agencies be prepared to act decisively, even under potential political pressure?

The stakes are high. A failure to downgrade in the face of deteriorating fiscal conditions could create a false sense of security among investors, allowing governments to postpone necessary reforms. This delay might exacerbate debt challenges, making it even more difficult for the US to restore fiscal stability.

As global financial markets evolve, the influence of credit rating agencies remains significant. Ultimately, whether sovereign powers or rating agencies prevail in the battle for fiscal health will depend on the agencies’ willingness to take bold, independent actions in the face of mounting pressure.

Adapted from an article by Moritz Kraemer, Chief Economist at German bank LBBW and former Chief Sovereign Ratings Officer at one of the international rating agencies.