Yesterday, the stock market experienced its biggest loss in over a month, falling 140 points, or 1.1%.
What spooked investors? Standard & Poor's (S&P) downgraded the US debt outlook from stable to negative.
The reasoning behind the S&P's downgrade is the growing debt crisis in America. As The Wall Street Journal reports, the US deficit is expected to grow from $1.5 trillion to $1.65 trillion this year and now comprises 10 percent of total US economic output.
The rating firm cited the budget gridlock and lack of faith in the government's ability to reach a deal to substantially lower the deficit as reasons for the downgrade, "The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term challenges will persist until at least after the national elections in 2012."
Currently, the US is the only one of 19 countries to have a negative outlook for their debt while enjoying an AAA rating. This move is substantial, and while the US still retains its AAA rating, over 50 percent of countries that S&P downgrade to negative eventually lose their AAA credit rating.
For years now, I've been writing about the dangers of the growing US deficit. And I've blogged here in a post, entitled "The Showdown", about what's at stake in the stalemate between the Democratically-controlled White House and the Republican-controlled House of Representatives.
In that post, I wrote:
Two important dates are coming up in this showdown. In early March, a stopgap-spending bill that's funded the government expires. If that bill isn't extended, the result will be a government shutdown. And in May, the government will hit its statutory limit on government spending, the debt ceiling. The Republicans are planning on using the showdown in May to push for deep spending cuts. The result will be a potentially epic showdown that will pave the economic road of the US for years to come.
Noticeably absent from these budgetary discussions is any mention of Social Security and Medicare, which together along with other entitlement programs make up 60 percent of all Federal spending and are expected to grow to 68 percent of all Federal spending by 2021. Overall, it's estimated that costs for Social Security will grow by 71 percent, Medicare will grow by 72 percent, and Medicaid will grow by 115 percent over the next decade. These programs, if eliminated, would wipeout the Federal deficit.
Of course, no politician will touch Social Security and Medicare because while they understand people want to complain about the deficit, they also know that no one wants to pay the price of the tough decisions it would take to tame our budget. According to a survey from the Pew Research Center this month, only 12 percent of Americans supported spending cuts on Social Security and Medicare. Touching those programs is political suicide.
Nothing has changed since I wrote that a couple months ago, and today's move by the S&P confirms my belief that the US government will be hard-pressed to actually put a real dent in our ever-expanding debt—and further proof that the recent budget deal is a Band-Aid on a wound that needs stitches.
The usual timeframe between a country's debt outlook being downgraded to negative and their credit rating being downgraded from AAA by S&P is around six months to a year. That means that you must be vigilant.
In the coming months, the ability or inability of the US government to get the financial house in order will determine the fate of many people's fortunes. If the US credit rating is downgraded from AAA, the result will be catastrophic for the economy. Most likely, stocks, bonds, and mutual funds would tumble; and commodities like gold and silver would skyrocket. Additionally, borrowing costs for both the US and the US consumer would climb sharply, causing another housing crisis.
And millions of baby boomers who rely on the stock market, mutual funds, government bonds, and their house for their retirement would be wiped out.
These are interesting times to live. As I've said before, we are in the middle of the biggest wealth transfer in history, and it appears it may get bigger. Only the financially intelligent—those who know how to make money in up and down markets—will thrive and grow rich.
I encourage you to continue to watch the financial news closely and to continue your financial education.