It's really amazing to me that anyone is shocked by the S&P downgrade. People are seriously going nuts. You even have Krugman out there saying that S&P has "no right" to downgrade the US because they were too lax on the mortgage backed securities. So they aren't allowed to be even slightly strict because they used to be lax? Uh, okay, that makes sense (I'm lying, it doesn't).
The US fiscal situation is atrocious, it's actually pretty amazing that we maintained our AAA rating for so long. Check out this graph showing that in just 14 years our entitlements and interest payments, by themselves, will be as high as the likely total revenues of the federal government:
In other words, our deficits will be completely out of control unless we dramatically increase our taxes, which by the way, will be disastrous for the economy, especially of the magnitude that would be necessary.
We just clearly don't deserve AAA status. Also, check out these charts from a 2006 S&P primer on their sovereign debt ratings. The first one shows the median deficits for the different ratings:
Basically, the median AAA rated country in 2006 actually had a surplus. Considering our deficit this year is something like 10% of GDP, I'm pretty sure we are pretty close to junk status at this point as even AA looks very generous at this point.
Now let's look at debt to GDP:
Considering we are likely to be at 75% net debt/GDP at the end of this year, once again it appears we are at junk levels, not even close to what anyone should consider AAA. At AAA your debt is pretty much riskless, does anyone believe that anymore?
The worst part is that S&P kept us on negative watch so we may very well be downgraded again (and based on the facts, we probably should). To get out of this situation we need to reform our entitlements and shrink our government massively in order to balance the budget. Yes, there will be some pain out because of this but we are pretty much a country stuck on the train tracks as a train is coming quickly towards us. Staying where we are is just not an option.