Everyone agrees that if the credit rating of the US debt is downgraded from AAA to AA, interest rates will go up. According to most sources, this would be terrible. But is it??? I could be totally wrong here, but there's another side to this.
First of all, the point of raising interest rates is to continue to provide incentive for investors to buy US debt. Rates will be raised enough for the market to reach equilibrium. Therefore:
1) Even if some foreign investors do sell their bonds, others will buy it. You need US Dollars to buy US Debt. This, paradoxically, could shore up the dollar, as investors buy dollars in order to buy the new, higher-yield bonds.
2) Hasn't the Austrian School been bitching about the low interest rates for years? Right now, banks have no reason to lend money to consumers or businesses because the ROI isn't worth the risk. Higher interest rates would mean that there's finally more incentive for investment than hoarding. Higher interest rates could actually encourage banks to lend more money, stimulating economic activity from the bottom up with innovation (Hayek), instead of the top down with gov't spending (Keynes).
3) One of the biggest fears associated with higher interest rates is that people with Adjustable Rate Mortgages - many of whom are struggling to pay their mortage at near-zero interest rates - will be unable to make their payments when their ARMs reset to a higher interest rate. A second wave of foreclosures will follow, pushing home prices down even more. But maybe that's what we need. When the price of homes falls low enough, people will start buying them again. And not just the Joneses either ... When the residential home market hits rock bottom, the big developers that have been waiting on the sidelines to buy up distressed properties and flip them can spring into action. I actually spoke with the owner of one of these real estate firms a couple of years ago. He said that (at that time) the market was nowhere near the bottom, and that when it hit the bottom, he was going to have agents in all 50 states snapping up deals. He's not the only one.
Is it going to be painful, no matter what? Yes, absolutely. But we're already in a lot of pain. An interest rate hike could be the enema this economy needs to start moving again. Everyone with dry powder has been sitting on it, waiting for an opportunity. A credit downgrade could be it.