Ratings agency Standard & Poor’s (S&P) downgraded its assessment of the British government’s finances from “stable” to “negative” on May 21, fueling fears that Britain may soon lose its coveted aaa credit rating.

S&P credit analyst David Beers said, “We have revised the outlook on the UK to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100 percent of gdp and remain near that level in the medium term.”

Accounting firm Pricewaterhouse-Coopers published a report the same day that warned that the Treasury needs to make ₤5,000 (us$7,850) worth of spending cuts or tax increases per household to bring the debt “under control.”

The European Commission estimates that British government debt will reach 68 percent of gross domestic product in 2009 and rise to a staggering 81.7 percent of gdp in 2010.

Many economists believe these numbers are actually optimistic. Pricewaterhouse-Coopers reports that officials may not have included the additional costs of supporting an aging population in their estimates. Of the 18 countries with the aaa credit rating, Britain is the only one that S&P says has a “negative” outlook. A “negative” rating “does not necessarily precede a rating change,” according to S&P, but it is usually the first step toward one. S&P said that it would downgrade the credit rating if there is insufficient political will to tackle the national debt, noting that there is a one in three chance of a downgrade.

Britain’s next election is one year away, at the most. Riddled with scandal, the current government is already hugely unpopular. Raising taxes or lowering spending would amount to political suicide. Simply put, Britain does not have the political will to tackle the problem.

“Loss of ‘aaa’ status is not in itself a death sentence. A string of rich countries have been ejected from the club over the past decade without calamitous results, and most have clawed their way back in after a few years of penance,” writes Telegraph columnist Ambrose Evans-Pritchard. “It is less clear whether Britain can hope to muddle through so easily if Standard & Poor’s pulls the trigger, given its reliance on foreigners to fund its debt and deficits.”

Evans-Pritchard points out that Japan did not really suffer from its credit downgrading, partially because 95 percent of government debt was owned by domestic savers and large pension funds. In Britain, the foreign share of public debt has risen from 18 percent to 34 percent over the last six years.

“We’re far more vulnerable than Japan ever was,” warned Société Générale global strategist Albert Edwards. “Japan had a huge current account surplus and a strong currency. The UK is a deficit country, at risk of a sterling collapse. Years of UK macro-mismanagement have dragged the UK economy to the edge of a precipice.”

Britain is looking to borrow even more in the future, but it will become harder to find buyers. Marc Ostwald of Monument Securities warned that if Britain’s credit rating is downgraded, Russia will start selling its British debt.

Several small states have to hold the vast majority of their reserves in aaa-rated assets, meaning that if Britain’s credit rating was no longer aaa, they would have to sell.

Because of London’s dependence on other countries to buy its debt, “Britain is at the mercy of foreign powers,” writes Evans-Pritchard.

Britain’s “negative” rating could also be a harbinger of bad news for America. After S&P’s report, U.S. Treasury Secretary Timothy Geithner warned that it is “critically important” that America reduce its deficit.

Co-chief investment officer of Pacific Investment Management Co. Bill Gross said America too will “eventually” lose its aaa grade.

For more information on Britain’s dire plight, and the warning it contains for America, see our article “Want to Know What a Former Superpower Looks Like?”