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Analysis/Comment Last Updated: Jan 17, 2013 - 7:31 AM


Dr Peter Morici: Uncle Sam’s “F” rated bonds
By Professor Peter Morici
Jan 17, 2013 - 6:17 AM

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President Barack Obama signs letters written by Hinna Zeejah, Grant Fritz, Julia Stokes, and Teja Goode backstage in the Eisenhower Executive Office Building's South Court Auditorium after unveiling new gun control proposals as part of the Administration’s response to the Newtown, Connecticut, shootings, and other tragedies, Jan. 16, 2013. The children wrote to President Obama in the wake of the Newtown tragedy expressing their concerns about gun violence and school safety.
Dr Peter Morici: Uncle Sam’s “F” rated bonds; Were the United States any other country, its bonds would have long ago been downgraded to junk. The national debt is careening out of control, and the underlying economy appears unable to support the taxes necessary to stabilize the amount owed. The political class has sunk into tragic dysfunction, incapable of civil discourse or creative thinking to address these problems. In 2007, the last full year before the financial crisis, the federal deficit was only $161bn but since, spending on health care, social security and other entitlements have exploded—the annual budget gap has exceeded $1tn for five years. Raising everyone’s taxes by 25% would not slice the budget gap in half and prove self-defeating. As in Greece and Spain, recession and unemployment would follow, significantly shrinking the economy and new revenue raised.

Policies to improve access to health care, reduce energy dependence and environmental emissions, and protect Americans from reckless oil rigs, bankers and the like, though noble in the eyes of President Obama, have taken a heavy toll on growth. In the wake of a terrible recession, the economy should be rebounding at a 4 or 5% annual pace, but instead, slogs along at about half that rate. Unemployment remains painfully high and that’s the root cause of the nation’s budget woes—too few Americans working and paying taxes to support their government.Faced with these realities, President Obama pretends they don’t exit. In budget talks with Speaker Boehner he declared the country does not have a spending problem—as if the federal government could indefinitely spend 50% more than it collects in taxes.

When industry leaders complain about burdensome regulations impeding investment and growth, his lieutenants exclaim those are necessary and can be managed.  

American businesses do cope—by shipping jobs to China.

Now, the President wants to raise the debt ceiling without negotiating a plan with Congressional Republicans to bring federal deficits under control.

Past GOP (Grand Old Party  - - Republican Party) efforts to curb spending by shutting down the government have ended badly, and the President will likely get his way.  Then Fitch and Moody’s will join Standard and Poor’s in stripping US bonds of their triple-A rating, but don’t expect any more than an indignant response from President Obama.

The dollar is the global currency, and the Federal Reserve can print dollars if no one wants to buy new Treasury securities to pay off maturing bonds and finance new spending.

Nevertheless, US Treasuries are risky investments.

Internationally, interest-bearing Treasuries function much the same as currency—sitting in bank vaults, they back up deposits, serve as collateral for loans and derivatives, and are accepted as payment for goods and debts.

However, whether as Treasuries or currency, too many dollars in circulation will instigate inflation when the global economy picks up steam.

Just the fear of inflation causes investors to demand higher interest rates on virtually all dollar-denominated bonds issued by government agencies, banks and corporations.

As Washington continues to spend and borrow, the Treasury will have to offer higher rates on new 10- and 20-year bonds, making comparable securities issued in 2013 and earlier worth less in the resale market.
 
That interest rate risk makes long-term US Treasury securities lousy investments—they have no place in most retirement portfolios.

For rating agencies, Washington’s monopoly on printing dollars makes difficult assigning a conventional rating between AAA and D on its bonds. Those can’t default but investors’ capital is still at risk.

Perhaps a special grade: “F” - flee now before you get stuck.

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

pmorici@rhsmith.umd.edu

http://www.smith.umd.edu/lbpp/faculty/morici.html

http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm

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