One of these days the United States will lose its triple-A rating, and the bond market won’t blow up. But don’t kid yourself into thinking that’s good news.
To the contrary, the tame reaction to Wednesday’s downgrade warning from Moody’s shows that the United States is already much further down the road to a Japanese-style quagmire than most of us might care to admit.
The Japan comparison sounds like a stretch. Yes, there are vast differences in culture and demographics and the official response to collapsed financial bubbles, many of which may eventually play out in America’s favor.
But the thread the two nations undeniably share – along with an unhealthy heap of debt — is a dangerous case of political gridlock at a time when reform is urgently needed.
In Japan, governments come and go and nothing changes, which is why the country’s debt load now dwarfs annual economic output. In the United States, we got lost in sea of borrowing over three decades of free spending, during which both parties have had their chance to move the rudder and neither has, even a little bit.
In response, the Tea Partiers and their Republican puppets now demand we change course drastically, by slashing spending without allowing for any tax increases. It’s like waking up one day, realizing you’re overweight and deciding the way to fix that is to lop off your left leg below the knee.
It isn’t the sort of thing adults typically do. Yet this is the sort of proposal that is received nowadays as a “solution” by a substantial part of the electorate. Can this end any way but badly?
A look at Japan’s performance since its asset bubble collapsed in 1990 says no – though not in the spectacular way the Bill Grosses of the world often suggest. Instead we may muddle through crisis after crisis, slowly getting poorer not all at once but relentlessly, irreversibly, over time.
“The history of Japan serves as testament to what can happen when the political response to a malaise or crisis is stalemate,” says Andrew Barber, a strategist at investment adviser Waverly Advisors in Corning, N.Y.
Consider what is likely to happen with the Treasury market, where bond manager Gross once promised a turkey shoot but lately has been using less colorful language.
A downgrade, when it comes, is likely to modestly raise U.S. interest rates, raising borrowing costs and squeezing an already anemic recovery. Yet the loss of the America’s gold-plated credit rating alone “would probably be a fender-bender rather than totaling the car,” says Janney Capital Markets strategist Guy LeBas.
Why? In part it’s because our foreign creditors, led China, aren’t the mighty flight risk they are often made out to be. Where, after all, are they going to go? Europe is on the verge of disaster, China is closed to outsiders and Australia, New Zealand and Canada are too small to accommodate massive fund flows.
“There is not much of an alternative to the dollar for global investors,” says LeBas. “It’s not like they can just flip a switch and go.”
That’s good news, as far as it goes. But as a look at Japan’s bond yields over the past decades (see chart, right) shows, avoiding a bond market shock alone won’t do much to get your economy back on track or create the jobs we need for greater prosperity.
That’s going to take actual ideas beyond tax cuts or, for that matter, unbridled spending. No one from either party seems to have any of those at the moment.
Gross is correct that how to revamp the economy to create those jobs is the $64 trillion question – but that debate is most certainly not taking place in Washington. Instead we have a pointless game of debt ceiling chicken going that could permanently crimp U.S. growth if it ends badly – or accomplish nothing if it is resolved in the next couple weeks.
That is not much reward for all the risk our Beltway betters are taking on, but by now it’s hard to be surprised.
