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Fiscal Follies: S&P, Groucho Marx, and the Bond Vigilantes

Posted: 04/21/11 02:48 PM ET

Admittedly, we may have an odd sense of humor when it comes to the federal budget. But after an initial shiver of fear, our first reaction to the news that Standard & Poor's had issued a "negative outlook" for the U.S. national debt was: "Oh, no. Mrs. Teasdale has finally made her move."

You may not know who Mrs. Teasdale is, but she's the oblivious dowager played by Margaret Dumont who starts the action rolling in the classic Marx Brothers political satire, Duck Soup. That movie starts with a government financial crisis, and Mrs. Teasdale may be the world's first "bond vigilante."

Some say the term "bond vigilante" dates from the 1980s, while others say it was coined during the Clinton administration. Either way, it describes what happens when the traders who deal in government securities start to get nervous about a nation's deficits and debt load, and threaten to dump their bonds unless a government changes its policies. That's what S&P is starting to do with its "negative outlook," and that's what Mrs. Teasdale does in Duck Soup.

Duck Soup takes place in the fictional nation of Freedonia, which is broke. Mrs. Teasdale, who has more money than sense, agrees to lend $20 million to Freedonia's government, but only if it will appoint Rufus T. Firefly (Groucho) as prime minister. Things only get worse, and more ridiculous, from there.

But while it's an absurd situation, it's also an indispensible lesson: when you're in debt and need to borrow, the people with the cash on hand hold the cards.

You might not think the United States and Freedonia have much in common. Now that we know we can't fix this thing by axing agricultural subsidies and National Public Radio, we face some truly unpleasant choices -- cutting spending on things that matter to people and hiking taxes in an economy that's still sputtering. Right now we're borrowing to get by, and we can only continue to do that as long as the world's investors continue to loan us money.

Right now, the United States relies on borrowed money that we get by issuing Treasury bonds. We have about $9.66 trillion in Treasury bonds outstanding, and we've got another $4.6 trillion in intergovernmental debt (mostly borrowed from the Social Security Trust Fund), which also has to be repaid. U.S, Treasuries are owned by investors around the world ranging from the People's Bank of China and the "Caribbean Banking Centers" (The Bahamas, Cayman Islands, and the like) to state and local governments to individual bond holders like Mrs. Teasdale.

For years, the United States has been in the catbird seat in the world bond market. Both here and abroad, investors have always seen U.S. Treasuries as a prudent, trustworthy investment in a dangerous, changeable world. Government bonds in general are considered one of the safest investments out there, no matter which government you're talking about, because governments (a) can always raise taxes to pay their bills and (b) rarely go out of business.

But sometimes governments get in too deep and then drag their feet on getting their fiscal houses in order. Then bondholders start wondering whether the government is actually good for the money. That's what has happened to Greece, Ireland, Portugal, and Spain over this past year. The world's bond markets had their Mrs. Teasdale moment when they started to see these countries as risky financial bets. That's the reason behind the wave of budget-cutting sweeping over Western Europe right now, as Britain and France try to head off trouble.

It's important to remember: the United States is a wealthy, powerful country, the biggest economy in the world. We're also the sole superpower, so it's unlikely any of our creditors would impose a leader like Rufus T. Firefly on us. (We're not saying he might not get elected on his own.)

But it's risky to think that we're invulnerable to the power of the bond markets. They know we're good for the money, if we tax ourselves more and/or spend less. But what S&P and others are really saying is that they don't think we've got the political will to do either one. S&P said there was "significant risk that Congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 Congressional and presidential elections," and S&P said there's a one-in-three chance it would actually lower our bond rating in the next two years.

Is it fair that the bond market has this much power? Not really. Did the bond ratings agencies behave as dimwittedly as Mrs. Teasdale when they missed the looming financial crisis in 2008? Sure. Does that change anything? Not at all.

We've been safe from the Mrs. Teasdales of the world so far, but with new red flags appearing every day, how long can that last? The cold fact is that the federal budget is on an unsustainable path, because as the population ages and our health care costs continue to go up, the costs for Medicare and Social Security are going to skyrocket. In a little more than a decade, our national debt could be as big as our entire economy, and nearly the entire federal budget could be taken up by Medicare, Medicaid, Social Security and interest on the money we've already borrowed.

If we don't start getting our deficits down and reining in our long-term spending, someday Mrs. Teasdale will come to call, and she'll be able to make demands, and we'll have to listen, and it won't be funny. At that point, every single one of us could be in duck soup.

 
 
 

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