Gyroscopic Investing

recently, the credit rating of the US central government has been called into question by rating agencies.

http://www.reuters.com/article/idUSTRE6BC32L20101213
http://www.nytimes.com/2010/03/16/busin ... .html?_r=1

as one of the reasons for US treasuries specifically, as opposed to others (munis, corporates) is lack of credit risk / risk of default...is this reason being reduced?

any thoughts / concerns on how a downgrade would impact the effectiveness of the bond portion to play its role when called on during a stock market decline like 2008?

or simply a more mundane erosion of purchasing power of Fed Reserve Notes? (guess that why we maintain the gold allocation in the PP)

what else?

p

The US will likely not default for the main reason that they can print money if they have to and make payments. But they would probably be forced to either cut spending, increase taxes and print money as the holy triumvirate of how states react to such crises. This would lead to a variety of other problems in the market.

A credit rating cut is always a risk, but this doesn't mean a default. Such a rating cut would probably push bond interest rates up as investors respond to the risk. But it also would likely be a big boon for gold prices as people sell off dollars. Hard to say what would ultimately fall out of the situation, but the reason we don't have 100% exposure to the dollar and hold hard assets is to deal with these remote possibilities if they should happen.

Also consider that as bad as it would be for a rating cut for the US, the munis and corporate bonds priced in dollars will be that much worse. IMO.

Craig,

I've often contemplated if it'd be possible for the treasury's rating to go lower than any other bond-issuing entity, and I just can't think of how that'd be possible.

Does an entity's ability/likelihood to inflate away its debt have any weight on ratings?

One interesting viewpoint I heard recently...

...U.S. debt is still the best-looking horse in the glue factory.

The threat of the US attempting to inflate away its debt is so well known that it's already priced into the bond market, no matter what the credit rating is (in my opinion).  The fact that the mainstream media is reporting it is probably all the more reason things will work out differently.  

I wouldn't be surprised if exactly the opposite happened--we put the breaks on the money printing, interest rates rise, weaker banks default, and we actually experience deflation, in which case Treasury Bonds, theoretically, should turn out to be a very sound investment (although you never know).      

Not making a prediction, just pointing out that anything can happen and things usually work out in ways that are very unpredictable.  

moda0306 wrote: Craig,

I've often contemplated if it'd be possible for the treasury's rating to go lower than any other bond-issuing entity, and I just can't think of how that'd be possible.

Does an entity's ability/likelihood to inflate away its debt have any weight on ratings?

I think the bond markets are well aware of a sovereign nation's ability to inflate. So that will be priced into the bonds. For instance it is relatively expensive for the Brazilian govt. to borrow money. Their 10 Year LT bond yields are currently 12.7%. Shorter term rates aren't much lower:

http://www.bloomberg.com/markets/rates- ... ds/brazil/

But keep in mind that they have a habit of inflating their way out of problems and the Bond markets punish this behavior by making it expensive for them to borrow. And no, I wouldn't recommend buying Brazilian bonds because there is a near 100% chance they will burn you eventually.

So the US doing the same thing will have the same problems. Now the people in power may not care, but the bond markets can make it very hard to finance debt if they want. Countries that use massive inflation to solve their problems do pay a price. If they don't trust the bond issuer to protect their money then nobody is going to lend to them at a reasonable rate.

The US will never default on its bonds.  They would be crazy to.  They can always print more money to pay the bondholders, and this inflationary risk is actually born more by 3rd world countries that peg their currency to ours.  Whenever we print money, the Chinese have to print just as much, or more, to keep their currency peg in place.

Anyway, these fears of a US debt default are mostly driven by politicians who have an agenda and want to cut government spending.  We would be wise to look at the source of the message, when evaluating the accuracy of it.

edit: corrected spelling errors

That's true, so far, but never say never.  Who knows what will happen if some of these foreign nations decide they don't like to import our inflation.  Things can change very quickly. 

Of course, that's the nice thing about the PP...you don't have to try to guess.

Adam