Those who followed politics in the early 1990s will recall the impact that “bond market vigilantes” had on the Clinton Administration’s fiscal policies. When investors in treasury notes and bonds lacked confidence in the administration’s commitment to sustainable fiscal policies, interest rates shot up and forced a reconsideration of spending and tax policies. James Carville, one of President Clinton’s top political advisors, famously complained about the power of the bond market:
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
A combination of risk aversion, lingering fears of deflation, and the Federal Reserve’s quantitative easing policies have combined to neuter the “bond vigilantes” even as Federal deficits reach post World War II highs with no end in sight.
The Wall Street Journal reports that Moody’s has warned that U.S. and U.K. sovereign debt could be subject to downgrade by 2013 if economic growth is slow and steps are not taken to control deficits. There are currently seventeen countries with AAA ratings.
Can credit ratings firms replace the bond market in terms of imposing discipline on fiscal policy? Although the credibility of the ratings firms has declined in light of recent high profile failures, any actual downgrade of United States government debt would be a major financial earthquake and could cause interest rates to rise. This would increase annual interest expense as debt is refinanced and would only make it more difficult to balance the budget in the long run.
If this plays out, James Carville may soon change his mind and wish to come back as a credit ratings analyst at Moody’s or Standard & Poor’s.