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Moody’s Solution to Debt Crisis Shows Market Irrationality

Interest-Rates / Global Debt Crisis Jul 21, 2011 - 02:20 AM GMT

By: Dr_Jeff_Lewis


The bond rating agency that missed the subprime bubble, financial crisis, and is perennially late to the downgrade “party” has toughened its language with the US government.  Recently, the company warned that a debt ceiling is the true problem facing the US government.  Eradicating debt fights from government would be a sure way to better the United States’ global standing as a first rate borrower.

This view shows the irrationality of institutional finance.  As long as payments are made on debt, Moody’s argues, there are no problems with the amount of government debt rising exponentially.  Even inflation is a palatable way to pay off current obligations—the United States can just print to make good on debt service, as long as the payments are regular, of course.

Expectations Matter

Moody’s treads a fine line between schools of economic thought.  Following the path of Keynesian economists, inflation doesn’t matter to the bottom-line as long as inflation meets expected levels.  Expected inflation isn’t the problem, but unexpected inflation, higher or lower than originally thought, sends the markets for a loop.

There is some rationality to this argument.  If investors can anticipate correctly the future inflation rate, then banks can charge a premium on top of expected inflation and still net out a significant profit in lending money to consumers, businesses, and governments. 

However, predicting inflation is almost impossible.  Forecasts for future inflation in the United States remain awfully low at 2% per year.  We can find the market expectation for inflation by finding the difference between US Treasury yields and US TIPS yields, which have the benefit of receiving “inflation protection” from the US government. 

Inflation predictions and models are created in an environment where nothing changes.  Every day, a new law is written, regulatory codes are changed, and the mechanics of the market are inundated with more government price controls.  How can you accurately predict inflation if the economy is artificially slowed in some industries, supported in others, and stuffed full with new price controls that shape consumer behavior?

Future Inflation

It is certain that future inflation estimates couldn’t be further off the mark.  High inflation is a necessary effect of a decade’s worth of massive government spending, growth in unfunded liabilities, and a national debt that sends hundreds of billions of dollars to far-off lands each and every year. 

The debt ceiling is the only government policy that forces congress to think about the debt.  Should it be lifted, the credit card of the US government will have no limit.  No matter where you stand in your political world view, you have to recognize that without the debt ceiling, no one in Washington would have to think about the debt.  Granted, the ceiling has been raised nearly one hundred times without incident, but finally, thanks to growing concern about government spending, the debt ceiling puts deficit reduction in play.

In the sense that the debt ceiling makes future projections difficult, it is a bad government policy.  But in the sense that no one in Washington cares about the national debt except when they have to vote for it, the policy has saved the government trillions and saved some of the spending power for the average American. 

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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