COLLEGE PARK, Md., Nov. 29 (UPI) -- The supercommittee's failure to compromise on $1.2 trillion in budget savings won't much affect the deficit and U.S. credit ratings -- or the interest rates and prices of U.S. treasuries. Still investors should limit holdings of those securities -- the long-term outlook isn't good.
Although the supercommittee didn't reach consensus on a combination of spending cuts and tax hikes, the Budget Control Act automatically triggers $1.2 trillion reductions in defense outlays, non-entitlement domestic spending and some payments to hospitals and healthcare providers.
Savings from winding down wars in Afghanistan and Iraq were already scored into budget projections; hence, new defense cuts will be from the "base" military budget that maintains readiness and defends U.S. security interests around the globe.
The Budget Control Act, passed in August, already cut defense spending by $450 billion over 10 years and another $500 billion is simply unacceptable. U.S. hardware is aging -- sons fly the same fighters as did their fathers; cyberwarfare requires new capabilities beyond conventional land, air and sea forces; and China is building a navy and will spend on defense 60 percent as much as the United States within a decade -- with lower personnel costs and without America's global responsibilities.
More, not fewer, naval resources are needed to meet that challenge in the Pacific -- on a recent trip to Asia, U.S. President Barack Obama committed to a beefed up U.S. presence.
Republicans in Congress will propose repealing the $500 billion cut but liberal Democrats will demand that spending be refinanced with other cuts or new taxes. Grover Norquist won't be able to stop such a deal -- hard realities, especially national security concerns, have a way of neutralizing the clout of mono-line political activists.
A deal on defense spending will legitimize similar trade-offs to reduce other Budget Act mandated cuts and make some tax increases acceptable, even among many conservative Republicans.
Consequently, the impact on the deficit of the supercommittee failure will be marginal. The budget dance that follows shouldn't provide a basis for Standard and Poor's to lower its AA-plus bond rating on U.S. bonds or for Moody and Fitch to lower their AAA ratings.
Longer term, the cuts the Budget Act required won't be enough. The United States will continue to borrow too much and grow too slowly until more important structural issues are addressed. Within a few years, U.S. borrowing costs will be much higher than today.
Currently, Washington enjoys low borrowing costs, because foreign central banks, private institutions and ordinary investors are all fleeing European debt. Similarly, China's shaky banks and dodgy accounting standards, along with Beijing's exhortations that yuan appreciation has run to course, are causing money to flee China for America.
That money is dumping into treasuries, solid corporate and state debt and even junk bonds.
Within a few years, that money will leave, after Europe has its ultimate financial crisis and then recovers and investors realize that China's sovereign debt is no more risky than U.S. paper. Rates on U.S. treasuries will rise, as investors become much more nervous that either Washington won't be able to continue floating $1 trillion a year in new debt or the Fed will simply roll the printing presses to buy what treasuries investors won't take.
Long bond rates will rise and treasuries bought today will lose value. Simply, in 2014, why would someone pay as much for treasuries maturing 27 years later and yielding 3 percent when a new 30-year bond pays 5 percent. At that point investors who purchased bonds today either must wait for those to mature and endure low interest rates or take a haircut if they sell.
The message to the ordinary investor is simple, treasuries are safe up to a point -- the U.S. government can always print money if necessary to honor its debt -- but those investors should only buy bonds with maturities no longer than their circumstances permit them to have their money tied up. Treasuries won't long be a liquid investment.
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(Peter Morici is a professor at the Smith School of Business at the University of Maryland and former chief economist at the U.S. International Trade Commission.)
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(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)
