x Abu Dhabi, UAEWednesday 26 July 2017

Debt warning is not reason to panic

There is no such thing as a free lunch. There is no such thing as a risk-free investment either. This week's announcement from Standard and Poor's, changing its outlook for US sovereign debt from "stable" to "negative", underscores that point

There is no such thing as a free lunch. There is no such thing as a risk-free investment either. This week's announcement from Standard and Poor's, changing its outlook for US sovereign debt from "stable" to "negative", underscores that point.

Since the United States has never defaulted on a bond, America's public debt has been the closest thing to a risk-free investment. While S&P did not downgrade US treasury securities below its highest rating with its recent statement, it did warn that buying these bonds is no longer without risk. The report should serve as a warning to politicians in Washington: a stalemate between political parties and their squabbling over spending priorities does not come without costs to the credit worthiness of their government and the stability of the global economy.

While S&P was right to sound the clarion call, they have announced what most of the world already understands. There are also lingering questions about the rating agencies's larger body of work. Their blindness to the risk embedded in the US sub-prime mortgage market helped touch off the global financial crisis, which required massive stimulus and deficit spending to contain. No, they did not create the toxic financial instruments that torched the global economy, but it was the rating agencies that gave bundles of sub-prime mortgage debt, known as collatoralised debt obligations, triple-A ratings.

That does not change the fact that the US and many other governments in Europe face painful decisions about their deficit spending. Hopefully S&P's more sober outlook will help leaders confront these realities more seriously. "There is a material risk that US policymakers might not reach an agreement on how to address medium-and long-term budgetary challenges by 2013," explained the S&P report. The same statement also declared that "the economy of the US is flexible and highly diversified" and that "a consistent global preference for the US dollar over all other currencies gives the country unique external liquidity".

And it is not the opinion of the rating agencies that matters most. Bond-buyers themselves will decide whether US treasuries are becoming too risky. For their part, they continue to buy US debt at historically low rates. What the S&P should help remind politicians in Washington is that this can't and won't happen forever. They too must come to understand that there is no such thing as a free lunch.