Despite U.S. deficit concerns, investors still pour money into Treasury bonds

By Neil Irwin
Washington Post Staff Writer
Tuesday, June 1, 2010

The U.S. government debt is rising inexorably, according to the conventional wisdom in Washington, and the political system is too paralyzed to take unpopular actions to rein it in. Privately, many policymakers take it as a given that the situation will change only when the nation faces a Greek-style fiscal crisis.

But apparently nobody told the people who lend the U.S. government money. On Friday, they were willing to hand over their cash to the Treasury for 10 years for 3.3 percent interest, a level so low it implies they consider the United States among the safest investments in the world. Collectively, those investors -- think mutual funds, pension funds and foreign central banks -- could lose hundreds of billions of dollars if they're mistaken and the United States has a debt crisis.

It is the Beltway vs. the bond market, and they can't both be right.

Perceptions inside the Beltway rest on this idea: Although the current large budget deficit is caused mainly by the weak economy and a short-term economic stimulus that will soon expire, in the longer run the government faces a vast unfunded burden, particularly tied to Medicare and Medicaid.

The mix of spending cuts and tax increases that could close the gap are wildly unpopular. With the threat of a filibuster in the Senate hanging over anything remotely controversial, a bipartisan budget accord seems unlikely. And many Republicans have declared they will not vote for a package that includes a tax increase under any circumstance.

This situation led Moody's, the debt-rating firm, to state in March that the U.S. government is nearer to being at risk of losing its Aaa credit rating and that maintaining the rating might require adjustments to tax and spending policy "of a magnitude that, in some cases, will test social cohesion."

Given those realities, the widespread view in Washington is that serious efforts at reducing the deficit will come only when a crisis moment, such as steeply higher borrowing rates, forces the issue.

"You can talk about the deficit until you're blue in the face, but we'll only get political traction on meaningful deficit reduction when there is economic pain being caused by the deficit in the form of inflation or high interest rates or both," said Bruce Bartlett, a Treasury Department official in the George H.W. Bush administration who recently wrote an article predicting that the U.S. government will be downgraded in less than a decade.

In effect, lending money to the U.S. government is like lending to a couple that is spending way beyond its means, and in which the wife refuses to take a second job to increase income and the husband refuses to spend less. No responsible banker in the world would make that loan, but banks and other global investors feel rather differently about U.S. Treasury bonds.

Among economic commentators, there have been rumblings that the debt crisis that started in Greece and increasingly affects such other Western European countries as Spain and Ireland could eventually spread into a crisis of confidence in United States government debt.

So far, the opposite has happened.

The financial crisis and recession drove Treasury borrowing rates to all-time lows -- and in recent weeks, the European debt crisis, rather than make investors fear for the safety of their Treasury bonds, has instead led to an influx of money into the United States, driving rates down further.

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