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Listen to Moody’s, not Mr. Market

Traders work on the floor of the New York Stock Exchange, September 12, 2012.

BRENDAN MCDERMID/REUTERS

Moody's Investors Service is worth listening to. The rating agency may have blown its Street cred on subprime, but its sober take on U.S. finances is spot on, if somewhat obvious.

Too bad Mr. Market is still on a bender, especially with the Federal Reserve ready to pour more drinks. But the market's apparent complacency shouldn't lull policy-makers into a false sense of security.

The rater said Tuesday that Uncle Sam could lose its once-cherished triple-A crown if lawmakers fail to rein in the nation's debt relative to GDP over the medium term. Markets largely ignored the statement.

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After all, Standard & Poor's had already stripped the government of its top-notch rating last year with little long-lasting consequence.

Treasury prices actually rose after the S&P cut and stocks, though battered by the initial shock, have risen nearly 30 per cent from those dark days in August, 2011.

Ratings, it would seem, don't matter. But the message should. The United States still hasn't tidied its fiscal house, despite last year's reckless brinksmanship over the debt ceiling.

The Moody's message isn't radical, or particularly tough. The U.S. simply needs to change the longer-term trajectory of its debt relative to GDP.

The government, in other words, needs to come up with a plan – something lawmakers have been incapable of crafting thanks to ideological inflexibility over taxes and entitlements.

Unfortunately, markets aren't bullying politicians to be more pragmatic. That's partly because the Fed has anesthetized erstwhile bond vigilantes. Another dose of quantitative easing should keep interest rates sedate.

That's enabling the government, despite its dysfunction, to borrow funds at rates lower than inflation. Yields on Treasuries maturing in five years or less are below 1 per cent. Ten-year rates are half what they were 10 years ago.

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And stocks are doing just fine, thanks to Fed chairman Ben Bernanke's do-whatever-it-takes approach. Even the dollar is holding up.

But as Greece, Spain and others have painfully discovered, complacent investors can quickly become panicked ones. Moody's and other rating agencies have sounded the alarm. Politicians need to listen.

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