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Related topics: politics, debt, bonds, portfolio, Anthony Mirhaydari

The global debt crisis, which started more than two years ago in Dubai, finally has washed ashore in the United States. Along the way, it resulted in deadly protests in Greece and threatened Europe's post-war unity. Now it will bring a new age of austerity to the U.S.

That means higher taxes, reduced spending and cuts in entitlements like Medicare.

Politicians have yet to face it, and the public hasn't accepted it. But the only alternative is a Weimar-style hyperinflation combined with a Greek-style bond market revolt. We'll do the right thing. We have no choice.

Wall Street sounded the alarm April 18 as credit analysts at Standard & Poor's doled out the first U.S. credit-outlook downgrade since the Imperial Japanese Navy bombed Pearl Harbor. Suddenly, the debt issues that cut down the spendthrifts in Athens, Lisbon and Dublin hit us at home.

So is the U.S. the new Greece? Not yet -- our credit rating hasn't been downgraded yet, for one. But there are similarities. Greece's problems stemmed from spending commitments enabled by easy credit, a growing deficit, a public liking for government services and a general dislike for taxes. That made it hard to tackle the problem until it became a crisis.

The situation here is severe. The U.S. economic recovery has been tepid, unlike the roaring recoveries in places like Germany and China. Credit Suisse notes that Gross Domestic Product (GDP) only recently reclaimed its pre-recession peak and is about 7% behind a typical recovery. And the debt load is significant: Besides Japan, there is no other rich world economy in such dire straits.

Image: Anthony Mirhaydari

Anthony Mirhaydari

Here's a look at what the S&P's warning means -- and how to get your portfolio ready for the fallout:

A shot across the bow

The S&P decision signals recognition of the government's growing debt burden and persistent deficits -- as well as the bitter political fight in Washington that threatened a government shutdown earlier this month. The cut, from "stable" to "neutral," means there is a one-third chance of a credit-rating downgrade within the next two years.

The move by S&P was inevitable as politicians play a serious game of chicken with both members of the opposite party and the bond market. The Treasury's outstanding debt nears its statutory limit sometime between the start of May and July, and the fight over raising the limit has begun.

The S&P analysts, while noting the inherent strength and flexibility of the U.S. economy, worried that no significant plan to address the debt will be put in place before the 2012 presidential elections. The real work couldn't begin before the post-election budget proposal for the fiscal year beginning Oct. 1, 2013. That's a long time from now. And waiting would push to the government's debt-to-GDP ratio to dangerous levels.

If nothing is done to curb the borrowing -- or if our credit is downgraded -- the results would be severe. Interest costs would rise. This would make the debt crisis worse by deepening the federal deficit. It would also crowd out private borrowing and increase financing costs for consumers and businesses. Banks would be forced to take losses on their reserves of U.S. Treasury bonds, prolonging the credit drought and weighing on the housing market.

We can't afford to let this happen. But do we have the stomach to take action?

The likes of Great Britain have embraced fiscal austerity despite the social pain and economic damage it causes -- indeed, U.K. GDP dropped 0.5% in the fourth quarter. Greece, Portugal, the U.K. and Spain have all pulled their deficits below the 10% level over the past year. Politicians there have made the hard choices despite electoral rejection and violent protests.

But our policymakers just can't seem to stop spending, borrowing and tax-cutting. Just four months ago, President Barack Obama and Congress teamed up to pass an $858 billion extension of the Bush-era tax cuts, along with additional payroll-tax cuts. These were added despite the fact the 2011 budget deficit is expected to hit nearly $1.7 trillion, or 11% of GDP.

According to the Organization for Economic Co-operation and Development (OECD), OECD, only the United States and Ireland maintain budget deficits of more than 10% of GDP.

We've seen a preview of things to come with the battle in Wisconsin over union rights and the recent budget fight. More acrimony lies ahead. For all the talk of cuts, a Tea Party-driven GOP won the House in 2010 in large part by saying President Obama's heath care plan would cut Medicare and hurt seniors. Obama will use the same argument against the GOP's budget plan. The 2012 election could get ugly.

The trouble with T-Bills

Still, investors are betting the outcome of this debate will be spending cuts and tax increases, if only because the alternative is worse.

You see, the global financial system is built on risk-free Treasury bonds. They are used as trade collateral. They are counted as bank reserve capital. Our creditors, including China and Saudi Arabia, hold huge amounts of them. Unlike Greece, the United States simply can't default or restructure its obligations. That's the price of our unique status as the issuer of the world's reserve currency. That status also brings benefits, including cheap financing and the ability to run persistent trade deficits.

We have to stand by our debt, no matter what.

This explains the wild volatility seen in Treasury trading on Monday after the news of the S&P downgrade watch hit the wires. First there was a plunge, which took down stocks, commodities and crude oil. But within an hour, as traders accepted that painful austerity is the end game and a U.S. debt default is out of the question, T-bonds enjoyed a massive bid and closed positive as yields fell.

The U.S. dollar also moved higher. If all this seems like twisted logic, that's because it is.