Institutional investors loading up on freshly downgraded US debt will inevitably be very sorry, writes MoneyShow.com senior editor Igor Greenwald.

We’re all the way through the looking glass now.

If you’re worried about the downgrade of the US credit rating to AA+ by Standard & Poor’s, when two-year Treasury notes yield 0.25% and the ten-year bond stands at 2.47%, that’s your right.

I’d be more concerned about the rationality of the markets when investors respond to the downgrade by fleeing the part of the economy that’s swimming in profits and cash (the S&P 500), and seeking safe harbor in the debt of a government that’s borrowing 40 cents for every dollar it spends, and appears to be irreparably broken along partisan fault lines.

And I’d be worried about the rationality of a government that responds to the widely anticipated downgrade by lashing out at its tormentors in the Tea Party and at the S&P.

The $2 trillion “mistake” the Treasury claims the S&P almost made involves a difference of assumptions about the pace of growth in federal discretionary spending. If anything, the S&P’s original projection of growth at a 5% rate could yet prove too conservative.

We can argue whether the UK and France deserve to keep their own AAA credit ratings, when the UK’s debt-to-GDP ratio is eight percentage points higher than that of the US right now, and France’s will be four percentage points higher in 2015.

But it’s impossible to argue with the S&P when it notes that “the political brinkmanship of recent months highlights what we see, as America’s governance and policymaking becoming less stable, less effective, and less predictable.”

That’s really the nub of the S&P’s case: The ship of state is currently on course for the reefs of default within a decade or two at most, and the longer the fight for the helm goes on, the lower the probability of a timely course correction.

Only it’s hard to feel much urgency about the situation with interest rates sinking ever closer to record lows. Short-term rates are being held down by the Federal Reserve, but the precipitous decline of long-term rates is clearly the handiwork of risk-averse investors with a shortage of good alternatives.

Gold is another safety trade currently in favor, though unlike longer-term Treasuries, it offers no yield and has traditionally been much more volatile. At the moment, that volatility is a gold bug’s friend. So is time, over which the supply of US debt is almost certain to grow much faster than gold stockpiles.

But as a safe-harbor alternative to Treasuries, the gold market is likely to prove too small and too crowded, over time. Already, US debt held by the public is almost $10 trillion, or almost $2 trillion higher than the value of all the gold ever mined.

And the US is likely to add almost $1 trillion a year in public IOUs for the next few years, while gold miners can only add $150 billion a year to the global stockpile of gold at the current price. So the supply of additional US debt is likely to outstrip the incremental supply of gold by a ratio of 8 to 1 in the near future.

That explains why the gold price has been climbing, and why it’s likely to keep doing so. But it also suggests why Treasuries remain so popular, especially with the institutional investors and pension managers who are seeking yield, and for whom gold is not (yet) a viable alternative.

As for foreign sovereign debt, most of these people look at Paris and see a much more functional government than in Washington, presiding over an economy that’s much less promising.

I’m trying to imagine how the 30-year bull market in bonds can continue over the medium term. It requires the economy to remain weak, but for the US government to either to slash its spending to the bone and beyond or to jack up taxes on the dispirited populace, setting off a deflationary spiral.

It’s hard to see this sort of dystopia persisting for any length of time, not while money printing remains such a tempting alternative. The much more probable possibility is that easy monetary regimes around the world will tide us over until debt is pared and demand returns.

There is a lot of pent-up demand in the poorer and thriftier parts of the globe. In that scenario, Treasury bonds are bear bait, while stocks, especially those with decent yields, are a value proposition worth exploring.

I think we’re almost there.

The global monetary regime has just become notably looser after the European Central Bank began buying Italian and Spanish bonds, beginning to reverse the sharp spike in those countries’ borrowing rates.

The S&P downgrade is a sort of coda to the debt-ceiling fight. It delivers no real news, but merely crystallizes the rampant negativity and fear among investors.

I have no idea whether the S&P will end the day 3% lower as the overnight futures foretold, 2% lower (as is currently the case), or 1% higher, which seems almost as likely.

But I wholeheartedly believe that the buyers of bonds today will be cursing themselves soon enough no matter how the US budget crisis plays out.