I didn’t want to let pass the warnings by Moody’s and others on U.S. credit ratings as a result of a potential default because the borrowing limit may not be increased to meet debt commitments. This is nothing new from Moody’s or S&P; they’ve been issuing warnings for some time; now they are stating the obvious about such a default.
The market has taken slight interest in the political wrangling other than to note that credit default swaps have increased slightly. What that means is that it now costs €58,000 to insure €10 million of Treasurys, an 8% increase in cost. Put in perspective the odds are 0.12% for default versus 14.04% for Greece. What this means in that the market believes they will increase the debt limit.
It always takes a crisis for politicians to act. Years of reckless spending are starting to run into a wall of huge debt, voter resistance to new taxes, and the realities of the bond markets.
Which leads to one obvious conclusion brought to my attention by Cato’s Jagadeesh Gokhale: the U.S. credit rating probably already is de facto downgraded. The reason the rating agencies haven’t already done it is because the role the U.S.’s debt and currency represents in international finance. If we were a smaller country spending 45% more than we took in, I am sure our rating wouldn’t be blue chip. The reason is hasn’t happened yet is because our house isn’t as bad as Europe, China, Russia, Brazil, or any other region or country, incredible as that may seem. As a result market dynamics keep Treasury rates low even at the same time as the dollar is devalued. That may not last.
What would happen if we defaulted? Financially probably nothing in the short-term. Debt would be paid on August 15, and at that point the rating agencies won’t downgrade. What would happen, at least according to the articles I have read, is that the government would have to start prioritizing expenditures. Here is a great graphic from the Wall Street Journal:
Moody’s economist Mark Zandi says a default will result in higher interest rates, stock prices will fall, and we will go into recession. He also believes that government spending cuts will also result in a recession. In one sense he’s right (not on government spending), a downgrade in Treasurys would cause substantial financial repercussions. Since I believe we are still in a recession, things would get worse until the markets found some equilibrium. My guess it wouldn’t take very long to find equilibrium, but Treasury holders would take a big hit. There are plenty of ramifications here, none good. I don’t mean to sound callous, but perhaps this could be the best result. It could give rise to spending reform sooner rather than later. Our current course is unsustainable and it is only a matter of time before we are forced to deal with these serious issues. That could be now, but I doubt it.
Politics is always theater. In a nutshell, the economy is bad, voters will blame the incumbent if it’s still bad during the elections, and each side is trying to pin the blame on each other. The budget is just a tool the Republicans are trying to use to get concessions on taxes from Obama and the Democrats. The Democrats are queasy about the fallout either way. The just-as-bad Republicans were huge spenders on guns and butter during Bush II. They approved a brand new expensive entitlement for prescription drugs. And now they protest t0o loudly. My guess: the Republicans will cave.
Mark Twain said, “Suppose you were an idiot. And suppose you were a member of Congress. But then I repeat myself.”