“A politically disruptive standoff is likely later this year,” Goldman’s David Kostin said, citing the bank’s economists while editorializing around the potential market ramifications of a worst-case debt ceiling outcome in Washington.
It’s unfortunate, to say the least, that the rest of the world is compelled to periodically ponder the prospect of a voluntary US default.
Do take a moment to consider how spoiled, selfish and reckless this looks in other locales. The rest of the world needs dollars, and countries which don’t issue hard currency are often compelled to borrow in dollars, and yet here’s the sole legal issuer of them threatening to default for the sake of domestic political grandstanding.
America established and perpetuated a global system of commerce, trade and finance predicated on its currency, and encouraged other nations to recycle their savings via interest-bearing versions of it (US Treasurys). To do that, and then deliberately default while haggling over an arbitrary limit on the creation of the very same securities that everyone in the world needs and wants, is painfully asinine.
More importantly, for the US to default on the tacit assumption that a lack of alternatives means the rest of the world will have no choice but to forgive us, is so mind-bogglingly pretentious — so disdainfully arrogant — that not even I can fathom it, and I’m someone whose personal penchant for selfishness and arrogance is such that the pile of associated burned bridges has rendered entire canals unnavigable.
“I’m not concerned in the sense that the debt limit really isn’t about the big question of whether the US government can continue to borrow money that people believe it can pay back, which is ultimately what’s relevant,” John Cochrane told Goldman’s Jenny Grimberg, for the latest installment of the bank’s “Top Of Mind” series. He went on:
The debt limit is serious because Treasurys are an important source of safe collateral in the financial system. If Treasury continues to make noise about defaulting — even if it’s only a technical default and bondholders will eventually be made whole — it would be disastrous for the financial system because Treasurys could no longer be used as collateral. Seeing that coming, investors would start unloading Treasurys. This was the experience of mortgage-backed securities during the GFC — they didn’t so much fail as become risky, so people wouldn’t take them as collateral, and everyone started dumping them. Given that risk, I am appalled that Treasury doesn’t say loud and clear that it will continue to pay principal and interest on the debt, which it has plenty of money to do. Not saying so risks igniting a financial crisis.
While I don’t agree with a lot of what Cochrane preaches about the relationship between fiscal policy and inflation outcomes, I wholeheartedly agree with that excerpted passage.
Some readers have inquired as to a CliffsNotes-style snapshot of prior debt ceiling episodes and their impact on markets. The table below, from Goldman, is a handy reference guide in that regard.
“During the 2011 debt limit showdown the S&P 500 fell by 17% from peak to trough in 22 trading days [and] the VIX tripled to a level of 48 from 16,” Kostin wrote, in the same noted mentioned here at the outset. “Outside of 2011, debt limit episodes have usually had a limited impact on financial markets,” he added.
The median peak-to-trough drawdown for stocks is less than 5%, and although options have exhibited more skittishness, the median VIX peak of 27 is hardly indicative of panic.
Obviously, Bills and stocks most exposed to government spending are at higher risk, but frankly, any discussion about the implications of a prospective US default are pointless because the elephant in the room is impossible to address. Specifically: How does a world which was forced to accept US currency hegemony cope psychologically with a voluntary default predicated on petty bickering couched in nonsense terms which suggest many US lawmakers not only don’t grasp the role of USD collateral in the global financial system, but in fact don’t understand the nature of Treasurys themselves?
I contend that “debt” is a mischaracterization of Treasurys, but even if you don’t like that contention, and insist they are debt, they’re unequivocally more than that. Treasurys are multi-faceted securities that serve a variety of critical purposes for their issuer and end users alike. Calling their creditworthiness into question would be to suggest that the system America built isn’t a safe system anymore.
While one should expect such suggestions from those who’ve been cut off from that system (e.g., Russia and Iran), or from those looking to supplant it (e.g., China), the very last people you’d expect to find calling it into question are US lawmakers. But that’s where we are in America. And if we’re being honest, that constitutes a kind of default in and of itself.
Back to back HRs. Give that man a contract!
Helpful article, good zingers.
I always looked at this as a charade, a stupid game of chicken. And I thought the fools on the republican side were just desperate to use some form of imaginary leverage to get attention but did not want to actually hurt the country. They merely wanted to shine light on themselves while they made spurious arguments, in the hope of obtaining some imaginary form of credibility within their own party (not that there is anything credible about their arguments).
I appreciate your intimate knowledge of this topic, Walt. These are not truths that I know in my everyday life. But your perspective of this topic is a product of life-long experience. Would it be possible to suggest that your argument find its way to the New York Times or Wall Street Journal? Are there any other former colleagues of yours on Wall Street, financial leaders with a similar understanding of the ramifications of the threats being made by House republicans?
Do members on either the democratic or republican sides of the House have such an understanding of possible outcomes enabled by this fools’ game? Are there not multiple, significant Wall Street donors that favor the Republican party who could make a call to the Republican caucus in the House and tell them to knock it off?
Amen
My hope is that some big donors have a meeting with the whole Freedom Caucus and tell them that a default only gives China the advantage. Once the trust and full faith of USD comes into question why not start writing business contracts in Yuan instead of USD.
On John Cochrane’s comparing MBS during the GFC, and Treasuries now, says “they didn’t so much fail as become risky, so people wouldn’t take them as collateral, and everyone started dumping them”.
Not being snarky; I’m very interested in how our “system” was devised/has evolved, but couldn’t that be construed a failure? Doesn’t it speak to the inherent pyramid-esque design of our system? Can we talk about the un-educated lawmakers on either side when it comes to debt/deficits without also getting into how confidence is the real currency (maybe collateral)? Is the process of educating the public impossible? There are still plenty of regular people with adequate levels of education that should be able to understand how our system works for us at home and others abroad. Is it too scary for people “in the know” to consider letting others in on things? If so, that seems problematic.
All way above my education level and pay-grade I guess. I don’t watch or listen to financial news pundits, but really appreciate this site for what seems to be intellectual honesty.
The concept of “the people”, while talked about a lot over the years, was not something the founding father’s totally trusted. When the constitution was adopted in 1789, it established two divisions in the Congress, There was a House of Representatives, to be elected by those “people,” apportioned by population in each state and serving for two year terms. The country chose to have a President rather than a king, after all that’s what we had fought and many died to get rid of. However, the rich and powerful liked the idea of England’s House of Lords whose members held hereditary titles and were major landowners. So we decided Senators had to own property and that they should not be elected by “the people.” Instead, the founders decreed that the legislative bodies of each of the several states would each choose two senators from their respective states to serve for six years. One suspects this was done to reduce blowback from the states, them not all being happy about ceding many key rights solely to the Federal government. While the property requirement was eliminated, the direct election of Senators was not enacted until 1913 through the 17th Amendment. Of course, it wasn’t until the 19th Amendment was passed in 1920 that the “people” came to include the ladies of the country. In between, as some may remember, Amendment 18 gave us the income tax and the beloved IRS. One thing this country didn’t erase when it was formed, was the dominance of white men and the power of the rich over the poor. (There was an equal rights amendment in there somewhere but it still hasn’t been enacted.) If you didn’t when H posted the link, go to OXFAM and read the white paper on “Taxing the Rich.”
Bravo!