Canceling the debt ceiling apocalypse

By Zachary Karabell
October 4, 2013

Before we begin, let it be said that the looming possibility of the U.S.’s default on its own debt is a not-insignificant issue. Let it also be said that the U.S. government may be unwilling to pay interest on its multi-trillion dollar publicly-held debt as of mid-October, and that this carries substantial risks. And, finally, let it be said that this is something we should most definitely avoid.

The potential for a default — however self-inflicted — raises the specter of just about every bad thing economically that you can imagine. And there have been no dearth of voices drawing attention to a variety of doomsday scenarios. The U.S. Treasury Department, which is not normally known for its hyperbole, just issued a report warning of a global economic depression should the U.S. default: interest rates will skyrocket, financial markets will panic, and the global financial system will lose one of its only bastions of predictability and stability.

Five years ago, Lehman Brothers was allowed to fail because of a complacent and erroneous view that its effect would be limited to little more than a market disruption. Today, the prospect of a U.S. default is met with the opposite of complacency. The only voices expressing skepticism that a default would be catastrophic are the very Tea Party ultras whose burn, baby, burn mantra appears to welcome the possibility of an implosion. How else to purify and rebuild a corrupt system?

There’s ample reason to believe that a default will sever once and for all the gossamer threads of trust and stability that sustain not just the U.S. but the global economic system. But it is worth considering that it may not have quite the feared effects, especially because it is such an unprecedented possibility that no one can predict what its outcome might be.

Let’s hypothesize that the next weeks are frittered away as the White House and Congressional Democrats refuse to negotiate on anything until the Republicans allow the government to operate and the Treasury to borrow. Let’s say the drop-dead date of October 17th is reached and the Treasury finds itself unable, logistically, to prioritize the tens of millions of payments it has due. Let’s imagine that it misses an interest payment on the debt, which is the definition of a default. What then?

The speculation is that interest rates will spike dramatically, equity markets will crater, funding markets for daily credit will come under immense strain, and the global financial and commercial system will teeter. That is akin to what happened in the fall of 2008, and the concern is that this coming crisis will unfold the same way.  It’s very easy to see that happening. Less clear is what comes after and when, and that is where we may be making a reverse-Lehman mistake and overestimating the catastrophic effects.

To begin with, there is currently just a tad under $12 trillion of debt held by the public, out of nearly $17 trillion of total U.S. debt. That is a considerable portion of the global bond market, comprising between 10 and 20 percent of all bonds issued globally depending on how one calculates. And some significant portion of that global market is priced relative to the price of U.S. Treasuries, which remain one of the few highly-liquid, highly-rated, and easily bought and sold instruments of credit in the world.

The size of the market for U.S. bonds is one reason for the high level of concern about what would happen if these supposedly safe and secure instruments were suddenly shown to be not so safe and not so secure. But that size also means that U.S. bonds are not like any other financial instrument. Faced with a default of a normal bond, investors shy away. They demand to be paid more for higher levels of risk. They sell what they have. Faced with a default of U.S. bonds, however, people are running towards them.

Bond yields have actually fallen in the past weeks, suggesting higher demand. Searching for safety in risky times, investors — and that means not just traders on Wall Street but large asset managers, investment advisors, pension funds and foreign governments — turn to the one thing that has been safe, U.S. bonds, even as the one thing that looks to be increasingly less safe is…U.S. bonds.

Now you could say that this is a sign of additional risk, because it flies in the face of common sense. Why buy the very thing that looks most imperiled by the political crisis in Washington? Because U.S. bonds are not like any other financial product.

Yes, these bonds are seen as safe, which is why they are so attractive. But that’s a dangerous cliché. The lure of safety is one of the great risks in current financial markets.

Nevertheless, the United States remains fully capable of meeting its debt obligations regardless of a default. The fears over Greek sovereign debt two years ago or Latin American debt in the 1970s was that those economies could not meet the burden of interest payments and could not turn to international financial markets for credit. They were indeed insolvent.

What’s going on in the United States has nothing to do with insolvency. This would be a default of choice, not of necessity. The reason why U.S. bonds are so attractive may in part be a false sense of security, but it is also a reflection of genuine U.S. economic strength compared to almost anywhere in the world. The output and consumption of the United States is largely not a product of the U.S. government, and would not radically change because that government made the monumentally odd and foolish calculation to default on debts that a small portion of the government does not respect.

Even with a dysfunctional government, it’s a good bet that the U.S. will generate sufficient growth compared to the rest of the world. The amount currently required to service the debt of the U.S. government is in fact lower than at any point since the 1980s, because interest rates are so low. And there is no question that the economic output of the country allows for that debt to be serviced, regardless of whether Washington is functional.

That is why the consequences of a default may not be what we imagine. Yes, such an event would likely trigger a financial market panic, and yes, rates would spike in response, forcing a series of consequences as those holdings were marked down to reflect changed market prices. But very quickly, another reality could take hold: because the crisis is purely self-inflicted, the ability of the United States to generate sufficient output to meet its obligations would not have been altered.

What would also quickly become clear is the disjuncture between government on the one hand and “the economy” on the other. For now, we have a tendency to conflate the two, and assume that government is either essential to economic growth (a classic Democrat stance) or inimical to it (a typical Republican approach). A default, or even the threat of one, might expose the degree to which government is one factor among many in the complicated world of economic affairs, and not nearly as powerful a factor as enemies or advocates believe.

It would, of course, be foolish to rest on the argument above and dismiss the risks. But it is wrong to assume the worst just because the worst is so easy to assume. Tea Party nihilism will lead us nowhere good, but the conviction that the actions of Washington are the primary pivot of both the global financial system and American economic vitality is both incorrect and limiting. If any good comes from this crisis, the waning of that conviction would be welcome indeed.

PHOTO: U.S. Senator Chuck Schumer (D-NY) (L-R), Senate Majority Leader Harry Reid (D-NV), Senator Patty Murray (D-WA) and Senator Dick Durbin (D-IL) stand with a clock counting down to a government shutdown at a news conference at the U.S. Capitol in Washington, September 30, 2013. REUTERS/Jonathan Ernst

24 comments

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The future is a construct that is built with intention. The future will be paradise if people make it that way. I would prefer to get to paradise without fighting on the streets, how about you?

Posted by 2Borknot2B | Report as abusive

Do we really want to see if your theoretical construct plays out as you envision it?

There is no need for any of this other than intransigence on the part of a minority in the House to impose their will on the Senate and the president, and in the process harm the livelihoods of many citizens, including me.

By not allowing a vote in the House, Mr. Boehner has taken the whole country hostage to further his political ideology, and assuage the egos of his tea party minority. The damage they are creating on Main Street doesn’t even register on their radar.

LET THE HOUSE VOTE!

Posted by pragmatist7 | Report as abusive

Lehman Bros sank beneath the waves SIX years ago with barely a ripple. The same might not have been true of the other too-big-to-fail/too-big-to-prosecute financial entities of the Wall Street Casinos, except that it was not just an issue of one of them falling into bankruptcy, but all of them where only trillions of cyberdollars created by the Federal Reserve could bail them out of their profigate gambling losses.

Besides, what would have happened to the Plutocracy, the One Percenters? Instead of making out like bandits, their assets in foreign tax-free bank accounts (all legal) might have taken a little bigger hit, but not enough to bankrupt most. The Pee-Ons, the Ninety-Nine Percenters, were mostly cleared of the stock and bond markets, leaving the wealthy profiteers to survive on the teat of taxpayer funds.

Over two years ago, Standard & Poor’s took the unprecedented step of knocking federal debt ratings down a peg from triple-A and the media, especially CNN, jumped all over this as a world-affecting disaster. “The United States has lost it’s favored credit rating! The sky is falling! Oh, me, oh, MY!” By the very next day, Moody’s (owned by Warren Buffett) and Fitch proclaimed that S&P’s action was entirely driven by political, not ecomonic concerns. The US debt has been stronger than ever in history ever since. The US dollar, the world’s reserve currency is the safest investment on the planet. At least, that’s what all the millionaires and billionaires and soverign governments seem to think. Maybe they’re just foolish.

Posted by ptiffany | Report as abusive

What congress intends to do is put a bit of a dent is a colossal government, getting bigger and more expensive by the minute. And we have a known empty suit of a president, who has shown to have no leadership skills to get things done, including negotiating. As dangerous as a default may be, perhaps some minority of the population would get to understand how deep in debt we really are due to an ever growing overpowering government.

Posted by egaliseur | Report as abusive

this reminds me of the reassurance my (then) employer offered when I expressed anxiety that the country was being steered toward the Iraq war. ‘This might turn out well’ he said

Posted by auger | Report as abusive

“Tea Party nihilism will lead us nowhere good…”.

@2Borknot2B,

Your statement “I would prefer to get to paradise without fighting on the streets, how about you?” presumes that this option AND outcome is among those actually available. I believe each day the U.S. keeps spending far, far more than it honestly has to spend, continuing to run the printing presses 24/7 moves “judgment day” for the dollar closer and closer.

If you don’t believe me, read this:

http://insight.rbs.com/articles/why-prin ting-money-is-a-fool-s-paradise.html?utm _source=outbrain&utm_campaign=rbs&utm_me dium=cpc

Posted by OneOfTheSheep | Report as abusive

This article should be titled: “Whistling through the graveyard”

“The problem” is our debt itself, and the fact we’re going into the hole at the rate of $2 trillion per year, just to keep everything from imploding. The author says our country is not insolvent, and I would say, “have you ever heard of a Debt to GDP ratio?” Ours is currently at 106%…and that’s not even counting: unfunded liabilities like social security and pensions, more state and city bankruptcies, the student loan crisis (over 30% have non-payments 90+ days old), any new wars our president wants to get us into, etc. That puts our Debt to GDP ratio in the 150+% range.

Verdict: Pretty much -Insolvent-

Posted by RD137 | Report as abusive

The article does not take into account the position of the dollar as well as the enormous overhang of non-liquid US bonds at the Central banks (including the Feds)to the tune of some 7 trillion dollars.
My personal prognosis is the following :
1.the 10y bond sinks right away/The Feds will be buying frantically ,with little effect.
2.the dollar will start to drop as people will start moving out of it __Continued below.

Posted by jvo | Report as abusive

JVO -continued.

3.The panic becomes really big when people realise that bond redemption values will be in US dollars which nobody wants anymore when the Chinese start disconnecting their currency from them.
4.Sauve qui peut! The house of cards crumbles. JVO.

Posted by jvo | Report as abusive

A few massively rich One Percenters fund the Tea Party extremists and plan to run Ted Cruz for president in 2016. This is who they are:

•Corporate billionaire brothers David and Charles Koch (front group Americans for Prosperity)
•Venture capitalist and hedge fund manager Peter Thiel (front group Club for Growth)
•Leverage-buyout specialist John Childs (front group Club for Growth)
•Investor Howie Rich (front group Club for Growth)
•Executives of JPMorgan (front group Club for Growth)
•Crow Holdings’ Harlan Crow (front group FreedomWorks)
•Shipping magnate Richard Uihlein (front group FreedomWorks)
•Investment banker Foster Friess (front group FreedomWorks)
•Executives of MetLife (front group FreedomWorks)
•Philip Morris (front group FreedomWorks)
•Foundations controlled by the Scaife family (front group FreedomWorks)

Posted by Des3Maisons | Report as abusive

To make your weekend:

Another report states that the Federal agency overseeing the Derivitaves market is SHUT DOWN.

The horrible regulations allowing garbage home mortgages to be bundled and traded as the highest quality securities, that crashed the economy.

Most Americans believe dozens of top bank executives should be in prison for fraud at the $Trillion level.

The right’s hero REAGAN did exactly that (S&L scandal) – only far more than “dozens”.

Posted by cirrus7 | Report as abusive

@Des3Maisons -

Bill Maher will let any right wing idiot say ANYTHING.

Last night – one said the Tea Party is a grass roots movement firmly against Corporate Profits and Wall Street. No challenge, because his next smirking comment was all teed up.

Posted by cirrus7 | Report as abusive

@Des3Maisons -

Thanks for the truncated list of top Plutocrats that is closer to 400, still a tiny fraction of the One Percenters Club. I’m sure that the offshoot of Occupy Wall Street with a more violent agenda for fighting the Class War will appreciate these names. All that’s missing is addresses…

You have identified the core issue facing this declining republic. These are the people who have inundated the gullible with side issues – abortion, gun control, etc. – that distract them from recognizing that the “job creators”, actually purely profiteers who are job destroyers, have taken over this country. They are busy counting their precious metals, gems and cash ferreted away in tax-free (all legal – wink, wink) foreign bank accounts.

Posted by ptiffany | Report as abusive

@Des3Maisons, cirrus7 and ptiffany,

You “99% vs. 1%” would-be class warfare instigators are today’s equivalent to the OWS side show or Nero fiddling while Rome burned. The collapse of the dollar as a credible international substitute for holding gold will be both swift and irreversible.

It will take down both rich and poor Americans. BOTH political parties and ALL elected individuals who pretend to know nothing (or look the other way) must be considered complicit and responsible (not that this will then matter).

Once all governments today squirreling away “Monopoly money” dollars of no meaningful backing start pulling them from national vaults they increasingly dilute the purchasing power of ALL dollars in actual circulation.
The scenario could well mirror the rampant inflation in the German Weimar Republic following WW I which ultimately led to Hitler’s election as Chancelor of Germany.

Few remain with personal memory, but Google it. It took wheelbarrows of paper bills to buy a loaf of bread. What one earned each day had to be paid and immediately spent less it’s value be halved the following day. To survive, people ate rats!

What does that have to do with you and yours? As an elderly American’s Social Security check becomes as worthless as our dollars our national economy will enter a death spiral from which no one will be isolated.

Today our political magicians of BOTH parties have some of the people, like you, fooled all of the time. But not ALL of us.

Posted by OneOfTheSheep | Report as abusive

According to CNNMoney,

“Congress has set a cap [or ceiling] on how much debt the U.S. can incur.”
[This limit is about as flexible as the limit on your credit card.]

“The U.S. [routinely] spends a LOT more money than it has coming in. In May 2013, the debt reached the [present] ceiling. Since then, the government has shuffled accounts to avoid any further debt, but they’re almost out of tricks…” and soon there will be no money to pay bills for excess ongoing spending that continue to arrive.

“They can’t borrow more, because that would push debt above the ceiling. So, either the debt ceiling must be raised, taxes have to go up to an unrealistic level, or spending must be slashed, also to unrealistic levels.”

“If none of these are implemented, the country would default. That could mean: Recession, Bond market crisis, Decline in the stock market, Lowered value of the dollar, Higher unemployment.” See for yourself:

http://money.cnn.com/interactive/news/ec onomy/whats-up-with-the-debt-ceiling/

Let’s try to pull back the usual curtain of obfuscation to reveal facts that which so-called leaders of both parties and the White House routinely conceal.

The Debt Ceiling legislation adopted by Congress publicly acknowledged the fiscal danger inherent in spending more than incoming revenue. The illusion was thus created that Congressional fiscal irresponsibility might thus be brought to an end. Alas, the illusion was but a mirage.

Today some used to watching government printing presses churn out endless dollars with NOTHING behind them wonder publicly why Congress ever adopted a debt ceiling. After all, they have routinely and painlessly increased adopted “limits” again and again.

“We, the people” today allow OUR government a “blank check” on OUR future earnings to squander without limit or permission. WHY? That’s neither rational nor logical. Yet OUR government bristles with outrage and indignity at each and every demand for accountability.

Worse, OUR government has exhibited neither shame nor honorable intent. It never paid off the debt run up during WW II. Over the years it instead intentionally inflated that debt into insignificance.

Along the way the car “We, the people” could buy for $3,600 in 1970 today costs $21,700. Think now about how much more you must earn today and pay in taxes on that before you have $21,700 with which to buy that car (or to buy it over time, with interest).

It has diddled with the “inflation adjustment” of Social Security such that recipients are NOT fully protected from OUR government’s intentional inflation. Today they propose a “chained index” that will further erode purchasing power over time!

The American government has become a fool’s paradise of unelected agencies and bureaucrats that judge their success by how many bureaucrats they employ and the size of their annual budget. Such agencies enjoy essentially eternal life utterly without meaningful accountability.

A self-funding “helping hand” of 22 weeks unemployment benefits has been extended up to TWO YEARS at taxpayer expense. Those on unemployment that have earlier lived within their means can take up to a two year vacation before seriously looking for a job.

America’s underclass is exploding in size, receiving far more from countless government programs than those able bodied adults could earn at minimum wage. They would actually have less money to spend were they to accept any of the jobs they qualify for. WHY does America pay these people to sit home and breed more of themselves?

Medicare Part D gave “Big Pharma” an excuse to end previous free or discounted drugs to those of low income and charge whatever they wanted as a “retail” price. When implemented this program actually cost my wife and me money “out of pocket”. Thanks, Washington.

Medicare fraud is rampant, and all “We, the people” hear is excuses why it can’t be controlled. Washington pays “Big Ag” not to plant food and keeps prices up for farmers (and consumers!). Food safety and drug safety are a laugh at great expense. Consumer protection is most evident by conspicuous absence.

The “bottom line” is that Congress wastes a huge amount of the obscene amount it spends each and every day. I find CNN’s description of the “option” of slashing spending to levels (LIBERALS IN GOVERNMENT deem) “unrealistic” most peculiar. What is “unrealistic” about government spending being limited to “available revenue”? It did so for well over a hundred years, so there IS precedence!

Congress has proved beyond reasonable doubt that it CAN NOT make efficient use of existing revenue to meet NEEDS exclusive of WANTS. Given this reality, allowing it additional revenue by raising taxes AT ALL would be much like trying to extinguish a fire with gasoline.

Look closely again at CNNMoney’s opinion as to the effect of a U.S. Default. So “the market” has either already discounted these fears or a “correction” is long overdue.

Americans know we’re STILL in recession. Our bond “crisis” merely reflects reality. Our stock market is ridiculously inflated. Countless U.S. dollars in foreign government vaults backed only by the value of their ink and paper guarantee over time the value of the dollar will fall. Everybody knows that published unemployment figures have NO relationship to reality.

When America ceases to print worthless dollars and again prioritizes it’s revenue to meet it’s day-to-day needs it will again deserve a measure of trust from it’s citizens. Governments holding U.S. dollars can again rely on America being willing and able to pay it’s JUST debts. NOT BEFORE.

Posted by OneOfTheSheep | Report as abusive

Scary indeed….Say debt ceiling heading to $23TRILLION..what does this figure mean.?…
250Million people say in the USA at $25TRILLION debt and rising…
EQUALS $100000 for every man woman and child in the USA…AND RISING…..NOT SUSTAINABLE.

If an individual was in debt to these levels with dwindling income and they said “I will just raise my debt ceiling”…What would the repsonse be.?????

Posted by coplani | Report as abusive

The GOP leadership should be wary of extremists. A small minority group by itself has few chances in politics. So it rides piggyback into parliament on the back of an established party, and then enforces its will on the party leadership. The last time this was done successfully was in 1933 by the German Nazis.

Posted by pbgd | Report as abusive

For us bystanders, the basic point is that we may be about to find out what happens when the U.S. debt ceiling comes and goes without being increased.

Posted by Bob9999 | Report as abusive

“it is worth considering that it may not have quite the feared effects”: how much is it worth and to whom?

Posted by MBmb | Report as abusive

Partisan politics supersede the common good.

Posted by rikfre | Report as abusive

“It is worth considering that it may not have quite the feared effects.” You make sense because the financial community has shown resilience and things will hopefully get better. Despite gold prices rising and stocks dipping, investors are acting sensible….And we shouldn’t be surprised at all.

Posted by VickyLeaks | Report as abusive

What all this means still isn’t clear, and it’s probably something other than what it used to be. At one time the US was undoubtedly the largest economy and the largest debtor in the world, but in spite of the increasingly huge numbers attached to our indenture, we’re no longer the biggest dog in the cave. Thanks to the tacitly legal criminality of the private financiers, there are now huge amounts of “assets” in the form of derivatives that some estimates put at something like $200 billion. This is more than the whole world’s gross “domestic” product. Even if someone actually had that much in cash, they’d have a hard time spending it because there aren’t enough goods and services to be had on the entire planet! At this point, do prices or debts really mean anything?

Posted by Art_In_Seattle | Report as abusive

Whether the markets are going nowhere or anywhere, if the government fails to raise the debt ceiling by October 17th, it may not just halt everything.

Though there are so many things to refer to for a common man, what does he infer from all that is being said by the big people including Warren Buffet? He too has called the raising as pretty damn dumb.

Posted by robtgossard | Report as abusive

Refusing to fund lawful obligations by minority goes against majority rule and what the American people expect. Sections 4 and 5 of the Fourteenth Amendment makes such actions unconstitutional. $ says lawful debt will be paid and 5 says Congress will make provisions for that.

It will take time for the courts to act and they may be packed by many year or Republican appointments. But the House’s Tea Party and their allies will remain known addicted to illegal, undemocratic and financially problematic for most actions.

Hopefully at election time and when people decide on political contribution.

Posted by Samrch | Report as abusive