The cost of the debt-ceiling deal

By Felix Salmon
August 1, 2011
Christine Lagarde put it:

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It could hardly have been done with more sturm und drang, but a deal to raise the debt ceiling now seems to be in the bag. This is a clear victory for the Republicans, who have managed to find a way to hold any Democratic administration hostage. Linking the debt ceiling to spending cuts makes more conceptual sense than linking it to, say, a constitutional amendment banning gay marriage — but in principle the Republicans could link their votes to anything they liked. After all, spending decisions are made in budget bills, not in debt-ceiling negotiations.

At the same time, the debate is a clear loss for America as a whole. Here’s how Christine Lagarde put it:

There was a positive bias towards the United States of America, towards Treasury bills. That was the case historically. And the current crisis is probably chipping into that very positive bias.

That very strong confidence that generally led to a flight to quality and investment in Treasury bonds is slightly eroded at the moment. I mean, it was unheard of, only six months, to imagine that the United States could be under negative watch by the rating agencies.

So here’s what I’m wondering: is there some way of quantifying the cost to the US of simply having this debate? Is there a way of taking Lagarde’s “positive bias” and giving it a number, in terms of say basis points of reduction on US borrowing costs?

It’s impossible to calculate the full cost of the debt-ceiling debate, since that’s going to become obvious only long after the US loses its triple-A credit rating. It’s in times of crisis that these things really matter, and the next time there’s a crisis, we might well see much less of a flight-to-quality trade with respect to Treasuries than we did in, say, 2008.

But there’s a real cost to the US just in terms of its day-to-day borrowing costs. All those foreign sovereigns, for instance, who love to invest trillions of dollars of their reserves in Treasuries — it’s easy to see how they might be rather less in love with that idea at the moment, and how they might start wondering if they shouldn’t just take that money and invest it domestically, instead, or in some other country’s debt or equities.

This paper, for instance, from 2005, estimates that foreign flows into US bonds reduced the interest on America’s debt by a whopping 150 basis points, at the long end of the curve. Take a US debt of $15 trillion, raise the interest expense by 150 basis points, and you’re talking $22 $225 billion a year in increased interest payments. Given the certain rise in government debt, that’s the best part of $250 billion $2.5 trillion over 10 years if you take the standard CBO way of costing things. If you want to reduce the budget deficit, keeping interest rates low is a great way of doing that.

But 150 basis points is a very old figure. Is there a newer one? And is there, specifically, any way of estimating the effect on US borrowing costs of this debt-ceiling debate? The answer could be very sobering to any genuine fiscal conservative.

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