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.

21 comments

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Huh? Why aren’t you taking the fact into consideration that there is no other investment available in sufficient quantities for people to flee towards? The reason other countries don’t invest in their own country is purely ideological, and isn’t going to change just because some corrupt CRA has put the US on neg watch..

Posted by Foppe | Report as abusive

The 2005 paper had flawed methodology, but if you take it as a starting point, you would at least have to segregate out long, medium, and short-term debt. Then you would have to dynamically simulate the roll-off of existing debt. You can’t just instantaneously apply 150 basis point expense to a dynamic debt load.

Then you have to account for, as Foppe notes, continued forced seignorage, as there is not as yet a credible alternative to the USD. If present trends continue, the Yuan may be a candidate, but not for another two decades. (And that, of course, depends on there being regulatory and economic reform in China.) So that is beyond the current discussion.

Taking these factors into account I would expect the maximum loss in 10 years would be about $12 billion, and the integral of the line to get there would come to about $50 billion (because of the term structure of the debt). I suspect that there are a lot of legislators that would take comfort in such a figure–$3T in savings for $50b in costs.

So perhaps these figures aren’t passed around because no one finds them useful. The tea-party folks don’t want to discuss costs; and their opponents don’t want to show a 60:1 tradeoff.

Posted by Publius | Report as abusive

I am not an economist, but I wonder if reality isn’t more important here than economic theories, which apparently are limitless?

In the present world, which has yet to be fully understood, we face rising education, production, and technology levels in a growing number of countries. Our own reality is different. We now have many more people to feed, far less cheap oil to pump, and rising environmental costs just to cope with rising population and expectations.

We will, happy or not, adjust to a lower level of personal spending, measured in real terms and viewed in comparison to emerging major nations, each of which is also trying to increase resource consumption.

Perhaps the least answered question is this: When does economic sobriety best begin? Yesterday, today, or tomorrow? For too many the answer has always been “tomorrow,” or “never.”

I think that we should not perpetually pass on ever increasing debt loads to future generations. They have no voice, but we do, and we can do better.

Posted by Marvinlee | Report as abusive

You won’t have to wait long Felix…

The U.S. will be a AA credit by the end of the year. As usual the ratings agencies are a few years late.

Put things in perspective our budget is 1.25T out of balance each year… and this mega deal promises to save 2.4T over 10 years.

So this deal saves in 10 years what we borrow in 2 years. Does that sound like a rock solid credit to anyone?

I see a huge market emerging for inflation protected fixed income assets that are not dependent on a goverment inflation calculation. Come on Exxon… sell me an oil bond I’ll pay you the dollar cost of 100 barrels today and you pay me just 2 barrels per year for 20 years. Think about it Exxon that’s just 2% interest for 20 year debt… that’s half what you pay in nominal dollar terms!

Posted by y2kurtus | Report as abusive

is my maths out? I make 150bp * 15trillion = 225bn? Or is there an american definition of a trillion that I wasn’t aware of?

Posted by jonners | Report as abusive

Time to insist that the so-called “Insurance” taxes on wage earners in the US be cut the same percentage amount as benefits. The Federal Government always presumes the poor need to get poorer and that that benefits what they call “society”. And they always assume that making the rich richer also benefits “society”. At least the society they live in as opposed to the society the rest of us live in.

It is also clear that after paying FICA taxes for 50 years that they “cannot afford” to pay what was promised. That means they want to keep the money rather than pay. What would we do to an insurance company with hundreds or thousands of times the assets needed to pay contractual policy claims, but who decided they “could not” (read — “do not want to”) pay them? Would we not seize their assets?

It is clear the Federal Government will not permit that. So let’s have a real tax cut for a change. But let’s not cut the fabled Income Tax, but the FICA wage taxes that account for 40% of Federal revenues and that have been spent on stupid pro-Israeli wars in Asia. Let’s cut the FICA taxes down to the zero they should be. No benefits, no taxes. No benefits, no taxpayer paid for military outside of the USA. No wars without a direct popular vote supporting it every 12 months. Mandatory benefit cuts for all Federal workers to match cuts in Social Security, Medicare, and Medicaid. Elected officials, in particular, are Federal workers.

That might get us on the road to tax equity in this country, and cause the common people to recognize how little they mean to the powerful foreigners we have permitted to live in, operate from, and rule our country.

Posted by txgadfly | Report as abusive

Don’t fret Felix, that plan all along has been to print our way out of this as inflation is the tax nobody has to vote for. It will be hyper-inlfation but the wealthy who control cCongress and more of US wealth don’t really care and can avoid it.

Posted by advocatusdiabol | Report as abusive

y2kurtus is on target, as usual.

Prior to these cuts, we were perhaps ten years away from a Greek-style debt disaster. These cuts might push that back a couple years. Not nearly enough, but it is a start.

Printing your way out of debt isn’t a workable answer until you balance the primary deficit, as borrowing costs will skyrocket as soon as it becomes obvious you are taking that approach.

Posted by TFF | Report as abusive

“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.”

But who are these countries that seem to have trillions of dollars of reserves to begin with? Nobody else issues US dollar but the US. Oh yes, these are the countries that incur trillions of dollars of surpluses with the US. And if they continue to incur trillions of dollars of surpluses with the US, they will always have trillions of dollars to invest. Will they invest it domestically in their economies instead? Not unless their people start accepting and circulating US dollars as alternative domestic currency. Have you ever seen an economy that is circulating trillions of US currency in their domestic economy? No. But if they start doing so, then that actually increases the value of US treasuries because if China, for example, starts circulating US dollars domestically, then their citizens will start saving in US treasuries.

Will they invest the US dollar reserves in other countries? Not unless other countries start circulating trillions of US currency in their domestic economy. Again, have you seen a country circulating trillions of US currency in their domestic economy? No. But if they start doing so, let’s say in Africa where China seems to invest a lot, then that actually increases the value of US treasuries because if Africa, for example, starts circulating US dollars domestically, then their citizens will start saving in US treasuries.

Posted by rogueecon | Report as abusive

I think I agree with Rogueecon.

U.S. debt isn’t the most profitable possible investment, but it is still the safest, isn’t it? Investing somewhere else? Where? The Euro? The yuan? The yen? Gold? The stock market? Presumably sovereign funds would invest in their own country if there was anything more secure to invest in. The U.S. debt ceiling crisis was politically manufactured, not a question of national insolvency. That’s a brute economic fact, apparent to all but the Tea Party (to our great national misfortune).

The U.S. dollar has enormous leeway internationally for historical reasons. As long as the rest of the world is in crisis (Europe) or boom (developing countries) the dollar has the great, if undeserved, cushion of being the world’s stable currency.

When and if more normal economic conditions return, the world may (wisely) decide otherwise.

Posted by jbernar | Report as abusive

“Presumably sovereign funds would invest in their own country if there was anything more secure to invest in.”

It is my understanding that sovereign funds often have a mandate that prohibits or limits the extent to which they can invest in their own country, sometimes for anti-inflationary reasons, sometimes just as a bit of bureaucratic turf-division.

On a related point: did Feldstein’s op-ed in the WSJ this morning seem as wrong-headed to everyoen else as it did to me?

The gist of his piece is that the US dollar will lose value vis-a-vis other currencies in coming years, and this will be a good thing, because it will help out exporters. That line of thought itself isn’t new or interesting. Nor is the first of the reasons he gives for this view. He says that various “sovereign wealth funds and other international holders of larghe dollar balances” will diversify the currencies of their holdings, and this will have the effect of reducing the value of the dollar. I can’t argue with that.

The second reason he gives for this expected fall, though, is what lights a fire under my sanguinary kettle. He says the dollar will fall in value because the Fed will engineer such a fall, and that will be a good thing becauise the Fed can do so without setting off wage-price inflation.

“In the U.S., where only 7% of private workers are unionized, there is now little danger of an inflationary wage-price spral. The Fed can therefore counter the current econopmic weakness by promising to keep short rates at a near-zero level for an extended period of time,” Feldstein writes. Of course, if the Fed keeps rates near zero while the ECB raises its rates, then people will convertt their dolars into euros to take advantage of the latter. Which will help our exporters. Get it?

Why is this offensive? It asks us to believe that inflation is only a problem if workers are organized and can fight back. If workers aren’t organized (as, in the US private sector, Feldstein rightly notes they aren’t) then they can’t fight back and demand increases as the value of their wages is being cheapened by ruling-class honchos like Feldstein and his policy making friends. So, stick it to them!

Ah, it’s all justified by creating more market opportunities for our exporters. Evidently, it won’t do much good for the people working for those exporters, because they are among those happily unorganized private sector workers who are going to get screwed. So Feldstein means that a loss in the value of the dollar, and their wages, will end up helping the stockholders of our exporters.

Sorry, Sahib, but this makes me want to head to the ocean for some salt.

Posted by Christofurio | Report as abusive

Two things, European sovereign risk is measured as the spread releative to the German Bund. Why not try that?

If a ten year treasury bill has a rate 20 basis points lower than a ten year bund, then a first order estimate would be 20 basis points for ten year debt.

But I think you are missing the point. Not only to the Tea Partistas see debt and tax as inherently evil (even if the federal tax take is lower than when Reagan left office), but all this buying of treasuries by foreign sovereigns can be viewed as PART OF THE PROBLEM.

It is a way of them keeping their currencies (hence export prices) artificially low in dollar terms.

If the US defaults, the dollar collapses, China gets pneumonia.

In some ways, they are right. US federal debt and budget deficits are out of control. The borrowing money from China in order to buy their goods model is clearly broke.

The left should really have been arguing for tax rises with the same zeal as the right for spending cuts. Getting trapped in the deficit denier hole was a big mistake.

Posted by Dafydd | Report as abusive

Mind you, I believe this will all increase the cost of borrowing for the US and for others borrowing in US dollar.

But if you were a country with so much dollar reserves, where are you going to put it? In US assets. And if you as that country were to buy some other country’s assets instead, that’s some other country now with excess US reserves. Where will they put it? In US assets.

The fact that the manufactured crisis increases the rate for US Treasuries is icing on the cake.

Posted by rogueecon | Report as abusive

Mind you, I believe this will all increase the cost of borrowing for the US and for others borrowing in US dollar.

But if you were a country with so much dollar reserves, where are you going to put it? In US assets. And if you as that country were to buy some other country’s assets instead, that’s some other country now with excess US reserves. Where will they put it? In US assets.

The fact that the manufactured crisis increases the rate for US Treasuries is icing on the cake.

Posted by rogueecon | Report as abusive

“The U.S. debt ceiling crisis was politically manufactured, not a question of national insolvency.”

We were maybe a decade away from having a formal national debt equal to 150% of GDP. Hard to define exactly what “national insolvency” means, but we might not be that far away.

“Why is this offensive? It asks us to believe that inflation is only a problem if workers are organized and can fight back.”

When wages are tied to inflation, then it is very difficult to reduce wages. When they are not tied to inflation, you can erode them in that way. Whether or not US wages *should* be reduced is another question, but that does appear to be the clear intent of present policy.

Posted by TFF | Report as abusive

Credit rating? Why do we have to depend on borrowing? Seems like the culture requires us to rely on borrowed money. Why is that? Seems like it means we have no control over our spending to me. Debt free would be a better feeling, would it not? Surplus would sound even better. A surplus is interest free. How does that sound?

Posted by ajmg1 | Report as abusive

@ActualTaxpayer anyone who doesn’t agree with you on Reuters is a leftist loonie without a clue…

I am afraid your well thought out commentary, such as constantly calling Obama Nobama, etc. doesn’t make you capable of being a journalist and would very much lower the bar.

Posted by hsvkitty | Report as abusive

I am inclined to agree with Foppe that the CRAs are corrupt and using their power when it suits them.

The USA has been borrowing 40c of each dollar it spends and they intervene now? Why were they so politically involved and scaremongering yet not involved every time the ceiling was raised?

Here is the divide Felix was talking about the other day…

“This deal trades people’s livelihoods for the votes of a few unappeasable right-wing radicals, and I will not support it,” said Representative Raul Grijalva, an Arizona Democrat.

Presidential candidate Michele Bachmann, a Minnesota congresswoman and favourite of the so-called Tea Party wing of the Republican Party, countered that the deal “spends too much and doesn’t cut enough…. Someone has to say no. I will.”

You guys need a Paul Martin. (Actually we need him back!)

Posted by hsvkitty | Report as abusive

It’s only the press and the average American that is oblivious to the debt crisis. Yes, it was politically manufactured… by the Progressive Left that keeps on deficit spending. (Note that I’m including Bush-43 here as he wasn’t a conservative, he was a progressive president, just look at his policies). Countries like China, Russia, Japan as well as the debt markets already knew the deep hole we were in BEFORE this became front page “news”.

As for the debate causing the slip in confidence and probably downgrade in the rating, you have it backwards. The only reason it hasn’t already happened is because there really is no place better to put your money. However, as the debt to GDP ratio worsens thanks to trillion-plus annual deficits, this too will change. We’re only the beginning of it.

Finally, when would be the right time to have the debate, AFTER the rating has fallen a couple of points? AFTER we’ve defaulted? We really should have been having this discussion for the last decade but the good economy up to 2007 hid it from us and the bad economy after that gave President Marxist cover to justify his spendathon.

Posted by iq160 | Report as abusive

The bill needed 42 Democrats; it got 95. Let’s see how the Senate goes.

As y2kurtus notes, this is at best a small move in the direction of prudence. 13-digit deficits each year, even in a stagnant economy, are well outside “prudent” bounds, and whatever this results in will still be some distance away. Still, this bends the second or third derivative in the right direction, and perhaps that’s worth something in terms of projecting the likelihood that we’ll remain solvent. If it is, the last couple weeks will ultimately have improved our credit-worthiness, not diminished it.

Posted by dWj | Report as abusive

“Finally, when would be the right time to have the debate, AFTER the rating has fallen a couple of points?”

Ten years ago… The problems would have been much easier to deal with then. Instead we spent a decade feeding a public/private debt frenzy that has left our national economics in shambles.

Posted by TFF | Report as abusive