The default has already begun

By Felix Salmon
October 14, 2013

The big question in Washington this week is whether, in the words of the NYT, we’re going to see “a legislative failure and an economic catastrophe that could ripple through financial markets, foreign capitals, corporate boardrooms, state budget offices and the bank accounts of everyday investors”. In this conception — and I have subscribed to it just as much as anybody else — the sequester is bad, the shutdown is worse, and the default associated with hitting the debt ceiling is so catastrophic as to be unthinkable.

This frame is a useful one, not least for the politicians in Washington, who seem to have become inured to the suffering caused by the shutdown, and downright blasé about the negative consequences of the sequester. Both of them could last more or less indefinitely were it not for the debt ceiling, which is helpfully providing a hard-and-fast deadline: Congress is going to have to come up with a deal before the ceiling is reached, because the alternative is, well, the zombie apocalypse.

There’s more than a little truth here: I’m a firm believer, for instance, that the president both can and should prioritize debt repayments in the event that the debt ceiling is reached. If we’re going to be so stupid as to hit the ceiling, then prioritizing debt service is the least-worst outcome. But at the same time, the situation is less binary than it looks, not least because the US government is already in default on its obligations.

The best way to look at this, I think, is that there’s a spectrum of default severities. At one end, you have the outright repudiation of sovereign debt, a la Ecuador in 2008; at the other end, you have the sequester, which involves telling a large number of government employees that the resources which were promised them will not, in fact, arrive. Both of them involve the government going back on its promises, but some promises are far more binding, and far more important, than others.

Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. Indeed, by Treasury’s own definition, it’s reasonable to say that we have already defaulted: surely, by any sensible conception, the salaries of government employees constitute “legal obligations of the US“.

Conversely, if you really do expect zombies to start roaming the streets the minute that the US misses a payment on its Treasury obligations, you’re likely to be disappointed. Yes, the stock market would fall. But the price of Treasury bonds would remain in the general vicinity of par, and it might even go up if Treasury announced that past-due interest would be paid on all debt at a statutory rate of 8% per annum. Even when it’s Treasury bonds themselves which are the instruments in default, Treasury bonds remain the world’s flight-to-quality trade, and the expected recovery on all defaulted Treasury obligations would be 100 cents on the dollar — or more.

The harm done to the global financial system by a Treasury debt default would not be caused by cash losses to bond investors. If you needed that interest payment, you could always just sell your Treasury bill instead, for an amount extremely close to the total principal and interest due. Rather, the harm done would be a function of the way in which the Treasury market is the risk-free vaseline which greases the entire financial system. If Treasury payments can’t be trusted entirely, then not only do all risk instruments need to be repriced, but so does the most basic counterparty risk of all. The US government, in one form or another, is a counterparty to every single financial player in the world. Its payments have to be certain, or else the whole house of cards risks collapsing — starting with the multi-trillion-dollar interest-rate derivatives market, and moving rapidly from there.

And here’s the problem: we’re already well past the point at which that certainty has been called into question. Fidelity, for instance, has no US debt coming due in October or early November, and neither does Reich & Tang:

While he doesn’t believe the U.S. will default, Tom Nelson, chief investment officer at Reich & Tang, which oversees $35 billion including $17 billion in money-market funds, said that the firm isn’t holding any U.S. securities that pay interest at the end of October through mid-November because if a default does take place, “we’d be criticized for stepping in front of that train.”

The vaseline, in other words, already has sand in it. The global faith in US institutions has already been undermined. The mechanism by which catastrophe would arise has already been set into motion. And as a result, economic growth in both the US and the rest of the world will be lower than it should be. Unemployment will be higher. Social unrest will be more destructive. These things aren’t as bad now as they would be if we actually got to a point of payment default. But even a payment default wouldn’t cause mass overnight failures: the catastrophe would be slower and nastier than that, less visible, less spectacular. We’re not talking the final scene of Fight Club, we’re talking more about another global credit crisis — where “credit” means “trust”, and “trust” means “trust in the US government as the one institution which cannot fail”.

While debt default is undoubtedly the worst of all possible worlds, then, the bonkers level of Washington dysfunction on display right now is nearly as bad. Every day that goes past is a day where trust and faith in the US government is evaporating — and once it has evaporated, it will never return. The Republicans in the House have already managed to inflict significant, lasting damage to the US and the global economy — even if they were to pass a completely clean bill tomorrow morning, which they won’t. The default has already started, and is already causing real harm. The only question is how much worse it’s going to get.


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The only way to remove sand from Vaseline is to arrange a meltdown!

Posted by daviddenton | Report as abusive

We would not have a debt ceiling if we lived within our means.

Posted by kevivoe | Report as abusive

@Callah: What kind of money is in your safe? Whose image is on your money? And what guarantees its worth?

Posted by matthewslyman | Report as abusive

False equivalence on this debt ceiling piece. It’s not “the politicians” who are “inured to suffering” it’s House GOP.

Posted by SocraticGadfly | Report as abusive

@OneOfTheSheep, I agree that the sequester was the best thing to come out of Washington in recent years. There is simply no way the parties could have agreed to spending cuts without their hand being forced.

Funny how Felix is no longer railing about the “Fiscal Clifford”. A lovely visual of apocalyptic doom, yet we went over that cliff — and kept plugging along. Contrary to the “spend and grow” school of thought, the deficit situation has actually improved by CUTTING spending.

That said, defaulting on the debt would truly be an economic disaster. We still need to borrow money weekly, both to support continued deficits and to roll over the existing debt. Let’s not do anything that might threaten the favorable interest rates we pay on that debt.

Posted by TFF | Report as abusive

I take it economics and history aren’t really required for journalism at Reuters? We’ve been on our way to defaulting for over 100 years when we first started spending beyond our means in the late 1800s and early 1900s. John Piers Morgan had to bail out the US Government. Twice. The 16th Amendment was passed but this did little to resolve the problem because more money coming in meant more spending and it was only compounded by both World Wars, the New Deal and The Great Society along with a constantly growing “defense” budget (should be called the Department of Offence. We had to create a Department of Homeland Security because the DoD actually does so little defense)

We’re so deep I really three options

1) This brinksmanship evokes such a public outcry that we have to figure out a way to make ourselves solvent or at least sustainable and not rely on the two dozen or so debt ceiling increases to just keep working

2) Inflate our money to pay down our debts infuriating the rest of the world and destroying the dollar and the economic well-being of most everyone. Weimar Republic anyone?

3) Refuse to pay our debts and use our military to deter debt collection. We screw the whole world over, ruin our credit and become the world’s most hated nation by FAR

Posted by elroydb | Report as abusive

In my view, it’s even worse than Felix suggests. The entire post WWII period – the last 65 years – business was done world wide in US dollars. Which created a demand for dollars, which, in turn, created a demand for American debt, allowing us to borrow money which the government could then spend (frequently foolishly). In the last couple of years and for more reasons than simply our obvious fiscal irresponsibility, we’ve seen bits of the world begin to move away from the dollar as the lingua franca of business. Which will reduce the demand for dollars, which will raise our borrowing costs, which will impoverish us all.

Posted by majkmushrm | Report as abusive

I agree with @OOTS & @TFF, the sequester was good for all of us and fairl. It should be done again, every year.
I don’t think I agree with @majkmushrm’s logic though, but being on psilocybin mushrooms might affect logic. probably in a positive way when it comes to politics.

Posted by tmc | Report as abusive

Well, @tmc, you’re welcome to disagree with my logic but I remember being struck by PJ O’Rourke’s cluelessness in his book Eat the Rich. He discusses any number of nations and how their economies suck but their numbers aren’t that different from the US’s. I thought at the time C’mon, PJ, you’re not stupid. The Romanians NEED US dollars but who the hell needs Romanian leu? Many, many people don’t appreciate the benefits of having the world’s reserve currency, especially since we’ve not done a good job of executing our responsibilities associated with that benefit.

Posted by majkmushrm | Report as abusive


“…benevolent public servants.” Now THERE’S an oxymoron if I ever saw one!

Posted by OneOfTheSheep | Report as abusive


“…benevolent public servants.” Now THERE’S an oxymoron if I ever saw one!

Posted by OneOfTheSheep | Report as abusive

in the current environment…..

Partisan Politics supersede the common good….

I’m running for office… brother, could you spare 10 million or so..?

Posted by rikfre | Report as abusive

How long can we keep going into debt and printing money?

Posted by CraigPurcell | Report as abusive


Only so long as China and others believe a dollar is still worth a dollar, a concept under attack 24/7 by our own government’s printing presses.

It’s a swindle of breathtaking efficiency and stupidity by the American government. It is purposely counterfeiting and then exchanging billions of dollars in purchasing power worldwide.

The cost, other than to international faith and trust in American currency, is only the direct expense of paper, ink and production labor. If this were the work of FOREIGN government, our military’s ships and planes would be there in a heartbeat forcing a “cease and desist.

Unfortunately, as Walt Kelly said in his “Pogo” comic strip years ago: We has met the enemy and he is us”.

Posted by OneOfTheSheep | Report as abusive

I’d be interested in knowing the opinions of Mr. Salmon (and anyone else) on the ideas set forth by Rodger Mitchell’s in his blogs on Monetary Sovereignty at uction/ and linked documents. Thanks.

Posted by jstoops | Report as abusive


This Bozo believes in free money, no fiscal responsibility, there’s always a bigger fool to buy U.S. Dollars, and the very idea of a government living within it’s means inconveniently old-fashioned. He is convinced that there exists a “perpetual money machine” and is trying to sell that idea as economic theory. Please.

It’ a little like jumping out of an airplane without a parachute. You and the person WITH a parachute have exactly the same trip, view, and experience all the way down to the last. But he lives. You don’t. BIG DIFFERENCE!

Posted by OneOfTheSheep | Report as abusive

Completely agree with you.
Underneath the superficial political circus the issue is much deeper.
The constant quantitative growth economy, the excessive overproduction/over-consumption is simply unsustainable within a closed and finite natural system.
And before the natural resources the human resources are already depleted, symbolized by social inequality, unemployment, unbearable public and national debt burden, and a host of domestic and international conflicts, problems growing out of this system.
As you suggested the solution is living within available means, adapting to the global, integral, natural system we exist in.

Posted by ZGHerm | Report as abusive

The posturing of the egocentric leadership “on the Hill” is despicable. They make too much money to do too little work and are only interested in promoting their private agendas (Reelection, Power, Money, Reelection,….) As an active constituency (NOT Tea Party), we MUST take back our government by voting out all incumbents and create “Term limits by the People, for the People and of the People” to remove the decaying odor of those gluttonous relics who have been feeding at the trough for far too long. We need people to lead our great nation out of this quagmire through compromise and respectful dialog with a genuine desire to serve the interests of the American People First & Foremost through reinstatement of the core values of The Declaration of Independence and The Constitution of the United States of America (51% Rules)!

Posted by BigKidBrother | Report as abusive