James Pethokoukis

Politics and policy from inside Washington

GOP should ignore Moody’s debt ceiling warning

June 2, 2011

Team Reuters reports:

Moody’s Investors Service said on Thursday there is a very small but rising risk of a short-lived default by the United States if there is no increase in its statutory debt limit in coming weeks.

In a statement, Moody’s said if there is no progress in increasing the debt limit, it would expect to place the Aaa sovereign credit rating on review for a possible downgrade.

“If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction,” Moody’s said.

I guess I would care more about what Moody’s had to say if a) they hadn’t missed the whole financial crisis, b) didn’t want to see higher taxes as part of any fiscal fix and c) if they made any economic sense. Let me again replay what Stanley Druckemiller opined on the topic (via the WSJ):

“Here are your two options: piece of paper number one—let’s just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don’t know, six days, eight days, 15 days, but I know I’m going to get it. There’s not a doubt in my mind that it’s not going to pay, but it’s going to be delayed. But in exchange for that, let’s suppose I know I’m going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured,” he says.

Then there’s “piece of paper number two,” he says, under a scenario in which the debt limit is quickly raised to avoid any possible disruption in payments. “I don’t have to wait six, eight, or 10 days for one of my many payments over 10 years. I get it on time. But we’re going to continue to pile up trillions of dollars of debt and I may have a Greek situation on my hands in six or seven years. Now as an owner, which piece of paper do I want to own? To me it’s a no-brainer. It’s piece of paper number one.”

Mr. Druckenmiller says that markets know the difference between a default in which a country will not repay its debts and a technical default, in which investors may have to wait a short period for a particular interest payment. Under the second scenario, he doubts that investors such as the Chinese government would sell their Treasury debt and take losses on the way out—”because I’ll guarantee you people like me will buy it immediately.”

 

Comments

Paper Number 3: The debt ceiling is raised, the gov’t, which won’t repair the budget, must print money (quantitative easing) to make its debt-service payments. Inflation rises to 7% while you lent money at 3%. Your “risk-free” T-bond portfolio loses much of its value.

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