Debunking Debt Ceiling Media Hysterics

[Timmy]

below is something I recently posted to my blog. Though I'd share it with y'all and solicit your opinions on the matter.

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"Mainstream media hysterics would lead the average American spectator to believe that the US economy is dancing on the precipice of disaster. Without a doubt, America's great wall of debt is a serious long term problem. Nonetheless, financial news hype notwithstanding, the marketplace shows little indication that the global economy is careening toward imminent catastrophe. Decisively pushing yields on the 10 year treasury note to a 6 month low on Friday, treasury investors have effectively shrugged off the prospect of a default on interest payments on US debt. Treasury bullishness is often suggestive of economic headwinds, but the trend certainly invalidates the widely heralded notion that investors are preparing to dump treasuries or else demand significantly higher interest rates on US debt. Meanwhile, major US stock indices continue to hold support, and though the VIX spiked into the end of last week, VIX futures contracts fell Friday, indicating that market participants grew less fearful of a protracted down move in stocks despite the hoopla on Capitol Hill. Finally, to my knowledge nothing systemic and exceptionally new or unusual has taken root in the foreign exchange market since the debt ceiling emerged as national priority numero uno. The dollar has been declining against most major currencies for the majority of the past decade, and this is a trend that is highly likely persist for the foreseeable future irrespective of the outcome of current debt negotiations.

In light of prevailing market conditions, my take is as follows: market players are expecting a resolution to the current impasse, whether by congressional decree or by executive pro-action. In the unlikely event of a partial default, investors are counting on the treasury department to continue servicing debt payments and are expecting the FED to beef up expansionary monetary policy to prevent deflation stemming from a sharp drop in government outlays. Such anticipation may even help to explain recent treasury bullishness. Perhaps it is partially a recognition of the potential for another round of FED buybacks of long term government debt in response to a partial US default that's got investors bidding up treasuries.

For now, all remains quiet on the western front. The debt dragon lurks noisily in the trenches but has yet to rear its fangs. I'm quite confident that this most recent media shit storm will soon pass. By fall, and likely much earlier, safely count on the news cycle migrating to greener pastures. It's about time the burgeoning EU sovereign debt crisis and the stalling US recovery, two legitimate emerging crises, took there deserved return to the front and center of the media spotlight."

[Timmy]

There was never going to be a default. Just a bunch of hysterics

Many have characterized failure to pay off non debt related spending obligations as a partial default. Not sure whether you agree with such terminology.

Now the US will probably lose its AAA credit rating over its inability to institute serious spending cuts, which will drive interest rates up and lunge the country back into a worsening recession.

Loss of its AAA credit rating could well be serious cause for alarm in the markets (if this were to happen, all the "hysterics" would actually have be justified), although not necessarily as a consequence of a hike in interest rates on US debt (which may not even happen). You see, the dollar is the currency of reserve and so a substantial portion of foreign reserve holdings are held in US bonds. Many foreign nations are legally obligated to invest exclusively in AAA rated securities. Under heavy selling pressure, the FED would likely step in replace slagging demand for US debt in order to hold interest rates low and protect bank solvency, which would be extremely inflationary and would crush the value of the dollar internationally. Ultimately, this would likely be the death blow to the dolar as global reserve currency, which hurts the US in all kinds of ways and would throw the markets into chaos.

Fact of the matter is that it's very unlikely that the ratings agencies will issue a downgrade to US debt. Rating agencies are US based companies and have little to gain from screwing the government under which they operate. Ratings agencies need to hoot and holler about a debt downgrade as a means of pressuring the US gov into action and sustaining the appearance of objectivity and professionalism, but they won't actually issue a downgrade until the US debt regime is already falling apart at its seems (which is not currently or about to happen).

[tcaudilllg]

Actually Moody's is on a tear. They are downgrading countries across Europe and they are quickly losing influence as governments realize they just might have an anti-Socialist agenda.

[Timmy]

Actually Moody's is on a tear. They are downgrading countries across Europe and they are quickly losing influence as governments realize they just might have an anti-Socialist agenda.

Moody's is a US based ratings agency. Downgrading US debt would be like submitting a negative performance evaluation to your boss. Not exactly a wise decision.

[Timmy]

Moody's is a US based ratings agency. Downgrading US debt would be like submitting a negative performance evaluation to your boss. Not exactly a wise decision.

I'm not sure why that would happen. They're relied upon to give (supposed) impartial credit ratings; if they lose that cred, then they'd become largely irrelevant as a fiscal standards agency.

This is true, ratings agencies' business model does depend upon the presumption of impartiality. For this reason, I suspect the ratings agencies would issue a downgrade if it reached the point where default on US debts became a foregone conclusion, but no sooner. I suspect this to be the case for a number of reasons. First, any large company operating in a heavily regulated industry depends upon political/corporate favor if it hopes to thrive long term. downgrading the US would entail pissing off many politicians and damaging relations with corporate partners upon whom ratings agencies rely for business. Second, major firms rarely operate perfectly in accord with the long term interests of the firm as a whole (especially in less competitive industries, e.g. the ratings industry) because incentives for influential actors within the firm are imperfectly aligned with the best interests of the company. Ratings agency managers may be more interested growing their annual bonuses or in their future career prospects than in preserving the reputation of their firm. Those responsible for opting to downgrade the US economy would find themselves hated figures throughout corporate and political america.

I suspect the sorts of market inefficiencies described above had much to do with the AAA ratings given to dodgy, mortgage backed securities in the early 2000's, which were not downgraded until the tower of cards had already begun collapsing.

[MisterNi]

I think the title of this thread is all that needs to be said on this topic. It's hysterics and clearly political posturing. The President has clearly said that negotiations have broken down on several occasions due to clear ideological differences between both sides and the refusal of the Republicans to compromise.

The economics are inconsequential in this case.

[Hitta]

A government shutdown at this point in time would be probably the biggest possible blessing that our economy could have, but the short term effects would be rather devastating. It's not quite the same as former government shutdowns because when it has happened before the entire economic scheme wasn't being taken out of people's hands and put into government programs and government jobs. It would be like the government taking the entire society on its back, then suddenly dropping everyone.