Sometimes the first duty of intelligent men is the restatement of the obvious. - George Orwell A faction of Congress is preventing action to increase the debt limit without significant fiscal tightening, and some are making a case that the US should not raise the limit under any circumstances, and that default on US obligations is preferable to raising the debt limit.
Meanwhile the bond market is rising, with the 10-year under 3%.
It might seem counterintuitive that bonds are going up while the Congress dithers about whether to pay them back. But it’s really not. Here’s why the bond market is doing well despite the debt ceiling debacle:
1) Everyone knows it’s all political theater. Except for a few Tea Party loonies, no one is seriously thinking of messing with US credit, and creating catastrophe.
2) If there was a government shutdown, interest would still get paid, somehow. Given the choice of not paying government employees and entitlements, and not paying China and other foreign investors… you cut off Grandma. Why is left as an exercise. (A hint: politics, and not wanting to spike the interest bill on $10T in debt.)
3) And if there was a government shutdown, the economy would tank, leading to a stock market correction, QE3 bond buying by the Fed, and lower inflation expectations.
So if you’re a bondholder, a debt ceiling impasse is unlikely, and probably means you get your interest, no new bonds are sold, prospects for the economy and inflation are diminished, and the Fed eases policy more (buying bonds). Even though it might seem counterintuitive, it’s actually pretty straightforward why the debt markets are sanguine.
The fact that the world is willing to lend the US money for 10 years at less than 3% shows that the US is not Greece. It does not have an overwhelming and immediate debt and deficit problem, despite the misinformation machine and the face-palming economic illiteracy of the debt ceiling debate.
The US has a political dysfunction problem, with voters unwilling to pay for government services through taxes, while demanding those same services and entitlements. Woe betide the politician who raises taxes, or cuts Social Security and Medicare or almost anything else.
This not to say that 10% of GDP fiscal deficits are sustainable, or that Social Security and Medicare don’t face demographic challenges and tough choices. But an immediate or rapid 10% of GDP fiscal contraction would clearly be catastrophic.
What’s needed is a credible long-term deficit reduction plan, which will inflict pain, and there is a propaganda war to the death going on as to who will bear the pain.