Banks Are Selling Off Short-Term Treasuries Because of the Debt Ceiling — Or Are They?

by Patrick Brennan

As the federal government approaches October 17, the day on which the U.S. Treasury says its borrowing limit will be reached and the federal government will have to pay bills with just the cash it has on hand, the Wall Street Journal reports that investors are slowly reducing their exposure to federal debt. Except, that is, when they’re not: Barron’s explains that Pimco, the world’s largest bondholder, is buying up short-term government debt. There are countervailing forces here: Investors are a little worried (up from “not worried at all”) about the U.S. government’s servicing its debt, but there’s also money to be made in that uncertainty. In fact, some investors are predicting that if things really aren’t resolved by October 17, the results will be so unpredictable that people will flee to safer asset classes — and U.S. Treasury bonds will still be the safest readily available and traded asset in the world. So it’s hard to say, then, how movements in short-term Treasuries (and the prices of long-term ones, too) predicts the costs of hitting the ceiling and the likelihood of an actual debt default. Markets could be extremely worried about hitting the debt ceiling, in other words, without showing it by making it more expensive for the government to borrow.

Other ways in which markets indicate how likely they think it is that the government will default are moving in the wrong direction, but, as Reuters’s Felix Salmon pointed out last week, this is hard to be sure about too, and isn’t really the same thing as the actual odds of default rising. For one, the market for insurance on U.S. debt (the main way of measuring the risk of default) is so small that it’s highly erratic; people also don’t buy it because they want to get paid when the federal government defaults, it’s all about price movements. Further, yields on short-term debt and the debt that’s coming due in late October and November are rising — but only marginally, and this doesn’t really raise the costs of financing the U.S. government. All of these issues get to why the risk of hitting the debt ceiling isn’t exactly the risk of a technical default.

Treasury hasn’t said whether it thinks it has the legal authority and practical ability to make sure debt service is paid with the limited tax revenue coming in (the legal concerns liberals and the administration have raised about such a unilateral decision a bit rich coming from them). But even if we’re pretty sure it can, the U.S. government’s losing the ability to meet all of its other obligations — to employees, taxpayers, contractors, etc. — would seriously disrupt the global economy. The IMF, Goldman Sachs, and Jamie Dimon aren’t kidding about the problems this would present; the predictions to some extent rely on Keynesian models that some conservatives will never buy, despite a track record much better than the alternatives, but even with parsimonious assumptions, the problems would be huge.

We can just ask people how worried this is making them, Gallup does that daily, and the answer looks pretty terrible:

Michael Strain argued in this space last week that this is hardly the time to inflict such problems on the U.S. economy, and unless there is a good chance of extracting an extremely valuable concession from this fight, he’s right.

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