Not raising the debt ceiling will not cause default

Copyright 20011 by John T. Reed

I have explained this before, so have a number of pundits, but the Democrats persist in lying about it and many, including Republicans repeat the lie. Bill O’Reilly, who says he is an independent, but who seems right wing, repeats the lie.

The truth is:

1. There will be no default on U.S. government bond payments because of a refusal to raise the debt ceiling. Very simply, tax revenues are far more than enough to pay debt payments. Pay attention to cable TV for a hour or so and they will give you the actual numbers. Page A4 of the 7/14/11 Wall Street Journal has them.

2. How the various financial markets will react to refusal to raise the debt ceiling is unknown. O’Reilly says the Dow will fall 1,000 points. If he really knows that, he should short a Dow index.

Refusal to raise the debt ceiling will require cutting spending about 43%. The remaining 57% is enough to pay all the bonds and other big stuff like Social Security. Substantial cuts would be required in stuff like Medicare, Medicaid, defense, and all the other stuff.

What will probably happen is Obama will have to choose what he wanted to cut and in a couple of weeks he would wet his pants and agree to the Republican plan which would raise the ceiling but also make significant cuts stretched out so that we don’t have to cut 43% overnight.

The stock and bond markets already know about all of this. I do not know why they would wait until August 2nd to react to it. Their reaction is almost certainly already reflected in the current prices of bonds and stocks.

I have been in the investment business my whole adult life. I have written over 20 books about it and about 4,000 articles.

Lately, the bond markets have also had to deal with the subprime crisis (subprime mortgages are bonds), the Russian default (a real default not a phony threat of default like Obama is now claiming), the troubles of the PIIGS in the Euro zone, the bankruptcy of Iceland, screwing the secured bond holders in the Chrysler and GM bankruptcies, and so on.

Most knowledgeable people figure the financial markets will shrug it off because we had so much notice of it.

The thing that no one is talking about is how much Obama is going to freak if the Republicans call his bluff and he has to start shutting down cabinet departments—which he will.

I predict that within a week or two of the shutdown, he will agree more or less to what the Republicans want. He thinks the public will blame the Republicans. I doubt it. But if he’s right, the Republicans will wet their pants and fold and this will all be a two-week event.

Of course, raising the debt ceiling means that the eventual cuts—which are inevitable and soon—will be more than 43%. In other words, Obama’s position is to make the fiscal situation of America worse on the theory that we won’t figure it out until after he’s re-elected. He is deliberately running America off a cliff because he thinks the nation will blame the Republicans for it.

The real story is not what will happen in the first couple of weeks of August. Rather, it is what will happen later when the world bond market refuses to buy U.S. bonds because they recognize that we have too much debt and will never pay it back with equal purchasing power dollars. That will ll be the day that Joe Biden’s “big ——- deal” comment will really be apt. I expect the aftermath of the impending bond market boycott of US bonds—which will have the exact same effect and refusal to raise the debt ceiling and more—will be far worse than the Great Depression.


Moody’s said they are “placing the nation’s credit rating under review for a downgrade.”


Moody’s says this is because the Republicans may not agree to raise the debt ceiling.

Moody’s is telling the same lie as the Democrats.

Why would they do that? We in finance are puzzled. Obviously, more and more and more borrowing—the national debt is about to exceed 100% of GDP, a mark we hit only briefly after the end of World War II—is a bad thing.

Why isn’t Moody’s applauding the Republicans for stopping the crazy federal spending? Why are they siding with adding even more to the too-high debt-to-GDP ratio? Why is stopping the insane borrowing an indication of default danger but borrowing over two trillion more is not a default danger?

Maybe Moody’s is grateful to Obama for not prosecuting them for their outrageous, dishonest role in the subprime crisis. Maybe the statute of limitations has not run out on that behavior and Moody’s wants to stay on the good side of the Attorney General’s boss. If you think I am way out of line to say such things, you apparently have not read Reckless endangerment, This Time is Different, All the Devils are Here, Too Big to Fail, and other books about the subprime crisis. I have.

It is an outrage that the top executives at Moody’s, S&P, and Fitch are not in jail. It is an outrage that those organization still exist. Enron’s accountant was forced out of business for a lot less.

I am not opposed to Moody’s and the other bond rating agencies downgrading the U.S. credit rating. They should have done it years ago. But I am opposed to Moody’s claiming Republicans refusing to add more to the national debt is a downgrade event. Raising the debt ceiling is the downgrade event.

If they do downgrade, watch the interest rate on U.S. bonds. If they downgrade and the interest rate on federal bonds does not rise, it means the bond market thinks Moody’s is playing some political game, not objectively evaluating the U.S. government’s credit. Recently, bond rating agencies including Moody’s lowered some European countries’ bonds and the interest rate on them did not change. That means the market thinks Moody’s is way late making that downgrade.

It’s because we might default on pay to Commerce Department bureaucrats, not bonds

The next day, one of the bond rating agencies said the U.S. downgrade would come for the increased probability of  renege on any obligations, not just bonds. That include Social Security payments, Medicare, salary to Commerce Department clerks, and so on.

Excuse me.

So Moody’s et al are no longer bond rating agencies. Now they are all purpose credit checkers that treat “full faith and credit of the United States of America” bonds the same as entitlements, layoffs of workers, payments to the Federal Reserve, a U.S. government subsidiary, etc. If we lay off 100,000 federal bureaucrats because  of the the debt ceiling raise not passing, we are less likely to pay the federal bonds we have paid on time since our country was founded? That’s a rather partisan Democrat view of fiscal policy.

Their new position seems to be failure to try to borrow endlessly to keep impossible to keep politicians’ promises is an indication that the U.S. government is not likely to keep its promises on any and all obligations.

There are all sorts of objective criteria regarding how much borrowing by a nation is too much. For example, the IMF and EU have standards like the deficit never being more than 3% of GDP. Ours is currently 10%. There are also standards on debt-to-GDP ratios. Ours is currently $14.5 T ÷ $14.8 = 98%. Obama wants to add $2.4 T to the debt limit. With the current GDP that would give us a ratio of $16.7T ÷ $14.8T = 113% which is very close to the all-time post-world war II record of 122%. Furthermore, all indications are that we will skyrocket past the 113% and 122% marks in the near future.

The PIIGS are in financial difficulty and eihter have had or are in danger of having their bond rating lowered by the same Moody’s et al. Here are their 2011debt to GDP ratios

Spain 68%

Portugal 98%

Ireland 114%

Italy 120%

Greece 153%

Ireland’s bonds have already been rated at junk level. And Obama wants to raise the debt ceiling to a level that, absent an increase in the GDP, would essentially match Ireland.

As I said above, the reasons to lower the U.S. bond rating are the deficit-to-GDP and Debt-to-GDP rations, not the absence of a debt ceiling increase. The bond rating agencies should be applauding America’s reluctance to raise the debt ceiling and the willingness of the Republicans to cut spending instead. The Democrat position is clear. No specific cuts with an amount and a date, just speeches favoring vague cuts in the abstract with no specifics, no amounts, and no dates.

If and when we ever get specific types, amounts and dates, I predict they will be defense, tiny, and far off in the future. That is what Moody’s et al should be basing ratings changes on.

I am a Libertarian, not a Republican. If Libertarians were in charge none of this crap would be happening. The Republicans are almost as responsible for this mess as the Democrats

John T. Reed

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