Congressional Republicans are falling under the spell of an unorthodox group of financial experts who dispute the views of their peers and say that the U.S. could default briefly on debt payments without major, lasting consequences to the U.S. economy and international markets.
The most influential of these dissidents is Stanley Druckenmiller, a billionaire former-hedge fund manager who helped George Soros build his fortune. His recent comments to the Wall Street Journal have carried the day with senior Republicans like House Budget Committee Chairman Paul Ryan (WI), House Majority Leader Eric Cantor (VA), and Sen. Pat Toomey (PA), all of whom now say the U.S. could weather three or four days of missed interest payments, as long as the U.S. debt ceiling were quickly lifted, and a credible debt reduction plan signed into law.Druckenmiller did not immediately respond to a request for comment. But the ascent of his view alarms everyone from industry insiders to Treasury officials to economists, conservative and liberal, to non-partisan analysts who say the consequences of the U.S. missing even a single interest payment to a debt-holder would be catastrophic — even if it was followed immediately by a legislative course correction.
“The U.S. dollar would be among the first casualties. If hot money were to flee what was once its safest haven, the dollar would sink and U.S. interest rates would rise,” writes Princeton economist, and former Fed Chairman Alan Blinder, also in the Wall Street Journal. “The latter could lead us back into recession.”
It’s not that investors would no longer have faith in the U.S. government’s technical ability to pay its bills. Nobody doubts that the U.S. can in theory manage its debt for years on the current fiscal trajectory before running into trouble with the markets. The fear is that buyers of U.S. debt would have to consider a new, previously unthinkable risk — that the country’s political system is too dysfunctional to set brinksmanship aside and steward the economy responsibly.
There would also be lasting costs to the U.S. government in the form of higher interest rates. For as long as anyone can remember, the full faith and credit of the United States has been as good as gold — no one has better credit. But if investors start to see default as part of U.S. political gamesmanship, they will demand compensation for this novel risk. How much? Again, no one can know. But even if it’s as little as 10-20 basis points on the U.S. government’s average borrowing cost, that’s an additional $10 billion to $20 billion in interest expenses every year. Seems like an expensive way to score a political point.
Here’s JPMorgan CEO Jamie Dimon. “Every single company with treasuries, every insurance fund, every — every requirement that — it will start snowballing. Automatic, you don’t pay your debt, there will be default by ratings agencies. All short-term financing will disappear. I would have hundreds of work streams working around the world protecting our company for that kind of event,” he told PBS.
JPMorgan followed up this comment with an analysis finding that even a brief default, quickly rectified, would likely trigger a run on money market funds, just as in the wake of Lehman Bros’ 2008 collapse, that would leave businesses unable to meet their short-term obligations and teetering on the bring of bankruptcy.
Ratings agencies would likely ding the country’s triple-A credit score. “Downgrade Treasury debt, and pretty much every bank up to and including the Federal Reserve is short capital and their ain’t no TARP big enough to bridge that gap,” one person who works in the bond markets told TPM.
There are other likely consequences, too. In an April letter to Treasury Secretary Timothy Geithner, the chairman of the Treasury Borrowing Advisory Committee listed all of them. And a February report by the Government Accountability Office found that simply approaching a default moment “could have serious negative consequences for the Treasury market and increase borrowing costs.”
Alternatively, the Treasury Department could take every possible step to avoid missing an interest payment. Indeed, this is how Toomey thinks the Treasury department should and must proceed if it runs out of runway space and has to slash government services to avoid a default. But that would have huge consequences of its own. “If we hit the borrowing wall traveling at full speed, the U.S. government’s total outlays–a complex amalgam that includes everything from Social Security benefits to soldiers’ pay to interest on the national debt — will have to drop by about 40% immediately,” Blinder writes. “That translates to roughly $1.5 trillion at annual rates, or about 10% of GDP. That’s an enormous fiscal contraction for any economy to withstand, never mind one in a sluggish recovery with 9% unemployment.” The ripple effects of a massive, abrupt drop in spending would likely exacerbate the debt problem — for as the economy spiraled downward, and revenue tanked, it would leave the government less and less choice but to default anyhow.
This is all very public. But influential Republicans are nonetheless warming to an alternative view — held by Druckenmiller and a few others — that after a brief period of churn, the U.S. would raise its debt ceiling, Congress would take steps to rein in its unfunded obligations, the bond market would stabilize and everyone would essentially get a mulligan.
According to both Ryan and Toomey, their confidence is based on private conversations with experts and debt traders who happen to support the GOP’s policy goals.
Ryan told CNBC that “most people” he talks to “lots of bond traders … lots of economists” would be fine with a default of “a day or two or three or four.” “They all say, ‘whatever you do, make sure you get real spending cuts,'” he said.
After an event at the conservative American Enterprise Institute, Toomey claimed to be in a similar boat.
“At the institutional level they are [lobbying for the debt limit to be raised],” he said. “I’ve had an awful lot of private conversation with a lot of guys who are right in the thick of the markets who are saying the most important thing is that you guys fix this problem.”
I asked Toomey if anybody in his confidence has taken the opposite view.
“Not that’s coming to mind right now,” he said.