The budget and debt ceiling fights in Washington often seem to take place in a hermetically sealed bubble. Or maybe on some faraway planet “Beltway,” where there’s definitely less oxygen in the atmosphere. But it’s important for average Americans to realize that going over the debt ceiling isn’t just a political spectacle—it’s a event that could have major, immediate, real world consequences for your quality of life. The key reason that Americans are able to buy homes at low interest rates, travel abroad for spring break, have flat screen TVs in several rooms, and pay the same amount for groceries every year at Wal-Mart is that the credit of the U.S. is good. That’s what allows us to keep the dollar high and borrowing costs lower than our debt levels, growth prospects, and frankly, political competency, would otherwise allow. Once that trust is gone, it’s often gone for good—just ask Argentina, which is still paying through the nose to borrow money thanks to a default that happened twelve years ago.
Unfortunately, the markets are already starting to price in the loss of trust in the full faith and credit of the US government. As politicians continue to wrangle over the shutdown, U.S. sovereign credit markets are increasingly worried about default. You can see it in the anxiety provoking little bump that reflects the interest rates paid out on U.S. Treasury bills. The lower the rate, the safer the bet is considered by the markets, and vice versa. Our bill bump is flat until about October 17th, when the government is expected to run out of money. It then starts to swell, and continues swelling into November—meaning the markets think that we’re more likely to default. The bump goes back down on Treasury Bills that mature in December. But nobody knows yet whether a pre-holiday delivery of a new debt ceiling increase will be successful. That’s why you can also see a rally in U.S. sovereign credit default swaps, complex securities that would theoretically pay out to investors if we did actually default. (Though if I were a buyer, I’d take a good look at Greece and notice that things don’t always go as expected during a default. Borrowers and lenders on all sorts of Greek assets are still duking it out for who gets paid and who doesn’t).
Uncertainty is the key reason that the sales of T-bills to overseas creditors are also very likely slowing. As a new Goldman Sachs report looking at the potential economic impact of the crisis noted today, purchases of Treasury Bills by foreign investors during past debt ceiling showdowns have declined markedly, and while figures are only currently available through July, the August/September numbers due out soon will almost certainly show the same trend. If the Chinese, Japanese, Europeans and others don’t buy as many of our T-bills, we won’t be able to keep rates as low as we have in the past. And it’s worth noting that one of the key reasons that T-bills sales went up so quickly after the 2011 debt debacle is because Europe was in the middle of its own, more serious debt crisis. We were the prettiest house on an ugly block then. But Europe is in recovery now, and the emerging markets are more stable. Who’s to say this won’t be the moment that the long predicted shift in the position of the dollar as the preeminent global reserve currency starts to happen in earnest? If I had to place a bet now, I’d say it’s very possible we could look back on the fall of 2013 as the beginning of the end of the dollar as the world’s sole currency superpower.
Certainly, confidence amongst the nation’s business leaders is down. CEO confidence has been trending lower for the last several months, which means that “companies capital spending plans for the rest of the year are likely to be limited,” notes Michael Purves, chief global strategist for institutional broker/dealer Weeden and Co. That will further depress the growth that’s already being trimmed by around 0.2 percentage points a week as the shutdown lags on. Combine that with lower consumer confidence, along with lower growth in the service sector and housing as people tighten up their wallets, and you’ve turned what was a more robust recovery in the first half of the year into an economy that’s once again struggling to hit 2% growth.
And if we go over the debt ceiling and default on our bills, hold on to your hat, your house, and your job. Failing to pay creditors would immediately downgrade the U.S. credit score. Markets would —the debt ceiling debacle in 2011, which wasn’t as real as possibility, resulted in a 13% drop in the value of U.S. stocks, and hundreds of billions worth of outflows from money market funds, as investors tried to redeem cash as the sky seemed to be falling. Our borrowing costs would rise significantly. By how much, nobody knows. But it’s worth remembering that back in 1979, we had a tiny, technical default on a few T-bills (thanks to a word processing glitch, if you can believe it). There was never any doubt that people would get paid, but rates on T-bills still jumped more than half a percentage point, costing taxpayers an additional $12 billion worth of interest payments. Because the incident was so isolated, it didn’t have much of an impact on consumer markets. A default caused knowingly, and for reasons of political gridlock, would be a very different story. Failing software, of course, can be fixed. Sadly, there’s no virus program we can run on Congress.