“Short-term U.S. debt prices tumbled again Tuesday amid rising investor concern about the prospect of a government-debt default, sending the yield on one-month U.S. Treasury bills to its highest level since the financial crisis.”
That’s from the WSJ today.
Here’s a graph from Irwin/Wonkblog depicting recent movements in yields.
Figure from Irwin/Wonkblog.
The WSJ article continues:
In the market for derivatives known as credit-default swaps, which some traders use to bet that a debt issuer will default, investors now are pricing in a 3% probability the U.S. won’t pay its obligations in timely fashion. Traders were asking Tuesday for €58,800 ($79,856) to insure €10 million of U.S. debt for a year, up 9.7% from Monday and up tenfold from Sept. 20 levels. U.S. credit-default swaps trade in euros to help users hedge the risk of a depreciating dollar in the event of a default.
Of course, this could be much ado about nothing (i.e., the markets are misguided regarding risks). As Representative Yoho (R-FL) stated:
“I think, personally, [not raising the debt ceiling] would bring stability to the world markets.”
Much of the belief that there is not much issue with breaching the debt ceiling seems to stem from the belief that interest payments can be prioritized so as to be only in technical default. As many have noted (including the GAO), it’s not clear that either legally or technically such prioritization could be implemented (think about all those government computers still running COBOL [1]…and Treasury makes about 4 million payments per day, many more than undertaken in 1957 when prioritization last occurred).
Finally, even if Treasury were able to implement prioritization, the reduction in spending would exert a contractionary impact on output. How big an impact would depend upon when the Treasury runs out of money and borrowing authority headroom, and how prioritization was implemented (payments to debt subject to debt ceiling, not subject, etc.).
The US has reached the jubilee constraint (the cumulative differential rate of growth of debt to wages and GDP achieves an order of exponential magnitude) of the supply-side, reflationary, Long Wave Downwave secular debt cycle after which debt can no longer grow faster than GDP.
The post-’08 trend of nominal GDP is 2% vs. 3.6% since ’00, 5% since ’80, and 6.5% long term (unsustainable without 4-5% growth of crude oil extraction and industrial production and wage growth for the bottom 90%).
If the US somehow tries to inflate out from under the debt with the unprecedented private and public debt to wages and GDP, price inflation will further destroy after-tax purchasing power of wages.
Raise taxes on the top 10% who receive 45% of all US income and who pay 75% of federal income taxes, and consumption will decline accordingly along with the trend of real GDP per capita, which is already at just 30% of the long-term trend rate.
The effective Obummercare (gov’t-sponsored, mandated income and profits for insurers, hospitals, and doctors) taxes on primarily healthy young people age 35 and younger, i.e., the Millennials, will further constrain spending by this cohort, the majority members of whom are already experiencing debilitating debt to income, persistent labor underutilization, low pay, sporadic contingency employment, and non-durable occupational tenure.
Raise corporate income taxes and watch the same corporations pass along the increase in costs to workers in the form of lower wages and benefits and to customers as higher prices.
Today, effectively an equivalent of half of the public and private wages and salaries of the bottom 90% of US households is in the form of imperial war spending and rentier income (interest, dividends, and capital gains) received by the top 1-10% of households. This is an OBSCENE waste and GROSS misallocation of talent, scarce resources, and distribution of labor product, business profits, and gov’t receipts required for the social goods to maintain our civilization and desired socially acceptable standard of material consumption and well-being for our fellow Americans.
The brightest among us ought to know better, and the wealthiest among us ought to perceive themselves sufficiently worthy of their wealth, privilege, and power so as to be exemplars for a much more equitable, sustainable, techno-scientific economy and society that serves all of us rather than a kind of rapacious last-man-standing contest to hoard all of the rigged game’s chips while the rest of us are forced to be content with a zombie apocalypse and acquiring a taste for warm brains and livers of our fellows.
Come on. The rentier elite top 0.01-0.1% now own everything directly or by proxy. You’ve won, guys. Congratulations. Now, how about the rest of humanity? Where is your sense of obligation? Imagination? Conscience? What about a humanistic, futuristic, techno-scientific vision for the species on a finite, spherical Spaceship Earth? Has human ape evolution progressed to the point that only you in the top 0.01-0.1% are worthy of having self-selected to survive, adapt, and reproduce?
And where are the self-satisfied, professional middle-class intellectuals at the Ivy and second-tier schools, media, and enlightened corporate managerial caste who are the only ones who can possibly hold the rentier elite top 0.01-0.1% accountable and persuade them to act on their better nature for the benefit of the rest of us?
The rest of Yoho’s response is revealing. It isn’t a direct quote but is reported as: “since they would be assured that the United States had moved decisively to curb its debt.” In other words, defaulting on debt would signal that the US … I can’t figure out a way to finish the rest of the sentence in a rational manner.
Bruce,
Excellent post from a Keynesian viewpoint! I would substitute production for consumption in your post but I would come to essentially the same conclusion. I believe what you post demonstrates is just how far today’s Progressive economist has strayed from Keynes, much less sound economics.
Bruce is always a good read, though reliably depressing. I think even permabears have a sunnier outlook.
His challenge:
“And where are the self-satisfied, professional middle-class intellectuals at the Ivy and second-tier schools, media, and enlightened corporate managerial caste who are the only ones who can possibly hold the rentier elite top 0.01-0.1% accountable and persuade them to act on their better nature for the benefit of the rest of us?”
That’s me! Guilty! But you way overestimate my power. Sure, we speak in hushed tones in the hallways when it’s revealed our CEO made over $25M and counting last year. A year our firm lost money – at least on paper. But how vocal are we going to be about it when our matching 401K contributions are being funneled into company stock? When a quarter of our compensation is in options? When our at-will employment status is dependent on hewing to the company line? When, if you donate to a democrat (like I did), the External Affairs office contacts you and strongly encourages you to stop donating individually and to instead donate through their PAC? (What kind of bias do you think that PAC has?)
As I am in the business I am digesting a post from FT Aplhaville (via Brad Delong) about where all the money is at. Holy crap – it’s revealing.
So yes, I am sorry I can’t do more, Bruce. Hell, at my “near” Ivy League school I studied the same US Labor History, US Economic History, Dialectical Materialism – hell, I’ll just say it, Marxism, the whole nine yards! – that everyone else did in the 70s but now I am effectively captured by the man because for all my efforts I am only one stock market meltdown away from everybody else. At least I recognize a healthy middle class and a healthy working class is the rising tide that will ultimately lift all boats and I vote accordingly.
Regards.
For some perspective – the 10 yr treasury, though up slightly over the last few weeks, remains far below rates that prevailed for all but the most recent of the past 50 years.
http://finance.yahoo.com/echarts?s=%5ETNX+Interactive#symbol=^tnx;range=my;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;
This is an indication that the market views the debt limit issue as temporary. If the market thought this would have a permanent impact on the value of U.S. debt, the increase in the 10 yr would be much higher.
Thought this from Rep. Yoho was priceless. Reminds me of Wimpy from Popeye with his line, I’ll gladly pay you Tuesday for a Hamburger today.
This is from the NYT:
Representative Ted Yoho, a freshman Florida Republican who had no experience in elective office before this year, said the largest economy on earth should learn from his large-animal veterinary practice.
“Everybody talks about how destabilizing doing this will be on the markets,” he said. “And you’ll see that initially, but heck, I’ve seen that in my business. When you go through that, and you address the problem and you address your creditors and say, ‘Listen, we’re going to pay you. We’re just not going to pay you today, but we’re going to pay you with interest, and we will pay everybody that’s due money’ — if you did that, the world would say America is finally addressing their problem.”
tj: Since the ten year is the average of expected overnight interest rates over the next ten years, under the expectations hypothesis of the term structure, then it is conceivable that the short term yields could be very high for a month or two, and still be consistent with low ten year rates. A month at elevated short term yields, relative to near zero rates that prevailed before, seems potentially problematic for money market funds, among others.
I am glad you are so sanguine; it must make sleeping at night much more easy.
“…so as to be only in technical default.”
There is no such thing as “technical default” outside of the political speak of the GOP. We don’t commonly see expressions like “technically dead” or “technically smelly” or “technically too dumb to be involved in the legislative process”. To use the term “technical default” is to adopt the strategic language of one side of the debate.
I believe it was Newt Gingrich who first popularized the expression. The point to watering down the fact of default with “technical” is to make default seem permissible and not really a big deal. If you believe that, then of course, you can use “technical default” in good conscience. Otherwise, why not rely on honest brevity, and just write “default”?
Debt Limit Deniers:
http://www.politico.com/story/2013/10/debt-limit-deniers-98041.html?hp=t2_3
Excerpt:
“I want to cut 20 percent of government spending if not more,” said Mark Calabria of the Cato Institute. “But this is the worst way to go about doing it.”
. . . The hopeful view among Washington insiders is that most of the deniers don’t really believe what they are saying but are trying to harden their negotiating position and get Obama to cave in and offer concessions in return for a debt limit hike.
Kochs to Congress: Focus on spending, not Obamacare
http://nbcpolitics.nbcnews.com/_news/2013/10/09/20886586-kochs-to-congress-focus-on-spending-not-obamacare?lite
Excerpt:
In a move that highlights a growing rift in conservative ranks, Koch Industries — the privately held energy conglomerate owned by billionaires Charles and David Koch — today distanced the firm from allied political groups lobbying to keep the government shut down unless Obamacare is defunded.
A letter, signed by the company’s chief lobbyist and sent to members of Congress, says that Koch Industries has taken no position on the shutdown dispute in Congress “nor have we lobbied on legislative provisions defending Obamacare.”
“it’s not clear that either legally or technically such prioritization could be implemented”
Is any other option possible? I thought defaulting on Treasury obligations was unconstitutional.
Menzie
under the expectations hypothesis of the term structure, then it is conceivable that the short term yields could be very high for a month or two
Sarno, L.; Thornton, D.; Valente, G. (2007). “The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields”. Journal of Financial and Quantitative Analysis 42 (1): 81–100.
You are arguing that a downgrade shock would not impact the long end of the curve.
Yes, it’s feasible short term rates can remain high for a couple of months or until debt limit negotiations conclude. But the yield at the long end cannot remain unchanged since the price is driven by expected changes in market rates.
Right now the expectation is that the rate on long term debt will not deviate much from the current expectation for the return on long term debt. It won’t change until new information arrives to move the expected return.
tj: I’m a big fan of Sarno’s work; however it’s important to understand that that particular test of the EHTS is a joint test — EHTS, rational expectations, and constant term-specific risk premia. In addition, the additional power achieved by imposing cross equation restrictions brings up the question whether the statistical rejection implies economic rejection.
On a more prosaic note, if it’s expected that the debt ceiling crisis pushes the economy into recession, I will say it’s completely plausible that the long rate can be unchanged even as the near maturity yields go up.
Don, yes, but it doesn’t matter. Policy and infrastructure may not be able to get the money where it is supposed to go at the appropriate times.
Menzie
On a more prosaic note, if it’s expected that the debt ceiling crisis pushes the economy into recession, I will say it’s completely plausible that the long rate can be unchanged even as the near maturity yields go up.
I can’t argue with that, (given that scenario). In a default scenario, we might actually see a perverse effect where a U.S. downgrade reduces the yield at the long end of the curve. It depends on the strength of the flight to safety trade, and the willingness of traders to hold U.S. treasuries.
This is great news. Buy those treasuries and make a killing. And by killing I mean 0.3% in a month or so. LOL JUST LOL if you think we’re going to default.
TBF YOHO is an idiot.
“Finally, even if Treasury were able to implement prioritization, the reduction in spending would exert a contractionary impact on output”
THis should say…
“Finally, even if Treasury were able to implement prioritization, the collapse of the Ponzi scheme would exert a contractionary impact on output that was not sustainable in the first place.”
for those who think a lack of movement in long term rates indicates no worries, you need to think again. for one, as menzie noted, if we are pushed into a recession then rates will stay low. they do not rise in a recession. most everybody agrees the treasuries will be made whole at some time, so upward pressure on yield may be limited.
but a possibly more critical issue is that a defaulted treasury instrument is no longer a valid quantity in transactions. anybody who used treasuries as collatoral, etc will be called upon to provide more collateral. but they cannot use more treasuries because they are in default. this is what will create another “crunch” in the monetary system. the stalwart economic instrument in trade will effectively get pulled out of the market, and there is probably nothing which can fill that void. this will put enormous pressure on a credit based economy.
baffled
Earth to baffled, earth to baffled, check your meds, repeat, check your meds.
for those who think a lack of movement in long term rates indicates no worries, you need to think again.
What if we think a lack of movement at the short end indicates no worries?
Follow this link and compare the historical 3mo, 6mo and 12mo rates to today’s rates. To remove any bias related to debt limit negotiations, check January through August. The 3mo, 6mo and 12mo are virtually unchanged compared to today’s rates.
It appears the market is not putting much weight on your wild scenarios. In fact, the market is making you look foolish.
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/Historic-Yield-Data-Visualization.aspx
tj,
where did i say anything about short term interest rates? what are my “wild scenarios”? you are a classic straw man argument, typical bait and switch.
if you want to know about my view of short term instruments, treasuries will change slightly with respect to each duration, as people will arbitrage their 30 day with a 90 day, under a scenario such as the 30 day will not payout until 90 days (pick your expected duration of default period). but at this point everybody expects the treasuries to be paid back in full, they just dont know the time period. so a 30 day may become a 60 day based on the length of default.
however, many financial transactions require collateral, and defaulted treasuries at this point do not qualify for that collateral. this will not affect the value of the treasuries nearly as much as the value of the assets backed by the treasuries. margin calls are what create such a crunch. if financial rules are modified to allow defaulted treasuries, then the game changes. but as of now that does not appear to be the case.