The news media are full of warnings of default. The New York Times proclaims:
Wall Street is showing few signs so far that it is fearing the financial panic it has been predicting should the government default on its debt.
The fiscal impasse in Washington continued to weigh on stock prices on Monday, as the market’s “fear gauge,” the C.B.O.E. volatility index, jumped 15.95 percent to its highest level since June. Nonetheless, the market reaction to date has been muted compared with past crises.
“We all tell ourselves, ‘This is something that is not going to happen,’ ” said David Coard, the head of fixed-income trading at the Williams Capital Group. “This would be like a black swan event — it’s not something that you would have thought that the U.S. could do in a million years.”
But the relative calm on Wall Street is worrying some investors, who fear the markets will not signal to politicians the true danger of hitting the debt ceiling until it is too late.
“The markets are sending this complacent message, and I think the politicians are interpreting it incorrectly and they have no sense of urgency,” said Douglas Kass, the owner of the hedge fund firm Seabreeze Partners Management.
A lot of people are throwing the word “default” around. What does it mean?
In legal terms any omission or failure to do what is expected is a default. From that point of view the United States government is already in default since it’s not open for ordinary business, public employees aren’t being paid for work done after October 1, and other (what we used to regard as) normal, expected operations.
In financial terms default means the failure to make timely payment of interest or principal on a debt security or to otherwise comply with the provisions of a bond indenture. Under that understanding the United States can only default if income does not meet interest obligations which is tens or even hundreds of billions of dollars from the truth or it consciously decides not to make its interest payments on time. That is the case with Argentina, recounted here. Argentina has just refused to pay interest on its debts.
Yet another view of default is that even bringing up the subject is unhinged. The federal government can issue new credit to make any interest payments. Alternatively, the Federal Reserve can buy any new bonds the Treasury might issue that aren’t being bought by anybody else. It amounts to the same thing. Note that foreign governments or companies that obtain dollars in trade don’t have a lot they can do with them other than a) buy bonds, b) buy other U. S. assets, c) buy U. S. goods or d) sell their dollars to someone else.
IMO some of the hysteria surrounding the “debt ceiling” is caused by confusion among these various notions of default. Fiscal superhawks probably thought that the United States defaulted as soon as spending more than was taken in became commonplace. To federal employees what’s going on must now must certainly feel like default. However, technical financial default has not yet occurred and won’t as long as the federal government continues to make interest payments which it can easily do.
That’s not to say the federal government can’t voluntarily decide not to make its interest payments. It’s happened before: once in 1790 and again in 1933.