May 21, 2011, was supposed to be Judgment Day according to Harold Camping. It was, in a sense. As the day came and went, the world judged that Camping’s 15 minutes of fame were up. Treasury Secretary Tim Geithner may yet learn something from Camping.
Geithner has been a whirlwind of worry about the nation defaulting in the event Congress fails to raise the debt ceiling. It is interesting, therefore, that the market for U.S. debt—where the default would occur—remains sanguine about the debt ceiling debate and dismissive of Geithner’s flailings. Notice how the bellwether 10-year Treasury bond rate has recently plunged to or below 3 percent—hardly a harbinger of trouble.
The markets know, as does Geithner (his protests notwithstanding), that there is no way the Treasury will default on the federal debt. No matter what happens with the debt ceiling, interest will be paid out of ample tax revenues. Geithner knows it. The markets know it. So they are unconcerned.
Debt markets also know the United States cannot keep on racking up trillion-dollar budget deficits. The long-run fiscal picture has long been disastrous, but President Obama’s policies have now nailed that long-run picture to a near-term frame, and it hangs outside the Treasury Secretary’s door, greeting him and his bond sellers every morning.
And it’s not as though the credit markets are unusually insensitive to such matters. On the contrary, with Europe imploding under the debt pressures from Greece, Portugal, Ireland, Italy, and maybe even Spain, the question of sovereign debt is first and foremost.
The markets are watching not whether the debt ceiling increases but whether Congress and the President let the moment pass without taking strong action to reduce spending now and in the future. This point was hammered home in a statement by Moody’s, a credit-rating agency, on the outlook for the rating of U.S. debt: A credible agreement on substantial debt reduction would support a continued stable outlook; lack of such an agreement could prompt Moody’s to change its outlook to negative on the AAA rating.
It can’t get much plainer than that. Make real progress or there will be a price to pay.
Contrast this statement, confirming the intense focus markets have on whether Washington can get spending under control, with the President’s earlier demand that the Congress pass a “clean debt ceiling”—an increase with no attempts to restrain spending whatsoever. Obama demanded that Congress do the very thing markets insist must not be done: ignore the deficits. Thankfully, rather than debate the point, the House leadership brought the proposal to the floor for a vote and the clean debt ceiling increase was soundly thrashed 318–97, with even Steny Hoyer (D–MD), the House Minority Leader, urging its defeat.
The Moody’s statement echoes a statement issued earlier by Standard & Poors, another credit rating agency, on April 18 in which they downgraded the outlook on U.S. debt:
We believe there is a material risk that U.S. policy makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013.… If an agreement is not reached…this would in our view render the U.S. fiscal profile meaningfully weaker.
By far, the best chance of reaching such an agreement is in the context of the forcing action of a debt limit increase.
If the debt ceiling remains unchanged, then there will be wrenching changes in federal spending and a slew of questions about governance in the United States. The President will be forced to prioritize spending with little or no statutory guidance. “Winging it” is no way to govern. However, it would not mean default on the debt, as interest would be paid, and it would relieve markets’ concerns about exorbitant and dangerous federal borrowing.
However, if the debt ceiling does rise, Congress must force substantial reductions in spending to ensure immediate and lasting reductions in federal borrowing. This is what the markets are watching closely, not whether the U.S. might default because the markets know better. The markets are watching whether Washington can demonstrate some responsibility and seriousness about spending. If Washington disappoints, the consequences could be sharp and painful not just to the budget but to the economy—and soon.
This is about the debt we leave to future generations. It is also about the state of our economy today. If credit markets begin to price in the risk of continued profligacy, the effects on interest rates and then on jobs will not be pretty, leading to a judgment day of another sort for those responsible—a very painful election day.