Another week and still no sign of a resolution to the political stalemate in Washington that’s kept the federal government partially shuttered. This is also the week that faces a Treasury default on Thursday, when the government reportedly will run out of money to pay its bills if Congress doesn’t raise the debt ceiling. The question is what happens on October 17 and beyond if the federal government can no longer borrow? The immediate result is that spending would be limited to cash on hand and incoming tax revenue. The big mystery is how such an event would impact the markets, the financial system, and the economy? No one really knows, but we may soon find out.
If Thursday arrives and the debt ceiling hasn’t been raised, the next issue will be estimating exactly when the cash runs out. Some analysts think this dark moment would come soon after, on the following Tuesday, October 22. At that point, assuming we go that far into the rabbit hole, the system may suffer a real shock as government spending would start sliding in more than trivial degrees. Interest payments on Treasury securities would probably be a victim, and delays on issuing checks for various programs—Social Security, for instance—are likely too.
For now, the financial markets aren’t all that worried about breaching the debt ceiling, or so it appears based on looking in the rear-view mirror. Friday’s yield on the benchmark 10-year Treasury: 2.70%, or near the low range for the past two months. Meanwhile, US stocks are showing minimal signs of stress: the S&P 500 closed up a bit on Friday, near an all-time high. Default worries: Where is thy sting?
Depending on the analyst, Thursday’s red line is a disaster waiting to happen or a technical problem that may cause limited disruption but otherwise go down in history as little more than an annoying non-event. But when you’re considering unknowns, minds will differ. The only certainty is that this self-inflicted problem will be resolved. “When push comes to shove there will be an agreement,” Pimco’s Mohamed El-Erian said at the IMF meeting over the week. Agreed. But when?
If the answer is sometime after Thursday, it may be a whole new ballgame… or not. “People have been saying that things are different this time, but Washington is just a distraction for markets, simple as that,” advises Ken Fisher of Fisher Investments Inc. “If a default was possible, you would see bond prices fall through the floor. Eventually you have to stop listening to the people crying wolf.”
Maybe Fisher’s right, but maybe he’s wrong. In any case, the insanity that has come to Washington boils down to the reality that the US is currently on track to test Fisher’s thesis, with some very large stakes hanging in the balance, including the world’s largest economy, the world’s reserve currency, and debt obligations that are still considered the “safest” on the planet.