To raise or not to raise the debt ceiling; that is the question.
This Shakespearean financial dilemma hangs in the balance between now and a somewhat theoretical Aug. 2, but I can tell you what an unbiased investment manager thinks: Don't mess with the debt ceiling. Raise it unencumbered if necessary.
Default would be a huge negative for the U.S. and global financial markets, introducing fear and unnecessary volatility into the economy and global trade. The market situation might resemble what happened after Lehman Brothers collapsed in 2008.
Congressional Republicans almost unanimously dispute this conclusion. House Speaker John Boehner, R-Ohio, sums up the Republican position best, saying that "it is true that allowing America to default would be irresponsible. But it would be more irresponsible to raise the debt ceiling without . . . taking dramatic steps to reduce spending."
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Responsibility in this case, however, is not an either-or proposition. An actual default — or even the threat of one — might set off a chain reaction that would raise Treasury bond yields by 25 basis points (a quarter of a percentage point) or more, pushing up the cost of debt throughout American financial markets. Moody's Investors Service, the bond rating agency, just last week put America's triple-A credit rating on review for potential downgrade, roiling equity and bond markets alike in the aftermath.
If an extra 25 basis points becomes the new benchmark, federal interest expenses might increase by $30 billion to $40 billion annually over the ensuing years as $1.5 trillion of new debt is issued each fiscal year, complicating efforts to narrow budget deficits.
Bond investors are a conservative lot. They earn only 1.6 percent on the average Treasury maturity these days, but they expect certainty on when, and whether, they will be repaid. Countries that keep them guessing or that are expected to default are punished severely, as reflected in 20 percent bond yields in Greece or even 5 to 6 percent in double-A-rated Italy. Like it or not, global investment managers have global choices these days, and a solvent Germany or Canada is just a wire transfer away for trillions of potential investment dollars looking for a safer haven.
There is an additional concern. The U.S. dollar is the global reserve currency, producing daily liquidity for trillions of dollars of transactions between trading nations. The greenback earned that status from decades of balance-sheet conservatism and strong economic growth. Now, as the ratio of federal debt to gross domestic product creeps closer to 100 percent — symbolic of double-A, not triple-A, status — and our growth rate remains mired at a 2 percent annualized rate, countries that have reserve surpluses (China and a host of petroleum exporters) are rethinking their currency preferences.
A ratings downgrade or an actual default could reduce the willingness of these countries to do business in dollars, jeopardizing trade receivables and overnight letters of credit in the process.
If our government doesn't care about the greenback dollar and its solvency, why should we expect others to protect its status as a reserve currency — a privilege that lowers our interest expenses by an estimated $30 billion annually?
The answer to our modern-day Hamlet's question then, is that there should be no question at all: The debt ceiling must be raised and not held hostage by budget negotiations.
Don't mess with the debt ceiling, Washington. Bond and currency vigilantes will make you pay.