In case you were in a coma until just now, the US government is about to run headlong into the debt ceiling.
Now many on the right are arguing that 'We won't default' if we only service our debt. That's completely asinine.
In fact, debating whether or not the nation will actually default is a complete waste of time. Why ? Because we're not the ones who decide whether or not our credit is any good. Our creditors do. When it comes to credit, perception is reality.
Remember the bank bailout in 2008? The day after Congress voted it down saying that bailing out the banks wasn't a priority, the stock market dropped almost 800 points in 6 hours, and they had to stop trading. It was in freefall. In 7 minutes, Congress' vote cost US publically traded companies 1.2T in market value. Many of the companies affected never recovered and went out of business.
And now, considering Fitch just put a negative alert on that credit rating, with the deficit going down, and our bonds are currently at record low interest rates, that means there's just one option left: they're calling the credit of the United States into question because our creditors are feeling that we might not pay our bills.
Somehow I have a feeling that the stock futures aren't going to look so good come morning. Jim Cramer agrees with me.
Now let's take this to a micro-economic level: an individual with a loan.
You take out a loan, and you're late on paying the bill. You have plenty of money in the bank to pay the loan back, and you have all the intent of doing so - but what happens? Your credit worthiness has just been called into question. The bank suddenly is at a higher risk of losing their money that they lent you. So they'll charge you more to service that debt.
That's basically what we're gambling with. We (the US) are going to do what just about every human being has done since the first credit card was issued in the 1950s.
"Hello? Yes, this is Dave. Yeah, I know..I know..I'm late on that payment. But check it out, I've had an awful month. My grandma, my mom, and my dog all died - on the same day. Well you see my grandmother was in the hospital, and my mom went into the hospital with the dog, you'll never believe what happened!!! The dog freaked out, panicked, jumped out of my mom's arms, knocked over grandma's oxygen tank. So now my grandma's choking, my mom is trying to give grandma mouth to mouth, and then all of a sudden the dog yanks out an extension cord and BOOM! blows up the room. And they're dead. They're all dead. So with the funerals and all of the grieving family members that I've had to help out, I just need another week or so to make this payment. Look, you know I'm good for it..."
The same thing here.
"Hi, everyone. This is the United States Government. I know we have a lot of obligations to pay off, but you see - the craziest thing happened. You'll never believe it. One party decided to hold the economy hostage over the healthcare law. Yes, THAT healthcare law. Yes, I know it was settled in court. But that's not the issue. So the government shut down. Yeah, I know...it costs more to shut the government down than it does to keep it open. We tried explaining this. But then..oh wait for this one - we've hit our debt ceiling, and now we have to pick and choose who we pay and when. But don't worry you'll get your debt payments, but all of those trade agreements we've made, all of those contracts we've signed that your companies and countries depend on - well, we can't pay ANY of those just this moment. But don't worry, you know we're good for it."
No...they don't. And there's 5.59T in treasury bonds held by foreign investors as of July 2013. Those bonds are backed by nothing other than the credit of the United States. The value of a treasury bond is that foreign countries KNOW that they'll be able to sell them if they want, and they'll get a return on the investment. 5.59T. 1/3 of our national debt, and 1/3 of our GDP. They hold them because they get that return in their investment.
But if that credit worthiness were suddenly called into question - who's to say that they won't dump them so that they can at least get something out of them? It would be akin to the scene from the Jim Carey movie "fun with Dick and Jane" which while fictional, is not too uncommon for a company (in this case country) who's asset value was reduced to junk status by the divestment of a major investor. (Think China, who holds 1/3 of all of our foreign-owned Treasury bonds.) They sell, it would likely spark a selling frenzy as the sale would devalue the remaining bonds through increased supply and then every holder sells their shares so that they at least get something out of it.
Overnight, our debt would be almost 23T if that were to happen, and suddenly, we have no one who wants to buy that debt, because it's not worth anything. So we can service the debts of 17T, but what about 23T?
Whether or not we default is simply an argument of semantics. The question is , what will the rest of the world think about lending us money or even trading with us?
That's the key question to ask here. And based off the relatively flat purchases of US treasury bonds by foreign markets lately , I think we know the answer to that question.
Perception is reality. And reality isn't good right now.