Sunday, January 11, 2009
uncle sam and daddy warbucks
one greg ip, a writer at the washington post, wrote today about the possibility of federal bankruptcy; and, slim though it is, there are signs among financial markets that perceptions of a default are on the rise. a risk-gauging instrument called a credit derivative (a form of insurance for investors) has posted a 5 percent rate jump on 10-year u.s. spreads since this date last year. given that formerly those rates were cemented at 1 percent, the spike is something to take note of. ip doesn't think default is, in actuality, something to fear, and neither should anyone else. the reserve status of the dollar almost guarantees that domestic and international lenders will do anything to prevent the u.s. from hitting bottom. the fallout for the greenback would be every bit as painful for issuers of the yen and renminbi. however, with net obligations totaling $3.8 trillion over revenues for the next two years, and that in addition to all of the bad debt we've agreed to guarantee, we're looking at debt reaching 60% of gdp by 2010 and, with it, some serious reconsiderations on debt servicing. inflation is the classic tool, but can it be encouraged? the fed has been thinking about posting a 'target' to reduce market uncertainty. whether or not shoulda is coulda is anybody's guess. me, i think signs point towards, if not full-out deflation, then minimal inflation in the short-run. we'd have to risk hyperinflation to get anywhere close to what we need, anyway, a measure i don't believe is really preferable to bankruptcy. at the very least, we're looking at low growth compounding the difficulties of higher borrowing costs (most of our creditors are foreigners, with little incentive not to sell our debt), making the recession all the more difficult to climb out of.
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I think this is massively unlikely. I know you already said that, but I'll say it again.
ReplyDeleteFirst, in a period of what could be massive and prolonged deflation, I don't think that debt-servicing policies coming at the cost of a weaker dollar and inflation are really worrying more people at the Treasury of the fed.
Second, 60& of GDP is small beans compared to Japan. Japan obviously isn't a shining example of macroeconomic policy, but it goes to show that a country with sufficient economic and political clout is NOT going to default.
Third, I don't know if this is true of CDSs on treasury bills, but I'm fairly sure that private CDSs are priced not simply based on the perceived risk of a default (the operative "D" in CDS), but also based on the chances of the bond in question falling below a certain price, which may, according to the structure of the derivative, still constitute an "insurable" event. That the gobbling up of T-Bills might slow, pushing up yields and pushing down prices, is certainly not inconceivable--much more likely than an outright default.
Last, I don't think any government official is going to buy your stance that a default outweights the price of inflation. With inflation, you get a weaker dollar and maybe a wage-price spiral. With a default, you get interest rates unseen since the early 1980s and a third-world U.S. dollar, which may very well trigger enormous inflation among imports, though the high rates and the resulting deepening of the recession might counter-balance that effect. Either way, I would guess a confluence of events nastier than anything since 1933.
first, to answer your last piece of criticism regarding inflation vs. default, i was contrasting the risks of hyperinflation against bankruptcy. i never said that a few percentage points on the cpi would be an impossible injustice. my point was that allowing a hyperinflated dollar to wash the slate clean would potentially do as much damage as a default. the phrase 'wage-price spiral' seems a little naive for describing 500 or 1000% price hikes; russia in 1990 is an operative example of the dangers there. let inflation spiral out of control and you wipe out savings across the board, weakening an already paltry commercial bank capital base and prolonging considerably the recession.
ReplyDeleteip's article is pure scare-tactics and is weak on evidence, but he does raise the most probable scenario, which is renegotiating the debt servicing scheme. it's been done before on several occasions. also, to answer your supposition that credit derivatives may be experiencing a price hike in response to a perceived fall-off in t-bill sales, with $3.8 trillion in expected borrowing through 2010 i don't think anybody but the worst investor believes that this treasury fire sale is slowing down in the near future. while the returns on 3-month t-bills is a much gossiped about 0 percent, 10-years are at 1.125 percent and climbing. clearly, there is no fall-off in perceptions of t-bill values for the near future; that leaves fear of default as a real element in the decision-making of financial markets.
I suppose, but I think it would be possible to begin servicing the debt in a gradual way without it resulting in hyperinflation. I don't think its naive to assume that the dilemma between hyperinflation and default isn't one that isn't going to present itself. And as long as I'm salvaging my much maligned honor, to defend my term of choice, I think "wage-price spiral" is a perfectly lovely term which can be accurately applied to hyperinflation--maybe more so than to an up-tick of a few digits. It ain't called a spiral for no reason.
ReplyDeleteAs for the treasury bill issue, all I can say is that I've been reading more and more articles recently suggesting a possible bubble in the t-bill market. I'd imagine that the panic in the financial market will eventually simmer down (or at least get replaced by another panic as demand for U.S. bonds doesn't keep pace with all that spending coming up the pipe). Anyway, it isn't all that important; I was just suggesting that the article might not be taking that into account the prospect of a massive price-decline in the near future. To look at a CDS price spike and assume that that only reflects a fear of outright default may be misleading. But as I said before, I don't know how these instruments are generally structured (if there is a general structure at all as most are OTC, I think).