Debt ceiling issue won’t lead to disaster

May 7, 2011
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Former Michigan Congressman David Stockman recently told National Public Radio that when he became the budget director for then-President Ronald Reagan, the nation’s total debt stood at $1 trillion. Thirty years later, the debt tops $14 trillion and continues to rise by the minute.

Congress is scheduled to vote on raising the nation’s debt ceiling soon, possibly as early as next week. One calendar has the vote coming May 16. But many House Republicans have said they won’t agree to jacking up the ceiling unless they receive guarantees of large spending cuts for future budgets, including next year’s.

However, some government officials, such as U.S. Treasury Secretary Timothy Geithner, and some economists have said not raising the ceiling would push the federal government into defaulting on its debt and would throw the world’s economy into a deep recession, perhaps even a depression. They estimated the Treasury would begin defaulting in early August without a ceiling lift and then interest rates would rise.

“We’ve looked into this and, certainly, after we’ve just been able to witness the 2011 budget process come to a close six months after the fiscal year started, I don’t think anyone should have particularly high hopes for how this is going to end up. It’s going to go long. It is going to be full of a lot of political vitriol,” said Mitch Stapley, chief fixed income officer for Fifth Third Asset Management.

“But I think the key thing is, while it will cause volatility in the marketplace, its real overall impact should be pretty minimal. Again, I think there could be a tremendous amount of volatility — up 100 points, down 100 points in the stock market,” he added.

Stapley said if the government does default, it wouldn’t be like Lehman Brothers, a case where creditors received 10 cents for each dollar. Instead, he said he will be watching how the short-term T-bills that mature in July and in August will perform. For now, though, that market looks stable.

“You do not see the price of those securities beginning to decline because investors would see there would be a potential that they would not be getting 100 cents back on their dollars with those things, when those things mature,” he said.

Stapley noted that the government still has a tremendous amount of revenue coming in, and officials fully understand what the impact to the marketplace would be if they somehow didn’t pay investors, even more so when officials know they’re trying to roll over debt worth trillions.

“We’ve got 60 percent of our outstanding debt maturing in three years,” he said of the nation’s outstanding marketable debt, not the entire $14.2 trillion before Congress. “So would there be actual economic harm suffered by investors, by the banking and the financial system? We believe it is no — we see no chance that someone is going to actually lose money in it.

“Now, could they lose sleep over it? OK. Because of increased volatility in the marketplace, could the dollar continue to weaken? We think there is probably a pretty high likelihood for pressure on the dollar — and then think of the enumerations that could come off that weaker dollar.”

Of course, prices for imported goods would go up if the value of the dollar goes down. Crude oil prices would rise at a time when a gallon of gasoline now tops $4 in many places. Then Stapley pointed out that a weaker dollar could cause investors to lose confidence in the U.S. and the government’s ability to address the long-term financial strain associated with entitlements and other spending issues.

A weaker dollar would also mean interest rates would rise, which would raise credibility concerns in the minds of international investors because the cost of financing the nation’s debt would increase. Stapley said foreign investors are buying more than 50 percent of the nation’s outstanding debt at auction right now, and they would need higher rates to compensate for the higher risk they would be taking to buy more U.S. debt.

“So, base Treasury yields go up at forces of interest and all through the economy. Mortgage rates go up. If you want to get a mortgage, I’d say you’d better do it now. Not because rates are going to be shooting up, but if Treasury yields go up that will put upward pressure on mortgage yields, as well,” he said.

As for the potential of inflation if interest rates rise as the dollar weakens, Stapley said higher interest rates could actually lower inflation over the long run because a higher cost for borrowing money slows economic activity. And less economic activity usually results in less inflationary pressure.

“It’s more the weaker dollar question and what that does to import prices,” he said of his main concern.

For Stapley, the bottom line is if the government can’t borrow this summer, then the country will be faced with a government shutdown. If that happens, non-essential services would be cut back and things like parks would close. But money would still flow because the Federal Reserve would still be open to keep the financial system going.

“There would be funding available for that,” said Stapley, who added that he doesn’t see a financial disaster in the country’s immediate future with a national election just over the horizon.

“You have to understand, with 2012 looming like it is, something of that magnitude is just not going to happen.”

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