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Calling Obama's Bluff   July 29th, 2011
The financial markets don't appear to believe President Obama       

 
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Last week President Obama told Republicans not to call his bluff. Republicans might cave and refuse to call his bluff. But, so far, the markets are calling Obama's bluff.

There is growing consensus that a failure to raise the debt ceiling isn't really a crisis. Government debt, Social Security, Medicare, Medicaid, and military salaries could all be paid with revenues and the rest would amount to a partial government shutdown.

Although the prevailing opinion was that interest rates will rise, there's even speculation that that wouldn't happen:

The nation is just days away from the debt ceiling deadline, and no one knows exactly what will happen when the borrowing limit is reached. But even in the worst case scenarios, many experts think investors will flock to U.S. Treasuries...

"We'll have a liquidation of risky assets and a flight into quality," said Kim Rupert, Managing director of Fixed Income for Action Economics. "There really isn't an alternative [to Treasuries]."...

And the expectation that the U.S. Treasury will continue to pay the principal and interest payments owed on existing debt, even in the case of a prolonged deadlock, will give investors a sense of confidence, even if there is a downgrade.

"I don't think a rating change will fundamentally change anyone's view about the likelihood of being paid back on Treasuries," said Josh Fienman, chief economist DB Advisors. "They will continue to think that Treasuries are 'money- good.'"


I wrote back in May that a temporary failure to pay our debt while we work out a solution to our fiscal problems is not the same thing as Greece where it's mathematically impossible for them to pay back their debt.

In the case of our failing to temporarily make debt payments, there'd be very little expectation that the debts would never be paid. Everyone knows they'll eventually get their money. This is substantiated in the quote above: "I don't think a rating change will fundamentally change anyone's view about the likelihood of being paid back on Treasuries." While there may be some short-term turmoil, it will be short-term.

Indeed, the "expectation that the U.S. Treasury will continue to pay the principal and interest payments owed on existing debt, even in the case of a prolonged deadlock" is validation of the Republican position: There is no reason why we would default because we have plenty of money coming in to pay our debts. Likewise, we have enough money to pay our debts and pay Social Security and most of the other prominent social programs.

If the markets were concerned about real default, interest rates would rise quickly. No-one wants to loan money to a government they think won't pay them back. But throughout this whole debate--and with the supposed deadline just two business days away--interest rates have remained at historic lows. In fact, they've even dropped since June and have also dropped in the last week even as a political solution has grown less likely.

Though it can be argued that the markets simply don't think the politicians will fail to reach a solution, at some point one would expect some reaction in interest rates as the deadline looms... unless, of course, markets expect that U.S. debt will be paid regardless of whether or not a solution is found by the deadline.

The fact that interest rates indicate little concern about default means that the financial markets believe Republicans and don't believe Obama will follow through with withholding debt and Social Security payments.

President Obama and Democrats are fear-mongering and it would appear that the markets are calling Obama's bluff.

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