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Selling a Default that Nobody's Buying

Can the U.S. really default
of the absurd?

or is the threat just theater

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By Mark Phillips

7 et's be clear: There
is no such thing as a
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._—_-_,default for the U.S.
Government. Should the
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government fail to raise
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the debt ceiling, credit
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rating agencies will lose,
lawyers will win and the
financial markets will go
about their business.
The value of U.S.
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Treasuries (namely bills,
,
notes, bonds and other
securities issued by the
it offshore and into the protection of the
government) will remain unchanged.
U.S. Government.
Treasuries, like the dollar itself, are
This motivates a large percentage
backed by the full faith and credit of the
of foreign purchases of Treasuries and
U.S. Government. The government may
demand for U.S. dollars as a reserve cur-
hit its self-imposed spending limit on
rency. More than $12 trillion is held in
Aug. 2, but faith in the U.S. as a AAA-rated
reserve currency around the world — just
entity will not be impacted. Most simply,
shy of the size of the entire U.S. economy.
because the people with the money (the
This is particularly true for develop-
market) are not interested in disrupting
ing nations like China or Mexico, where
the system.
political turmoil could undo decades of
U.S. Treasuries are different than
economic gain. (Compare that to the
other assets. They are more than a credit.
political turmoil of two parties fighting
They are a contract. To be considered in
in the U.S. — both of which rely on hun-
default, one side or the other has to press
dreds of millions of dollars in fundraising
the claim. That's not happening here. No-
for their existence.)
body wants to stop using them. There is
If nobody's buying, who is selling the
nothing to gain by rocking the boat. The
default scare?
threat of default is a paper tiger created
Attorneys and lobbyists:The U.S.Trea-
by the rating agencies.
sury needs about $125 billion in credit
Treasuries are embedded into the
each month to meet all the government's
current world economic system as a AAA-
obligations. This represents about 40 per-
rated credit and a safe haven for global
cent of ail spending. In theory, if further
liquidity. Neither one of these factors is
borrowing were cut off, the government
changing.
would automatically have to reduce its
Trillions of dollars of U.S. Treasuries
spending by 40 percent.
are used in financial markets everyday
This is a daunting prospect, particu-
as collateral for the complex web of trans-
larly since there's no precedence for who
actions that make up the fundamental
would get paid first. Soldiers or retirees?
underpinnings of the world economic
States or foreign bondholders? It would
system. They are the baseline against
start a legislative slugfest that would
which all other assets are priced and
make the rush for TARP money look like a
against which financial contracts are
well-organized line at Disney World. (Cre-
written.
ating a big opportunity for attorneys and
Individual insurance policies and credit
lobbyists to put in their two cents in.)
cards use them as a reference point, as
The second: Bond-rating agencies.
do complex municipal investment plans
These folks need to prove their relevance
and corporate depreciation schedules.
after falling asleep at the wheel precipi-
Treasuries, unseen, are everywhere in the
tating the 2008 meltdown. The ratings
system.
agencies have a history of being lagging
Unwinding Treasuries as a AAA-rated
indicators and seem to be making a spe-
credit would take an army of lawyers and
cial effort this year to appear proactive.
an immense amount of time. It's going to
The problem they're facing is nobody
be far easier to simply redefine a AAA rat-
seems to be listening to their warnings.
ing as a U.S. Treasury, rather than rewrite
Failure to raise the debt ceiling poses a
and restructure all the contracts that
particular problem for them. If the rating
currently use them as collateral (provided
agencies define the U.S. as technically
all parties in the contracts agree).
being in "default" Aug. 3, but nothing
And there's every indication that they
changes, it's the bond-rating agencies'
do. Interest rates on Treasuries, which
value which will take a potentially lethal
fluctuate inversely to their price, have
hit. _- -
stayed low — or dropped — as the dis-
cussions in Washington continue.
Mark Phillips is an economist and former Wall Street
Further enhancing the strength of the
analyst. He holds an M.S. in applied economics from
U.S. Treasury is the demand by foreign
the University of Michigan and a B.S. in economics and
governments and wealthy foreign nation-
philosophy from the London School of Economics.
als to secure their wealth — by moving

1 . • ` •

4

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14

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16 August 2011 1

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