Default Among Friends
Unless you are living under a rock you've been hearing about the shutdown and default...and nothing but…again. It’s enough to make us want to jump out of our skin, and our portfolios.
While a temporary solution appears forthcoming, I would remind investors this game of D.C. chicken seems to be turning into an annual event. To date, leaving our portfolios alone has been the prudent and successful course.
But If you're feeling every time we face these issues is scarier than the last, you're right. Because that’s the media’s job.
I don't say that flippantly. The media is paid by advertisers. If the media can't keep our attention, it doesn't get paid. You may have heard the journalism adage, "if it bleeds it leads."
For those unfamiliar, this means you put the most shocking stories first to keep the attention of the audience. As journalism seems to have evolved into a form of reality TV, perhaps the adage should be updated:
"If it doesn't bleed, make it."
In economic terms, no time we reach indecisiveness that could cripple the full faith and credit of the United States is worse than any other time. In real life, when these instances occur time after time, each is worse than the last because the negative effect compounds.
Once every decade or two and we seem to be having a tiff. Do it every year and our government is sending the message that we can barely keep our car in the road.
The irony in this is, our politicians erode the "full faith and credit" of the United States each time they encourage such occurrence whether or not we actually default on our obligations. Don't believe me?
Earlier this week China, a communist country* that happens to own 13 TRILLION in U.S. Treasury bonds, globally chastised the U.S. for the way in which we are running our democracy.**
I'm not saying actually defaulting wouldn't be worse. What I'm saying is repeatedly threatening the people you owe money that you might sends a similar message.
Saturday Night Live did a great job of expressing how one in China's position might feel. It's short and well worth watching here.
The good news for investors is each time we go through this we understand what it means a little better. Further, as uncomfortable as it is to live through, it is this kind of uncertainty and volatility that provides inflation beating returns over time.
So if you want to change something, forget about moving your investments around. Write your congressman and tell him or her to stop using the credibility and future livelihood of this country as fodder for negotiation.
Following is an excerpt from an article here regarding the debt ceiling and default. Though the dates and amounts are specific to the current situation, the result of shutdown/default remains static whenever we invite a "Fiscal Cliff." Remember that one?
This is the opinion and perspective of Moody’s:
Moody’s on the Debt Ceiling and Default:
Two issues now affect the outlook for US government finances: the government shutdown and the debt limit. The government shutdown began 1 October and resulted from Congressional inaction to authorize spending through either a budget or a continuing resolution. The US government (Aaa stable) reached its statutory debt limit of $16.7 trillion on 19 May. Since then, the US Treasury has used “extraordinary measures” to raise funds and pay government expenditures. Treasury estimates that it will exhaust those measures on 17 October and government expenditures will have to be reduced. Below, we address key questions stemming from the US government shutdown and the failure to raise the debt limit.
How does the government shutdown affect US creditworthiness?
The shutdown has no effect on the government’s ability to pay interest and principal on its debt obligations, and therefore does not directly affect the government’s creditworthiness. The shutdown prohibits discretionary spending, but not mandatory spending or debt service, such as interest and principal on Treasury securities, which the US government will continue to be able to pay.
Will the government default after 17 October if the debt limit is not raised?
We believe the government would continue to pay interest and principal on its debt even in the event that the debt limit is not raised, leaving its creditworthiness intact. The debt limit restricts government expenditures to the amount of its incoming revenues; it does not prohibit the government from servicing its debt. There is no direct connection between the debt limit (actually the exhaustion of the Treasury’s extraordinary measures to raise funds) and a default.
What is the pattern of US interest payments after 17 October?
Interest payments on Treasury bonds and notes are due twice monthly, on the 15th and the last day of every month. After 17 October, the first interest payment date is 31 October, when a relatively small $5.9 billion is due, and the next is 15 November, when $30.9 billion is due.
Why are only interest payments potentially affected and not principal?
The statutory debt limit is a limit on the amount of debt outstanding. As debt matures, it can be refinanced with new Treasury issuance without affecting the total amount of debt (principal). Interest, by contrast, is an expenditure and could be included among the expenses that the Treasury could decide not to pay.
Is the situation worse now than it was in 2011, the last time that the debt limit was an issue?
No. The budget deficit was considerably larger in 2011 than it is currently, so the magnitude of the necessary spending cuts needed after 17 October is lower now than it was then.
