The Doomsday Book
Doomsday is a lot easier to ignore if it isn’t accompanied by four ghoulish fellas on horseback. With month long Treasuries now maturing beyond the June 1st deadline, the unthinkable has been quietly switched to plausible, and is being priced as investors brace themselves because the day is nigh.
Mind, the original meaning of “doom” wasn’t disaster per say, but merely a final and unsympathetic reckoning or judgement. Which is enough to scare the devil out of most of us. You may recall the “Doomsday Book” from some far-off history class when, in 1085, when in William the Conqueror sent out agents to every shire in England (and those in Wales that wouldn’t kill the king’s agents on sight) to record who owned what and how much tax the crown could wring out of his loyal subjects. The rub was that there was no appealing it’s judgement. And there isn’t much that we can do to appeal the judgement of the markets if the debt ceiling negotiations this week go sideways.
What will happen if the US defaults? The collateral traders use will evaporate and all manner of financial contracts will simply come apart, the accounts corporate cash managers use to pay each other will be thrown into chaos and liquidity will drain out of the system. Many economists estimate that the effect of a month-long default would take some 30% off the stock market.
And lo, there will be gnashing of teeth and rending of Columbia vests.
US Treasury Secretary Janet Yellen has chided congress: “Since 1789, the United States has paid all of our bills on time. It should stay that way.” Her conclusion is spot on, her history may need some work.
In 1793 – four years into the unsullied run of credit worthiness, she mentions – Congress suspended payments on the loans from France we gratefully took during our revolution. When France had its own revolution a few years later, we argued that the war loans had been with the previous management team, and so voided. In response, France started repossessing our naval vessels leading to the Quasi-War (1798-1800) with our former allies in which we were supported by our former colonial overlords, Great Britain. Twelve years later we were at war with Great Britain, again, and we defaulted, again. Per then Treasury Secretary Alexander J. Dallas: “The dividend on the funded debt has not been punctually paid; a large amount of treasury notes has already been dishonored.”
We had a pretty good run after that. Until in 1933-34 when FDR refused to pay Treasuries in gold – as the government was obliged to do – opting instead to pay coupons in rapidly deprecating paper money. This, by the way, is why my grandfather, and probably yours, had that safety deposit box full of Krugerrands.
These historical examples miss an important point: the US dollar was not the world’s default currency at the time. Those early defaults had the same global effect as a credit crisis in Uruguay. FDR’s creative accounting caused a little more of a stir, but it was the Depression and everyone was trying to get away from gold.
The only US default of the Greenback Era was under President Carter, in 1979, and was plausibly blamed on a computer error; it was short lived and bondholders were repaid with interest. There will be no blaming a bad internet connection on this one, though.
Today, the greenback is the world’s reserve currency and our monopoly to produce them puts us in an economic VIP lounge of one. China is big, hot on our heels and gunning for the yuan to replace the dollar as a reserve. For that to happen, the rest of the world to trust their money, which they don’t. Without the ability produce the modern equivalent of gold, an economy can never command to advantages that American one takes for granted. If the greenback loses its reserve status the advantages for America, and the global markets, will evaporate.
Chances are that our Washington will likely find a theatrical deal out of the deadlock, but financial markets have already crossed the Rubicon. Whether a last-minute deal is struck or not, the scenario of a US Sovereign default is now plausible, if remote, and priced accordingly. McCarthy, Biden and Co may forget about the suicidal dance running into an election year, and so might the exhausted and terrorized electorate but the investors won’t. They’re pissed; their cheap collateral just got a little more expensive. Since the treasury has already run down its reserves to virtually zero, a deal would be followed by a wave of new issuances needed to rebuild the buffer the Treasury has been burning through for the last few months – draining liquidity from the market and push yields higher.
Even that’s not the real long-term danger: That massive pile of debt remains as we quietly approach the point where United States can no longer grow itself out of our ballooning liabilities. Certainly not with higher rates, short-sided industrial policy, looming trade wars of Cold War II, and a retreat from globalism will all restrict global markets and trade.
No, gentle reader, “Doomsday” is just an unsympathetic reckoning of accounts, and doesn’t necessarily mean disaster. But