What Will Happen If Debt Ceiling Is Not Raised And The US Defaults12 July, 2011, 2:41. Posted by Zarathustra
Tags: Debt Ceiling, Economy, United States
As the political gridlock continues in Washing, it is now sensible to ask what will happen if the debt ceiling is not raised and the US government actually has to default on its debt
I am controversially bullish on the US dollar, except if the debt ceiling talks fall apart and debt ceiling is not raised by 2 August 2011. Of course, even the debt ceiling is not raised on time, the more likely outcome would probably be that the government try to prioritise its payments so that creditors get paid but not some of the others. It might be social securities, it might be other payments which got delay. By not defaulting on creditors, the government will default on other obligations.
But what will really happen if a default, albeit temporary, occurs?
The most obvious response would be for everyone to dump the dollar and Treasuries, as the United States is no longer credit-worthy. Indeed, the CDS of insuring the risk of default by the US government on its debts has surged in recent weeks and months amid the political gridlock even though yields have been falling amid a weaker economy and even scarier debt crisis in the Europe. But as far as the CDS market is concerned, a default of US Treasury securities is no longer unthinkable. Some might fear that this poses a systemic risk, as the US dollar is the reserve currency and the yields of US Treasury securities are widely used in pricing other securities.
This is a big but. It is something that has never happened before, so there is no precedent to look at. Things can actually go both ways. Here are some alternative schools of thoughts:
Perhaps US Treasuries will rise because as the US government can’t issue more debts, the supply will be limited, pushing down yields.
Or, as things look uncertain with default, money will go into US dollar, pushing up the currency.
Or, as things look even more uncertain in the Eurozone than in the US, money will go into US dollar, pushing up the currency.
Or, as things look even more absurd in China, money will go into US dollar, pushing up the currency.
Or, as things look really scary, people buy gold.
Or, that’s the end of the world, so it doesn’t really matter.
So what will happen?
I don’t know. I have no idea.