How we view a default ‘doomsday’

Each week, Symposium Magazine invites authors to guest-blog. This week’s featured article is Why U.S. Financial Hegemony Will Endure by Sarah Bauerle Danzman and W. Kindred Winecoff.

We’re excited to be blogging here this week to supplement our article in the new October issue. We plan to address readers’ comments and questions as well as to talk a bit about how thinking about the international financial system in network terms can inform policy responses to major current financial issues. Of course, the political news cycle is increasingly dominated by the impending debt-ceiling crisis, and that seems about a good of place as any to focus today.

The U.S. is slated to reach its debt ceiling on October 17, at which point it will not be able to continue to meet its financial obligations without congressional authorization to raise the limit on U.S. government debt. The U.S. could go into default with its lenders (who, shockingly, are not just the Chinese but a lot of American citizens, and perhaps most importantly, banks) on October 31,, when a $6 billion interest payment comes due.

There’s a lot of collective handwringing about what a U.S. default would look like, and much of what was written during the last debt-ceiling crisis in the summer of 2011 is getting recycled back into current analysis. Clearly, a U.S. default could become the type of massive shock to the international financial system’s core that could threaten to bring down the entire network. The media is consistently running with this doomsday scenario.

A key implication of our network model, however, is that it takes quite a lot of things happening at once to create a fundamental structural change. Not only must there be a large negative event in the U.S., but policymakers must be completely unwilling or unable to respond to crisis, and investors must have a fit alternative in which to place their assets. This scenario seems highly unlikely. If Congress fails to raise the debt ceiling by Oct. 17, the U.S. could technically go into default at least temporarily.

But it’s pretty clear that the debt ceiling issue is really a bargaining tool Republicans are using to try to extract concessions from President Obama and the Democrats. There is no indication that default is the first preference of either side. Congress will eventually raise the ceiling; the question is when. Treasury yield curves reflect this assessment, with 1-month rates rising substantially in recent days but with 3-month and longer rates remaining largely unchanged.*

In a political environment consistently characterized by eleventh-hour deals and crisis bargaining tactics, perhaps it’s reassuring to see our financial system is robust to short-term deviations from normalcy. In the long run, the U.S. might not have such a cushion as other countries develop viable alternatives to an American-led financial system. But for now, at least, the future of humanity does not rest on whether Congress passes a debt ceiling increase by midnight on Oct. 16.

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