Solvency Is Not An Issue Here!

Over at The Volokh Conspiracy, Kenneth Anderson has a post asking what would happen if Congress increased the debt ceiling so high that it were effectively infinite. What would happen, Anderson asks, if "the markets[] now have to focus on the longer term ... question, is the debt sustainable?" 

It's a good question, if only because so few people seem to understand how completely the answer contradicts the premise that financial markets think the federal government is a bad long-term bet.

On this page, you can see reports of the yields the market is requiring the Treasury to pay for its debt. On July 25, the day Anderson asked his queestion, the market was requiring Treasury to pay well less than 1 percent for a 3-year loan, 3.03 percent for a 10-year loan, and 4.31 percent for a 30-year loan. 

Two points here. First, the financial markets already focus on the longer term question, because bond purchasers are choosing to lend over the long term.

And second, the markets aren't worried about the government's capacity to make good on long term loans. People with capital to invest are lending it to the U.S. Treasury at very low rates for very long periods of time. The notion that the U.S. government faces anything like a solvency crisis is wildly inconsistent with what financial markets are telling us. The real risks from the current political crisis are (i) the possibility of default on short-term debt,* and (ii) the huge negative shock to aggregate demand that would accompany switching to a de facto balanced-budget fiscal policy in the middle of a serious downturn.

 

*The yield-curve data at the page linked above shows that 1-, 3-, and 6-month yields have ticked up somewhat over the last week or two. This pattern is consistent with a concern that the probability has risen that Treasury might not be able to make good on short-term debt issues; of course, there might be other explanations, too.