U.S. stocks fell Monday morning as the dollar rallied sharply vs. the euro amid renewed concern the sovereign debt crisis will spread to Italy. Treasury prices rallied in concert with the dollar as U.S. bonds are still seen as a safe haven in times of financial stress.
But that status could be in jeopardy after negotiations to raise the debt ceiling as part of a "grand bargain" to cut the long-term deficit broke down this weekend.
Like most observers, David Walker, founder of the Comeback America Initiative, believes a deal to raise the debt ceiling — at least temporarily — will be made before the Aug. 2 deadline set by Tim Geithner. But with about three weeks to go and a lot of political obstacles to overcome, it's time to ask what happens if no deal is reached before Aug. 2.
First and foremost, Walker says the U.S. will continue to make interest payments on Treasuries as mandated by Sec. 4 of the 14th Amendment to the Constitution.
The real question, he says, is "who's going to get laid off and who is not going to get paid on time?"
While many conservatives cheer the idea of federal workers being laid off, Walker notes such workers are historically rehired after a crisis, with retroactive pay. Taxpayers will pay for that, he notes; similarly, taxpayers would have to pay interest and penalties on any missed payments to federal contractors, thanks to the Prompt Payment Act. And if 55 million Social Security recipients don't get their checks on time — a possibility in September if no deal is reached — there will be major political repercussions, Walker says.
Meanwhile, "nobody knows" how the financial markets will react to Uncle Sam missing payments "and we would be stupid to figure that out," Walker says. "We're the largest economy on earth, temporarily the sole super power with over 60% of global reserve currency and we're trying to figure out what bills we're going to pay and not pay?"
Although Treasury yields remain low by historic standards, "we have huge interest rate risk" if there's no deal by Aug. 2, says Walker, a former U.S. Comptroller General and longtime deficit hawk. "There's all kind of warning lights going off — these people need to get to work and get a deal done."
Walker doesn't believe the Treasury market will collapse if there's no deal on the debt ceiling, but "I do think we'll pay an interest rate price."
How big a price is unknowable but Walker notes every 100 basis point (or 1%) rise in interest rates costs the U.S. $150 billion in additional interest costs, which would only exacerbate America's long-term deficit woes.
- Tim Geithner
- basis point
- interest rates
- reserve currency
- interest rate risk