It’s not going to really happen any time soon, so don’t hold your breath waiting. At most we might get a technical default and we will have to sit around and watch Wall Street wet its pants for a week or so.
Who Owns US Debt
Approximately 85% is owned by US institutions and only 15% foreigners, with Japan and China equally holding around 6%.
What Is a Default And Why China And Japan Don’t Want To Make Origami Cranes
A country defaults on its debt when it cannot pay the interest on its outstanding loans. And, nearly every year the US raises the debt ceiling to pay that interest because our debt has slowly grown for the last 80 years (why that happens we will save for another day). But some times minority factions in Congress – the Crazies – threaten to not raise the debt ceiling as a negotiation tactic to get things for their home boys/donors that have NOTHING TO DO WITH REDUCING US DEBT MATERIALLY.
This is the Debt Ceiling Rain Dance and it gives the financial industry’s drama queens something to talk about on television, but it’s a negotiation tactic first and foremost. The President can order the US Treasury to print more digital money to meet US debt obligations. Oh Yes He Can. The US prints its own money, so we do not have to default unless the US collectively chooses to do so via Congress by stating “the US is defaulting on its debt” AND the President has to go along with it. The US is not Greece waiting for another truck of money to arrive from the Bundesbank.
Further, Japan, China – our debt-happy trading BFFs – surely do not want a US default. No Way Jose because a US default means they are sitting on a pile of greenbacks that are only good for making origami cranes. So, the Asians will not dump all their Treasury investments. They’ll be patient – being Asian – and let this current batch of Crazies in Congress self-immolate on Capitol Hill. And the other 85% that holds US debt is US government institutions and wealthy Americans managing enormous American pensions. They don’t want to see their investments become worthless overnight either, but they won’t dump it for a different reason though, reinvestment risk. There’s not enough alternative anything in the world to mop up that kind of money if it floods out of Treasuries.
Why Even The Threat Of a Default Matters To Everyone
The downside of having even a few Crazies in Congress is that the US begins to slowly look a bit more unstable. And appearances are everything in markets driven by fear and greed. It’s kind of like being a normal person but having a contingent of unstable friends you occasionally hang out with; people start to wonder how stable you really are based on the company you keep. Therefore the US starts to look “higher risk” the Crazier Congress gets. And when you are not the most stable game in town, your BFFs and other people counting on you to keep it together won’t want to lend you money as quickly.
So interest rates begin to rise the Crazier the US seems (which is why 2007 was the last time interest rates soared). And if interest rates rise too quickly, then asset prices worldwide will fall with a big thud because almost everything on earth has been bought with loans on the back of cheap money.
If a Full Blown Default Happens, It Won’t Happen The Way You Think It Will
Today US debt comprises nearly 1/3 of the nearly $100 trillion debt market, so a default means soaring interest rates, prolonged deflation globally and massive depreciation of the US$. It means the end of Money Market funds and funding as we know it, and that comprises the bulk of the short term capital most MNCs and banks use worldwide.
The world’s wealthiest people, the 1%, are, as yet, still in the United States or have enormous exposure to US assets, like property and municipal bonds (including all those wealthy Asians sheltering money in North America). They collectively control more assets and, by Constitutional definition, more political leverage than anyone. There is no way, short of WW III, the 1% is going to let their asset prices fall 50% again over a few Crazies in the US Congress.
In other words, the 1% will get in front of that fall out BEFORE it happens. Imagine a day when the US political establishment will have set up Trusts offshore in places like Singapore (as a few Congressmen have), or purchased massive plots of land in South America to escape the pain of a currency so devalued that it is worthless. This means, a US debt default ain’t gonna happen the way you think it would happen i.e. with a big warning from CNBC and warm hug to the retail investor.
Does This Mean The US Will Never Default – Let History Be Your Guide
Never say never.
Serious default aficionados will know that the most recent formal US ‘default’ was when FDR refused to pay back 1917 WWI Liberty Bonds in gold from the Treasury in 1933 and instead paid with paper money after a huge money printing session. That default took 16 years to come to fruition and affected a select class of assets. Before that, the US ‘defaulted’ after the Civil War (which some say led to Lincoln’s assassination) when the US did a huge money printing session and issued inflated “Greenbacks” in place of the currency promised on the debt. So, the “tells” are not Congress doing a Default Rain Dance but instead war + big money printing + big, bold moves by a President with big cojones instructing Treasury.
What Can You Do When You Get Nervous About US Debt Defaults
Relax. Turn off the TV and start making some Origami Cranes. For now, given the flood of money from Asia going to the US, US debt default seems to be some way off. Only the simplest minds in investment advising are saying “the US is defaulting” or “buy gold”. Listen at your peril. However for long term investors who want options:
If you are American – buy property overseas or follow the lead of wealthy Republicans by setting up overseas Trust Funds where you can invest outside the US financial system. Or use US fixed rate debt and buy US property, and deflate away your debt just like the US government!
If you are not American – pay down those variable debt payments, own your assets free and clear.