Bring on the (USA) downgrade

I think Krugman essentially has it right about the apparent lack of bond-market excitement over a possible US debt repayment event (which might arise if Congress refuses to authorise a higher debt ceiling). 

To paraphrase him: why should the markets worry when it has been made crystal clear that the Fed is capable and willing to ensure liquidity in the US Treasury market?  This is QE. Moreover: if big spending cuts are to be implemented, then that will be extremely bullish for bonds even in a world without QE. But it also pushes back the anticipation of tapering to some day in the far future. Maybe holding Treasuries in the face of a credit event isn’t so dumb after all. And remember what happened last time the big bad credit raters passed judgement on the Treasury market. 

The Treasury market is attractive not for its payment streams but for its liquidity. It is the safe place to hold your US dollars. I don’t think a default or downgrade will change that — unfortunately. Why “unfortunately”? Because the US dollar’s status as global numeraire currency is a burden on the economy. It is one of the reasons why we’ve had a super-sized financial sector, which isn’t a priori helpful for the real economy. Rapid financial sector growth  (i.e. above and beyond ‘financial deepening’) has an asymmetric (negative) impact on the real sector via instability and probably also by over-valuing the currency.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *