May 27, 2024

Economix: Fear the Bond Market

James Carville famously said that if reincarnated, he’d like to come back as the bond market, since “you can intimidate everybody.”

“Everybody” includes politicians, with good cause.

A showdown over the debt limit is coming down the pike, and despite warnings from Timothy F. Geithner, Ben S. Bernanke and many  economists about the potential catastrophe that could result, the game of chicken has continued. But it appears that bond traders are now weighing in.

Politico reports:

Republicans are growing increasingly concerned about the impact a bruising fight over raising the nation’s $14.29 trillion debt ceiling could have on financial markets in the United States.

House Speaker John Boehner (R-Ohio) has had conversations with top Wall Street executives, asking how close Congress could push to the debt limit deadline without sending interests rates soaring and causing stock prices to go lower, people familiar with the matter said.

Ezra Klein notes that Republicans may back down because they do not want to upset Wall Streeters, who have donated large sums to the G.O.P. (and Democrats too, really).

But there’s a more fundamental cost at stake: If there is fear that the government will default on its debt, the costs for the government to borrow will go way up, as would be the case with any borrower. The Politico article cites this potential consequence:

“They don’t seem to understand that you can’t put everything back in the box. Once that fear of default is in the markets, it doesn’t just go away. We’ll be paying the price for years in higher rates,” said one executive.

What do higher government borrowing costs mean?

For one,  the federal debt will become even harder to pay off, which is obviously not the desired effect.

And two,  a rise in long-term interest rates could derail the recovery. Treasury yields are used as a benchmark for all borrowing, and so higher interest rates for the government could make it more expensive for other parties (including consumers and small businesses) to borrow, too. A botched economic recovery affects not just Wall Streeters and the size of their donations, but voters everywhere across the country.

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