Democrats and Republicans have been bargaining for weeks doggedly to raise the limit of Treasury debt: In the US, Congress establishes a maximum limit to the liabilities that the Government can issue and the current ‘stock’ of public debt is already very close to reach that limit. A few days ago, the Senate authorized a small increase in this debt ceiling, from 28.4 trillion dollars to 28.9 trillion, but the ‘stock’ of public debt today reaches 28.43 trillion, so that in just A few weeks (it is estimated that by the beginning of December) we will find ourselves in the same situation again.

If the Republican minority refused to raise the limit further by then, the Treasury could not issue new debt, so it would suspend payments: it would have to prioritize whether it continues to pay public salaries, social benefits or debt maturities. Ultimately, debt repayment would end up being affected. And what would be the effects of that USA defaulted on your debt?

Oscar Gimenez. Bilbao

In this regard, it is important to distinguish between a sovereign ‘default’ due to economic inability (or political repudiation to repay the debt) and a sovereign ‘default’ due to temporary legal inability to face the debt. In other words, if the US defaults, it would not be due to a lack of fiscal capacity to have a long-term positive surplus balance with which to withdraw its current obligations, nor because the country’s ruling class has decided not paying your creditors, but because US politicians have not been able to agree at the moment to overcome a regulatory obstacle that prevents normal service debt repayment (An obstacle that predictably in the future would end up being saved when the negotiations come to fruition).

In other words, if the fundamental value of an unpaid debt equals the present value of the main portion which is expected to end up recovering from it, in the case of US liabilities that fundamental value should be equal to 100% of the principal: no one doubts that, even if the US Treasury is unable to pay its debts, within a few weeks or In a few months, it will recover that legal capacity to pay and fully amortize the temporarily unpaid obligations (and if anyone doubted it, there would surely be many investors willing to buy their debts, which would end up raising their price to around face value).

If the US defaults, it would not be due to a lack of fiscal capacity, but rather because US politicians have failed to reach an agreement

The foregoing does not mean, however, that a temporary US default would not have serious consequences on the financial markets. If the Treasury does not pay when it owes, even for causes that can be corrected in the near future, the rating agencies should lower the ‘rating’ of the debt, which would have two types of consequences wicked.

On the one hand, it would force many institutional investors – by regulations legal or statutory– to dispose of that official low-quality debt en masse. And although many other non-institutional investors jumped in to acquire it – I would be happy to do so if it were settled at a sufficiently attractive price – and those voluminous purchase orders managed to stabilize its value in the short-medium term, the liquidations could lead to significant losses from the outset. for those institutional investors who put their solvency on the ropes.

Fed Chairman Jerome Powell.  (Reuters)Fed Chairman Jerome Powell.  (Reuters) Fed Chairman Jerome Powell. (Reuters)

On the other, the US public debt is today the main instrument through which many nuclear agents within the global financial sector (private banks, clearing houses or foreign central banks) get short-term refinancing in dollars. In essence, they sell their US government bonds with a commitment to buy them back in the short term (‘repo’ operation). In this sense, if the US sovereign debt were declared in technical default, many of these agents would not be able to continue using their public debt ‘stock’ to articulate ‘repo’ operations and would face liquidity restrictions. One might think that, at that point, the ‘repo’ operations would continue to be carried out through another asset that acted as collateral, but it is doubtful that this would be feasible: financial assets denominated in dollars of very low risk are scarce if we exclude debt public (and in some cases, even including public debt: the recent expansion of the Fed’s reverse ‘repo’ operations had the dual purpose of reabsorbing banks’ excess reserves and also providing them with public debt securities of which they could have in the markets).

Furthermore, and as is often the case in financial markets, solvency and liquidity problems they give each other negative feedback. If investors detect that some financial institutions suffer from solvency problems, they will stop refinancing them and will demand collection of their due and due obligations (that is, banks or monetary funds could face liquidity problems due to the demand for repayments of their securities, which would also lead them to refuse to act as counterparty in repo operations, aggravating the problems of the repo market); in turn, liquidity problems can quickly turn into solvency problems that arise if financial intermediaries are forced to liquidate their portfolio of assets at a loss or if they have to be rolled over at prohibitive interest rates.

EFE

In short, although the failure of the negotiations to raise the ceiling of debt in the US would not lead to a real deterioration in the country’s solvency and, therefore, in the quality of its debt, that does not mean that it could not have serious effects on financial markets. However, as we will explain in a future article, it is doubtful that the blood ends up reaching the river because both the Treasury and the Federal Reserve have different tools, bordering on legality but within legality, that would allow them to avoid the ‘default’ .

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