Debt and more debt seems to be the object of economic consternation across the globe these days. Pretty soon, one could envision government leaders phoning Peter Francis Geraci to extract them from their predicaments.
Recently, considerable debate was generated by a Wall Street Journal editorial interview of Stanley Druckenmiller addressing the so-called “debt ceiling.” Druckenmiller, now retired, was a “highly regarded” hedge fund manager who worked with billionaire George Soros.
Druckenmiller raised a few eyebrows by suggesting that, as an owner of U.S. Treasury bonds, he would prefer to accept a “technical default” by the U.S. government versus raising the federal debt limit (ceiling) without any plan to reform spending.
In explaining his radical view, he offered two scenarios. Say you hold a 10-year Treasury bond to provide an income stream for the next 10 years. Say the holder has one of his upcoming interest payments temporarily delayed for a couple of weeks, but in all reality he knows he is going to get paid eventually.
Now, what if, in exchange for this delay, the government enacts massive cuts in entitlements. Druckenmiller posits that, irrespective of the temporary default on his current interest payment, the bondholder is now much more confident he will receive those latter interest payments in years eight, nine and 10.
Scenario two is that Congress promptly raises the debt ceiling and next month’s interest payments on Treasury bonds are made on time without a hitch. However, without any budget or entitlement reform, Treasury bond investors conclude that trillions of dollars in additional debt are going to pile up and that a Greek-style debt crisis could be in our future. These bondholders are less assured that their latter-year interest payments are secure.
Which scenario would you choose?
Druckenmiller’s thoughts on a debt default are in sharp contrast to those of Treasury Secretary Timothy Geithner and Federal Reserve Chairman Benjamin Bernanke. It’s their contention that a failure to raise the debt ceiling would have a “catastrophic” impact on the markets. The notion that the U.S. government would even delay an interest payment is enough to get these bureaucrats very nervous.
The public must understand that the arguing in Washington over raising of the debt ceiling is just political posturing. The debt exists and the symbolic number for the debt ceiling will eventually be raised, but not before some drama that amounts to a high-stakes game of chicken.
There is some history of debt-limit squabbling. Back in 1995, President Clinton was threatening to veto Republican budget cuts, when Congress countered it would not lift the debt ceiling above $5 trillion (since then our debt has nearly tripled to $14 trillion). Back then, Druckenmiller was saying the same thing as today—that “technical default” would be welcomed by the bond-market vigilantes (investors that demand fiscal and monetary responsibility). The bond market actually rallied once investors realized the first baby boomers would not retire until 2010.
So, here we are 16 years later with the hole that has been dug. No longer are the debt figures a sort of distant actuarial figment. Even if policymakers rise to the occasion, the task of cutting expenditures and raising taxes will be difficult in this slow economic environment with 9-percent unemployment.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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