US Treasury Secretary Timothy Geithner said it will be unthinkably damaging to the economy, much more damaging than even what we faced in the dark period of '08 and '09, if Congress fails to raise the debt ceiling by August 2011.
Geithner is so right but so wrong.
He's right that the US debt situation is unthinkably damaging to the economy and will spark a crisis worse than the dark period of '08 and '09. However, the danger isn't the failure to raise the debt ceiling.
If the debt ceiling is reached and the US government delays paying its debt obligations for a few days, or even a week, it would be bad.
However, it would only constitute as a technical default because everyone knows that the US has more than enough borrowing power (for now) and assets to meet its debt obligations.
If this technical default forces Democrats to yield to Republicans and pass some serious measures to deal with the US budget deficit in the long term, it'll be well worth it.
The market isn't stupid. Especially the long-term players in the US Treasury market.
If you gave them a choice between receiving some payments a couples days late versus having the US go down an utterly unsustainable fiscal path, the vast majority of investors would opt for the former.
Legendary hedge fund manager Stanley Druckenmiller said as much in a WSJ op-ed.
He said: I think technical default would be horrible, but I don't think it's going to be the end of the world...What's going to be catastrophic is if we don't solve the real problem.
Some think a technical default will have a domino effect in the financial system and cause another electronic run on the bank, like the dark period of '08. However, there is a vast difference between Lehman in 2008 and a technical default in 2011.
Once again, investors aren't stupid and will recognize a technical default for what it is. Moreover, the financial system is flush with liquidity and there won't be a cascading of margin calls that will force liquidations across the board.
Geithner would be a horrible trader.
He's the type that would hold losers until he's wiped out because he's more concerned about a small but certain consequence rather than a probable and devastating deathblow.
He knows that if the debt ceiling isn't raised, he's for sure going to face a technical default. (A trader knows that if he sells a small loser, he'll for sure realize a small loss).
So he's trying to avoid it at all cost. (So the trader hangs on to that small loss.)
Meanwhile, he knows that the bigger catastrophe lies in the unsustainable fiscal path of the US. (The trader knows that the bigger problem is if the small loss turns into a big loss).
However, he just prays it'll go away - even though the US debt is growing by the day - and kicks the can down the road. (As his losses get bigger and bigger, the trader still holds on to it. He desperately prays that it'll one day magically turn around).
Eventually, the day of reckoning comes and the US faces a far worse crisis than a mere technical default. (The trader receives a margin call and blows up his account. He's initial loss would've been just 5 percent of his capital).
Unfortunately, most people are like Geithner and the trader. Therefore, it's likely that only a catastrophic crisis will provide lawmakers with enough political will to fix the budget deficit problem.