Default Isn’t the Only Danger

Last week’s debt-limit negotiations occasioned dire warnings about what would happen if the federal government defaults on its obligation. But even if there isn’t a default, great damage is done by the debt negotiations, which are part of a persistent pattern in which the government creates large, destabilizing market risks under the rubric of enhanced stabilization.

Markets reflect the danger of default. Credit default swaps currently exceed the 2011 levels observed when government debt was downgraded. Short-term Treasury bills expiring near the X-date in June are heavily discounted, with yields north of 6%. Donald Trump’s suggestion that lawmakers use default as a credible, as opposed to noncredible, threat in negotiations, may exacerbate this effect. Even absent default, these risks will increase the cost to taxpayers of financing the debt.