On the political calendar in Washington, we are more than halfway from government shutdown to sovereign default. It is worth remembering that two weeks ago, a majority of pundits, voters, and politicians did not believe the government shutdown would happen. The House inaction, we imagined, would give way to action when there were three or four hours to go, as we had seen in the past. But that transition did not come about. Flash forward to yesterday. Some in the House Republican caucus thought they needed a six week extension on the debt ceiling to give them more time to dither — while the government remained closed, of course. But in the end they could not agree on that either. Instead, today’s plan to get the House of its rut of inaction is . . . more talks. It is not Halloween yet, but can we all practice a ghostly wail for a minute?
I say all this just to put the risk of default in context. Most of the people who say a default can be easily avoided are not paying any attention to what is actually going on in Washington, and in the House Republican caucus specifically. It is a narrative worthy of the fall of Rome, so who is to say that now is not the time for the fall of Washington?
The reliability of United States government debt instruments is an unstated assumption in finance worldwide even today. Precisely because it is accepted as fact and not seriously examined, we cannot predict what parts of the global financial system will break when that assumption is broken. I will cite just two of many possible breaking points.
- Money market funds famously keep much of their liquid assets in government bonds, especially ones issued by the U.S. Treasury. If the Treasury is seen as no longer liquid, that could provoke a run on money market funds. And that, of course, is on top of the withdrawals already taking place now that furloughed employees of government contractors are living off their savings. Sponsors of funds that made mistakes while trying to keep their funds liquid could end up illiquid themselves.
- A huge sum, I am guessing about $3 trillion, in deposits are kept in banks in the United States at considerable inconvenience, just because of the perception of the United States as a safe haven for deposits. If that perception is shaken only slightly, so that a small fraction of deposits are moved to other countries, the giant banks in the United States could be looking at deposit flight on the order of $250 billion in a matter of a few weeks. That could easily be enough to change the color of a bank’s balance sheet. Half a dozen boutique banks that rely disproportionately on the deposits of foreign billionaires could be seeking emergency capital.