In an article titled “GOP Senate Nominee Would Profit From Government Default“ Talking Points Memo reports that Ohio Senate nominee Josh Mandel has a short position on US Treasury bills. The candidate’s stated position is to “stop raising the debt ceiling.” The site argues that if the debt ceiling is not raised, the US would default on its debt, dramatically raising the value of bond yields and increasing their value for Mandel. They conclude, “the very optics of a politician profiting off a default could present problems for Mandel as he tries to convince Ohio voters to send him to Washington next year.” There are several problems with this assertion.
First, it assumes that refusing to raise the debt ceiling would necessitate a default on US debt obligations. This is almost certainly not the case since many believe President Obama already has the power to unilaterally raise the debt ceiling himself. Even if he chose not to, it wouldn’t necessarily force a default, but would simply force the government to make interest payments from tax revenue. The Constitution may require interest on US debt be paid, but entitlements (food stamps, social security checks, etc.) are not protected by constitutional law. In short, there is no possibility of a default on the debt resulting from a debt ceiling debacle.
Second, if the debt ceiling were not increased, it would force the government to begin to live within its means immediately. This would immediately plunge the US into a depression since government spending constitutes so much of our current GDP. While this would hurt the government’s ability to pay down the debt, it would also show a willingness to deal with the debt and might even lower bond yields. Theoretically, if the debt ceiling was not raised, Mandel could just as easily lose money on the trade.
Third, even if somehow the US did default on its debt, Mandel’s position would be the equivalent of an “Armageddon trade” where the trader has the benefit of being right, but cannot collect because the whole financial world as we know it will have been destroyed. Its ludicrous to suggest Mandel wants the US to default for any reason, let alone personal financial gain.
This is all irrelevant theory crafting anyway. There is zero chance of this scenario playing out in the foreseeable future since everyone knows it would cause a massive and immediate depression. The debate is simple theatrics done for political purposes.
Still, there are reasons to be concerned about the direction this debate is heading. We all know from the recent health care decision that the government now claims the authority to force you to buy health insurance and any other product it deems necessary by taxing you for non-compliance. Is it difficult to imagine that the government might require Americans to purchase US debt and keep borrowing cost low? Talking Points Memo is treading dangerous ground when it asserts that someone not supporting low US treasury yields is traitorous, unpatriotic or otherwise conflicted.
To date, the Federal Reserve and associated banks have done an excellent job keeping treasury yields low and disguising their intervention as a market driven “flight to safety,” but they are not gods. Treasuries have become the latest and most dangerous of bubbles. Eventually these yields must rise and when they do, that’s when the real fun begins.
