Tuesday, April 20, 2010

tipping point for debt?

Great stuff from the WaPo editorialists (hat tip: C-J)...

The great fear associated with the U.S. federal debt, to which we are now adding at a rate of more than a trillion dollars per year, is that investors will lose faith in Washington's ability to keep such a colossal financial promise. In the nightmare scenario, bond markets simply refuse to keep buying up the Treasury's paper unless offered much higher interest rates. The president, Congress and the Federal Reserve then would face a choice between terrible options: Inflate the debt away or enact massive tax increases and spending cuts. No one knows, really, whether we'll hit the tipping point tomorrow, in 10 years -- or never. But it certainly makes sense to watch for danger signs.

Some market mavens thought they spotted one March 23. On that day, the Treasury found itself paying a slightly higher interest rate on 10-year bonds than private banks were paying on a standard 10-year hedging instrument known as a "swap." In market parlance, the "swap spread" had gone negative, implying that investors actually viewed lending to Uncle Sam as a riskier proposition than lending to blue-chip private firms. So far as anyone knows, this had never happened before....

The spread crept back into positive territory on April 1 -- barely -- but it is still well below historical norms. And the mystery remains: Why did it plunge in the first place? Market experts we have consulted blame technical factors...these recent strange occurrences in the credit markets remind us that excessive government debt, too, can be destabilizing. The United States is not at a Greek-style crisis point, but there's no guarantee that we'll have plenty of time to prepare before we do get there. The only sensible policy is to start getting our financial house in order well before the bond markets force us to do so.


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