Last week we began to discuss the practical implications of what could occur if the U.S. federal government made the deliberate decision to miss a U.S. Treasury security interest or principal payment, which is called default.
Just to be clear, nearly everything I read indicates this possibility as extremely remote. Even if the parties in Washington cannot come to some sort of agreement on the government shutdown and more importantly the Congressional authorization to allow the government to borrow more money, the federal government will continue to bring in about $230 billion a month in revenue. It only needs to pay out about $16 billion a month in service Treasury securities. So while the Feds may not reopen our parks, I don’t think they will choose to default on U.S. Treasury securities.
But it is important to consider possibilities and attempt to discern what a default, regardless of how unlikely, could mean.
U.S. Treasury securities serve as the world’s “riskless” asset in the portfolios of banks, insurance companies and pension funds. U.S. Treasury securities maintain this position due to their Aaa credit rating and super large liquid market. If the government chose to default on a U.S. Treasury note or bond payment credit rating companies would be forced to downgrade this Aaa rating.
This downgrade would wreak complete havoc on the credit and money markets and would likely cause these markets to seize up, similar to what happened after the Lehman collapse in 2008.
In previous credit crisis events (1998, 2008) U.S. Treasury securities served as the safe haven asset for global capital. When these investments themselves are the cause of the crisis, the consequences will become unpredictable.
Capital cannot exist in a vacuum; it must be stored or invested in some form. If U.S. Treasuries become an uncertain store of value, other financial vehicles will need to emerge to absorb capital.
Some analysts predict a sharp decline in the value of the U.S. dollar as investors flee U.S. Treasury securities and head for other markets. I’m not so sure about this conclusion. The U.S. dollar still enables access to the world’s largest and most liquid financial markets, and considering the state of the world’s other major economies, I wouldn’t assume investors would flee the dollar during a time of great financial stress.
But capital would seek new safe havens. Only four companies in the world maintain Aaa credit ratings: ADP, Johnson and Johnson, Microsoft and Exxon Mobil. Three insurance companies, New York Life, Northwestern Mutual and TIAA-CREF maintain Aaa ratings. No US banks currently maintain Aaa status, but the strongest U.S. national banks by credit rating are BNY Mellon, US Bancorp, Northern Trust and Wells Fargo. A number of countries maintain Aaa ratings, the most notable being Canada, Australia and Switzerland.
Absent a deal, the U.S. government will run out of money to pay all its bills by the beginning of November. While this possibility remains unlikely, a strategy should be devised to address this issue, and then hope for the best.