Financial Illiteracy

We normally don’t write about politics or economics, but the feverish comments about ‘default’ and associated topics by pundits, radio talk show hosts and other are just too much.

We’d like to inject, for our readers at least, some financial sanity into the discussion.

About the only national pundits on this topic who know what they’re talking about on the default topic are Rush Limbaugh, Dr. Charles Krauthmmer and George Will, who have all correctly used the ‘default’ term

It’s clear that most of the national punditry never took a course in finance. Default means you can’t pay your credit card bill or your mortgage. The US government has coverage of over 10 times the interest payments on the national debt (revenue is 10 times debt payments), so there’s no risk of default unless those paying the debt bills decide not to pay them. But, the debt interest should be the first to get paid.

What’s got everyone so fevered, we think, is that there will have to be serious cuts to discretionary spending to get expenses in line with income. Probably about $600 billion or so, or about 20% of the total. And one could anticipate that the Dems will make the cuts as annoying as possible.

As for the debt ceiling, when we hit it, it just means that we can’t increase the debt level, but we can roll over existing debt and refinance it. One would also expect that our interest payments would go up, since rates at which we refinance would be higher than the rates on the debt being refinanced. But even if rates rose by 50%, our quick estimates are that the coverage ratio would drop to about 8 times or so, still pretty healthy.

As for the economic consequences of reduced government spending, they’re not bad. Government spending is about 20% of total GDP, and we’re cutting it 20% in rough terms to get back in line, so that’s a 4% reduction in aggregate spending. Not much, and one could probably argue that corporations, with increased capital access (no government crowding out) might make up the difference.

So, everybody, take a deep breath, and relax. Hitting the debt ceiling isn’t so bad and might, like so much of what we see, just be a manufactured media crisis.

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