Debt, not ceiling, the real issue 

While President Barack Obama and congressional Democrats are warning of dire consequences if there’s even a debate surrounding the increase of the debt ceiling, actual investors are dismissing the much-hyped showdown as political theater.

“We have bigger long-term issues than the debt ceiling,” said Axel Merk, president and chief executive officer of Merk Funds. “The debt ceiling is about politics. But ultimately, we have to look at the substance of the issues, the entitlement reform.”

The impression given in headlines is that the nation is on the cusp of defaulting on its debt if a deal isn’t reached by May 16, and that even flirting with the idea of not raising the limit would strike fear in markets.

Yet Ian Lyngen, senior government bond strategist at CRT Capital Group, brushed aside the idea that investors are concerned about political brinkmanship over the debt limit.

“From the Treasury markets perspective, we’ve been down this very well-worn path a number of times and everybody knows the debt limit is getting raised, full stop, end of story,” Lyngen said. “If there was a real expectation that the debt ceiling wouldn’t be raised to accommodate continued debt payments, then you wouldn’t have 10-year Treasury yields trading at 3.35. If there were any chance of delayed or defaulted payments, then we would see yields trading much higher than they are.”

There is no “hard and fast” deadlines for raising the debt ceiling, Lyngen said.

“They’re not actually in default until they don’t make payments,” he said. Since the Treasury will still have tax dollars coming in, it could make payments after the theoretical deadline has passed, and there are also various tricks available, such as shuffling money among accounts.

Merk said, “Ultimately, if there was a delay, the market would just price in a delayed payment rather than an outright default.”

To be sure, such a strategy cannot go on forever. “We are not like a family who has a 30-year mortgage and the question is just paying the interest payments,” said John Cochrane, a professor of finance at the University of Chicago’s Booth School of Business. “We are more like a family that has a house, and we borrowed money for one year, and every year we have to refinance the house.”

Cochrane said simply maintaining the current debt limit is not a credible long-term strategy unless “the way we are not going to raise the debt limit is we are going to cut spending so that we don’t borrow one more cent, so that this year’s deficit is zero.” Of course, no such proposal is on the table.

He went on to explain that, “The bond market is not worried about the short-run technicalities. The deeper worry is, will the U.S. pay off its debt, or are we going to inflate it away 10 years from now?”

In this sense, Merk said one positive from the debate over the debt ceiling is that it’s another event that raises public consciousness about the long-term fiscal crisis. On Monday, Standard and Poor’s warned that it may cut the U.S. credit rating in the coming years if no agreement was reached to put the nation on a sustainable fiscal course.

“One thing [the debt ceiling debate] does, it highlights to the American people that there are some serious issues,” he said. “With the S&P warning and the debt ceiling [debate], hopefully the public at large will recognize that we are on an unsustainable path and that there’s nobody rich enough to get taxed to get rid of these issues. We have to tackle entitlement reform, and that’s what this debate is about.”

Philip Klein is a senior editorial writer for The Washington Examiner.

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