When you hear about interests rates, it’s usually an announcement that they’ve been raised, lowered, or left unchanged. What many laypeople fully understand is it’s not the interest rate on a T-note that changes, it’s the price of the bond itself. The interest rate, what stock-jocks call the coupon, is fixed. What determines the interest rate is what people are willing to pay for that bond. A bond is simply a loan, and the big factors on a loan is how safe is it, when do you get the principal back, and what rate does it pay? The less safe the lower the price people are willing to pay and, since the coupon/interest rate is fixed, the more interest it yields. Obviously, if the loan is going to miss an interest rate or if the agency issuing it is about to default, it’s less safe.
US bonds are considered among the safest investments in the world, people are willing to pay top dollar for a safe investment, but if that changes significantly it crashes the bond market. A crashing bond market crashes pretty much everything else, even currency stashed in a matress might cease to have value. Which is why the Wall Street Journal is telling Teaparty Republicans to STFU about defunding the government:
Perhaps the only war strategizing more inept than President Obama’s on Syria are GOP plans for the budget hostilities this autumn. Republicans are fracturing over tactics, and even over the nature of political reality, which may let Mr. Obama outwit them like a domestic Vladimir Putin.The latest GOP internal dispute is over a continuing resolution to fund the government at sequester-spending levels. The current CR runs out at the end of the month, and about 40 to 50 House Republicans (out of 233) want to attach a rider that either delays or defunds the Affordable Care Act for a year and leaves everything else running.
Just as conservatives have cooked up a whole branch of pseudoscience supporting creationism or the idea that no one gets pregnant from rape, they are now busy telling themselves and their grassroots supporters that the threat of default either wouldn’t hurt anything, or would actually help the economy in some hare-brained way. But the WSJ understands something the Teatards don’t: the people who will decide what bonds are worth are not motivated by delusional thinking, they’re looking at risk and arithmetic; they’re making an investment.
If the bond market crashes completely, the WSJ and the entire Wall Street edifice it depends on collapses faster than the Confederate dollar.
That would be bad for the working class and poor. But it would be catastrophic for the investment class the Journal and much of the GOP was cultured to serve. Bodies would fall by the hundreds from luxury apartments and corner offices if the bond market flat-lined. The staff of the WSJ knows who signs their paychecks and reads their site. And they’re scared because the Teaparty wing of the GOP may not care at all and may really do it this time.
Speaking from outside the country, the crash of the markets would, indeed, be a serious problem, and not only for the US. But I can’t deny a certain schadenisch Freude about the GOP maybe finally splintering into two explicit factions, because if they end up breaking the party in some way, the potential vote-splitting would mean a chance for the Dems to actually make some progress with legislation. And just as with the markets, the US being less right-wing would have knock-on effects on the politics of other nearby countries, where similar forces have joined together to make parties that might win.
A bond is a loan contract: the issuer is borrowing a given amount of money from an investor (almost always $1000 per contract) for a stated length of time at a stated annual rate of interest. Every six months, the issuer pays half of the annual interest rate to the bond holder. At the end of the period (called the bond’s maturity), the issuer gives the bond holder back the original $1000.
The interest rate is fixed when the bond is issued. Bonds can be written to have a variable interest rate (for example, the current US Savings Bonds are set to the prime interest rate) but this is very rare. Bonds can be written to have an early maturity, which allows the issuer to buy back the bond when certain conditions are met, but this is also pretty rare.
Stephen, what you are thinking of is the secondary market for bonds, the price used when, say, I have a bond that I want to sell and you want to buy. The price is set by a lot of factors, including the rate of interest, how long until maturity, and the perceived dependability of the issuer making interest payments. Current interest rates play a part in setting the price, but only incidentally: if the current prime rate is 3%, a bond that pays 3.5% will command a higher price than an otherwise identical bond that pays 2.5%. All three of these bonds will pay the stated interest rate regardless of how much it trades for in the secondary market.
The perceived ability of the issuer to make payments is also a consideration: if XYZ Corp is doing well, its bonds will be seen as safer investments and will trade at a higher price in the secondary market. If the company gets slapped with a potentially ruinous lawsuit, people holding the bonds will try to sell and few people will be willing to buy: high supply and low demand will drive the price down. Unless the company actually goes into bankruptcy, though, the bond is still good, and will normally continue to pay interest. Even if the company does go bankrupt, bonds are debt, which means they are at the top of the list of things that must be repaid. A bond holder will not get expected interest, but she will likely get back the bond’s $1000 face value, and may still come out ahead from what she paid for it.
If the federal government were to halt paying interest on federal bonds, it would be a major clusterfuck, yes. But not because of the bond market: that would be just a symptom. The disease would be the loss of international trust in the dollar. The United States has been on a fiat economic system since 1971, when we left the gold standard. Since then, the US dollar has had value because the US economy backing it was perceived as having value.
The vast majority of US Treasury bonds are held by other national governments as part of their foreign currency reserves. Interest on these securities is the largest part, by far, of the national debt. It is also an important part of our economic stability: just as the UK and China and Germany and Japan hold billions in US notes, the US holds billions in pounds and yuans and euros and yen. This shared risk means that if one country stumbles, it has supports. If the US’ corporate “brand” is tarnished — as it was early in George W. Bush’s presidency — other countries start selling off their Treasury bonds. Because of the way these contracts are worded, the Treasury must buy them if no other buyer is found. This, in turn, requires that we sell off our foreign notes to raise the money necessary for the buy-back. The US loses its economic ballast and rudder, making the ship of state much more vulnerable to rough seas. That is where the damage would really be.
Isn’t the Government Shutdown and the debt ceiling two unrelated issues? A government shutdown would not be nearly as catastrophic as defaulting on the debt. Right now, they’re mostly just threatening to do a government shutdown.
doublereed @3:
Beyond all of the suddenly-furloughed government employees, a government shutdown could be potentially catastrophic for towns and cities where a lot of federal employees and contractors work. Full disclosure, I say this as a state employee who works in the capital city of his state, where the previous (Democratic) governor consistently threatened furloughs and layoffs every June when he and the legislature couldn’t work out a budget. The city itself is already distressed and filed for bankruptcy.
“the Teaparty wing of the GOP may not care at all and may really do it this time.”
The ‘baggers have never cared about reality so they don’t care what happens in it. Besides, it’ll give them an excuse to buy more guns & bibles.
You’re really going out on a limb there!
Of course it could go to an intermediate stage where the GOP defaults and the Democrats, and POTUS, simply walk the issue over to the supreme court, The court, reading the simple and direct language in the constitution declares that the controllers of the government checkbook, congress, cannot fail to pay and support obligations the congress has legally agreed to.
The congress can’t set spending levels and then fail to authorize payment for those levels. They can’t sell bonds and then fail to pay the agreed upon interest. In any case they can’t have it both ways and arbitrarily decide not to pay. Not as long as there are assets available.
The trick here is that the Teaparty hasn’t actually read and understood the constitution, Something of an irony for a group that purports to strictly cleave to constitutional principles and hold the constitution in such high regard.
Of course seeing bonds as debt is just one way of conceptualizing them. You could, quite validly, see bonds as savings accounts. People want a safe place to store their excess US dollars. (It helps to understand that that the only thing you can buy with a US dollar are more US dollars and/or US products or services.) The interest they receive, as with most savings accounts, is quite minor. The main thing is that if you put in $1000 you can get $1000 back out. Any extra is gravy.
Lorn the problem with the reasoning is that there is a time period between decision to stop the payments and the court ruling. It doesn’t matter if the ruling comes before the actual non payment it will give the same effect as actually defaulting.
Remember when the GOTP took the country’s credit hostage with the debt ceiling in 2010? Guess what happens when you negotiate with hostage-takers?
That’s right, they do so again. This time they will take the debt ceiling hostage and not compromise.
Obama, for his part has refused to negotiate on the matter. Then again, his red lines have not meant much in the past.
Expect a temporary deal that will postpone the fight by six months and more governing by crisis.
There is another possibility.