Ted Cruz may be a dangerous scheming sociopath, Rand Paul is a dangerous idiot. At least according to his own words.
Real Clear Politics –I’m promising to the American people and to the markets to Wall Street that we will always pay the interest on the debt as a priority. Do you know how we do that? We bring in $250 billion in tax revenue every month. The debt payment is about 30 billion. We just promise we will always pay it. What’s going on is interestingly the Democrats are scaring people and saying, we might not pay it because Republicans don’t want to raise the debt ceiling. If you don’t raise the debt ceiling, what that means is you have a balanced budget. It doesn’t mean you wouldn’t pay your bills. We should pay the interest and we should never scare the markets. So, if I were in-charge, I would say, absolutely, we will never default. I would pass a law saying that the first revenue every month, the first revenue, has to go to pay interest.
He’s promising …. he’s good for it …
You see that old fashioned Treasury Note up above? Notice there are some squares that have been cut away and are now missing below the main part, or corpus, of the bond? Those are called coupons. They come with a date and an ID number, in the old days you would clip them off when that date rolled around and mail them to a bank or the Treasury Department, a check would be mailed back representing your interest. T-notes typically pay twice a year for the life of the bond, when the time is up the deal is over, you get the face value back, usually in thousand dollar denominations. That’s how people used to get their interest paid and principle back.
Not anymore though. It’s been a long time since I’ve see an actual bond like that, with coupons to be clipped, outside of a museum. Like everything else interest has long been automated, bonds bought and sold through brokers are held in what’s street name, meaning as far as the payer knows, the brokerage company owns the bonds, and the interest is electronically deposited into the bond holder’s account by that broker-dealer.
There is no way for the US Treasury to know who owns what bonds if they are held in street name, and there’s no way Treasury could get that info, especially if that bond is held in street name in an overseas brokerage account, without courts and subpoenas and all that stuff. In short, if we start defaulting, we have no way to pick and choose if grandma gets her interest paid on time versus a Chinese hedge fund holding T-notes. Our automated system is not even set up to pay partial interest out, or pay late, or pick and choose who gets paid in the event we could play faves. Vast volumes of code and giant international super-network would have to be completely rewritten and rebuilt for that to be possible. Which is a long way of saying what a fucking idiot and megalomaniac Rand Paul really is.
But it gets worse. The reason he’s dangerous is because that bond up there, or rather its descendants, are US money. Most people think of money as currency, bills or coins, but its not. A dollar bill might be best thought of as a bearer check that anyone can use for payment without having to supply ID or bank account numbers or any of that stuff. It’s a bearer check, meaning whoever has it owns it without question, and doesn’t matter if it’s a one-dollar bill or a hundred-dollar bill, its such a safe check that venders don’t have to bother calling up the issuing ‘bank’ to make sure it will clear. But that dollar bill is not based on gold or anything of tangible value, it’s based on notes/bonds issued by the US Treasury Department. Same for all US money, every dime to your name, regardless if its in you wallet or electrons in a paypal account.
Those bearer checks called dollars are so safe that most every nation on Earth maintains large reserves of them. They’re so safe that large producers of essential commodities like oil only accept dollars. That means that most every nation on earth is constantly buying more dollars as they spend theirs, which puts a demand on the dollar and keeps it value high relative to other currencies.
If we cannot raise the debt ceiling, we cannot generate the money needed to pay interest and other obligations. If we short or miss a single interest payment on those T-notes, they will crash as people, institutions, and entire nations bail out of them, which means the dollar crashes, and the world could flip into economic chaos the likes of which we have never seen or imagined. Even change stashed in a coffee can in your closet could cease to have value beyond the scrap metal.
That’s what Rand Paul and his dumb ass Teaparty morons have convinced themselves would never happen, because they promise it won’t. For Rand Paul to keep that promise, he would have to be worth about Ten Trillion in gold. Or be able to go into our Treasury Department, fix the code and rebuild the network, conjure up money out of nowhere and get it to the right people, oversee every trade via every interbank currency department in every nation and, by simply promising he’ll do all this, sooth the market and stop the crash in its tracks. IOW, he would be moving faster than Santa Claus on Christmas Eve and it woudl be the biggest government takeover of the entire free world ever conceived. But hey, he promised … he’s good for it … we can trust Rand Paul …
I don’t understand this post. I don’t get the relation between the different parts of the argument. I do understand that dollar bills are bearer checks but not what that has to do with raising the debt ceiling or what either of those two points have to do with not being able to pick and choose who gets paid interest or why Rand Paul’s promise can’t be kept.
I’m not quite sure what Darksyde is talking about here. There is a facility on the Treasury Department’s web site call Treasury Direct which one can use to by notes and other treasury instruments directly from the department. No need to go through a broker.
The problem with Paul’s argument is not that it would be for some reason impossible to prioritize the servicing of treasury bonds over other federal spending, it’s that the U.S. has a lot more legally obligatory spending than that. Employees have a contractual right to their pay, the recipients of entitlement benefits are legally entitled to those benefits. Not paying your bills and balancing your budget are NOT the same thing.
“But that dollar bill is not based on gold or anything of tangible value, it’s based on notes/bonds issued by the US Treasury Department.”
Not quite true. The dollar is a fiat currency: it has no intrinsic value and there are no material assets backing it up. Like all fiat currencies, the dollar’s value comes from an issuer who says it has value and the agreement of those using it. The value of a given currency will float relative to other currencies, depending on how much faith people have at the moment in those currencies.
This isn’t to say that Treasury bonds aren’t important. If the US were to start defaulting on federal bonds, investors would take a very dim view of the country’s economic strength. Not only will investors sell off US bonds, hoping to cash in before they are stuck with worthless paper, they will also start to sell of US dollars: if the US government cannot meet its corporate obligations, why should it be expected to meet its economic obligations? The value of the dollar falls and the country heads into steep recession.
It is astonishing that the party which loudly squawks about how the country must be run like a business would champion the sort of policies that would drive any business into utter ruin.
Sorry if I was unclear. I’ll simplify: the vast, vast, VAST majority of these instruments are held by banks or broker-dealers on behalf of the owners, to the tune of trillions and trillions of dollars. All those US notes/bonds would crash if we come up short on interest or principle, and since our currency and by proxy much of the world’s currency is directly or indirectly tied to our obligations, that kind of all out crash would precipitate a global meltdown like nothing we have ever seen before. Anyone who tells you different — which seems to be a mini misinfo campaign on the hard right these days — is lying or ignorant. Just the immediate spike in interest rates from a short term missed payment alone would set off a crisis that would make 2008 look like the go-go 90s.
Rand Paul personally promising ‘people will get paid’ won’t make any difference to that at all. That he thought that mattered, that he appeared to believe all people needed was his promise, is either evidence of extreme megalomania or extreme ignorance of how the debt market really works.
The point I was making is that bonds are not money. Legally, they are bearer contracts, with centuries of contract law behind them. A check is also a contract, with similar laws backing them. When the US was on the full metal standard, and currency could be redeemed for a set amount of gold or silver, bank notes were a legal contract, too. That faltered when we went to a metal backed currency in 1934. In 1964, when the phrase “Payable to the bearer on demand” was removed from paper currency, US bank notes ceased being any kind of contract.
Aside from which, the $1000 price means that bonds are out of reach for most individual investors. Most Treasury bonds are held by mutual funds, with the interest returned to shareholders. There are a lot of funds that specialize in government bonds: while the interest is typically pretty low, the returns are tax-free, making them a very safe investment for people who are approaching or are in retirement. For similar reasons, a lot of these government bond funds have very large corporate investors, ranging from state and union retirement funds to large corporations in need of a safe place to park their solvency. If the government stops payment on the millions of dollars of bonds held by Fidelity, a great many individual investors will be seriously hurt.
Nearly all of the bonds not held by mutual funds are held by foreign banks as part of their foreign reserves. Failing to pay them will destroy international trust in the dollar, which will in turn destroy the US economy. That’s not hyperbole: if China and Germany and the UK sold off their dollar reserves, the US would not be driven into a recession. We would not be driven into a depression. We would be driven into complete economic collapse.
This is no way to run a business, and it certainly is no way to run a country. It seems to me that Paul is expressing the Republican end game to destroy the United States of America forever.
Well, bearer check or fiat currency or whatever you want to call it, the point is, that the value of currency or even money in general depends on trust. Even the gold standard is/ was a form of trust, very ancient but so what? Who needs gold except for shiny baubles and some chemical reactions or whatnot, you can’t eat it, farm it or inject it. Base your money on gold, shiny beads, cowrie shells, or your reputation, it’s all the same difference as long as everyone agrees to trust it, share it, honor it. In fact, I consider money to be a kind of fantasy, an imaginary thing we all agree on. It’s just an instrument for distributing and differentiating value.
I understand that if the U.S. doesn’t make its payments, particularly international ones, that that would hurt trust in the currency. I also understand that dollars are used as a reserve currency all over the world. But I don’t understand why a late payment or a default would necessarily crash the whole system in. one. fell. swoop. That’s an opinion, a prediction, right? (question not rhetorical).
Seems to me a late payment or default or risk of both or either would necessarily be harmful and potentially extremely harmful but I don’t see how the result can be predicted.
I also don’t understand what the debt ceiling is. And I don’t understand why congress can’t just convene and say “pay the international bills” and then it’s done. I’m certainly willing to take it on faith that Rand Paul is an idiot, but I don’t understand why his promise is hollow.
Lots of countries delay or default or renegotiate and the result is their credit rating goes down and then they get more into debt and, as far as I have seen, this can also lead to some serious inflation and hyperinflation. I’m thinking Argentina and Greece.
If the world starts off-loading its dollars I suppose they’d be buying gold, diamonds, oil, uranium and euros? I don’t know. I do know that that would really suck for the U.S. because a lot of its power is based on having the dollar as an international reserve currency and that this allows the country to live well beyond its means. But who knows, maybe in the long run abandoning the dollar would be better for the planet.
In any case, I still don’t understand this post or the comments that follow.
To sum up, I have no idea how the debt market works.
lol @8 – no worries, it’s insanely complicated.
I’ll try to help you out here. You’re right to an extent that the value of currency depends on “trust,” in this case, this “trust” takes the form of what is written on each dollar: “Backed by the full faith and credit of the U.S. Government.” Gregory in Seattle @4 went into detail about this in discussing fiat currency, which is what our dollars are. This is different from gold or the “gold standard” we were on until the 70s, in that our dollar was tied to gold, which is a finite resource. There’s another discussion to be had about the gold standard (something Paul is in favor of returning to), but that’s for another time :] Very briefly though, there actually IS a difference between basing the value of your money on something like gold instead of the credit of the institution backing it.
You’re starting to touch on the problem in your second paragraph. So the United States has debts and pays them as well as the interest on those debts. In order to pay for them, the government collects taxes, but these are obviously not enough to cover the debt, and so the government also borrows and lends. This gets a little tricky in how it works, but generally the interest rates that are set and the money that is generated from interest factors in as well. That’s not too important to understand the bigger picture at this point. You always hear about treasury bonds being the most stable or safe investment, and this is true because of a hard-earned reputation we have; the United States will never default on a loan or fail to pay. If you recall the big deal last time over the credit rating being downgraded, this is why that was a big deal. Investment in treasury bonds from the US is, again, the safest bet you can make.
What does this have to do with the debt ceiling?? Earlier I was talking about how the US incurs debts and pays for them with taxes and borrowing. The debt ceiling is just what it sounds like – a metaphorical ‘ceiling’ or ‘cap’ on how much can be borrowed (the opposite of a ceiling in this case is called a ‘floor’ [same as literal ceilings and floors :P], a simple example of a ‘floor’ being minimum wage, where the number cannot go BELOW a certain amount, rather than a ceiling preventing the number going ABOVE a certain amount), and so we raise the debt ceiling in order to allow more borrowing to cover debts already incurred. I stress that point for a reason – raising the debt ceiling allows us to pay for spending we have already authorized. This is where a lot of the hair-pulling comes from when we talk about this. Congress has essentially already spent this money, and raising the debt ceiling is done to pay for the spending Congress has already done. That’s sort of why raising the debt ceiling was a boring, bland function of Congress that was never an issue before.
When countries start to default on their loans or cannot pay back their debts, you start to have serious problems. You’re right in a sense that this is largely based on predictions since this is new territory, as we have never NOT paid. However, those predictions are based on extensive history of what happens when a country cannot pay it’s debts. A fine example is the French Revolution at the end of the 18th century. Obviously I’m simplifying here, but the king racks up huge debts, can’t pay said debts, increases taxes to disgusting levels, plundering the populace, and eventually ends with the king and his wife executed.
Anyways, I hope this cleared a few things up for you :]
Ok, Bonds 101.
Bonds are contracts. When a bond is issued, the backer borrows $1000. In exchange, the backer promises to pay a rate of interest on the loan. When the loan expires, the $1000 is returned. Most bonds pay a fixed rate over a fixed time, say, 4% over 20 years, but some bond contracts are written to allow for a variable rate (say, prime + 1%) or over a variable life span (say, 20 years with an optional call-in after 10 years.) Once issued, though, the terms of the contract are fixed and cannot be changed without serious consequences.
Terms are set, in large part, according to the backer’s debt rating. Investors want to maximize the interest rate, of course, but they also want bonds from a backer that will actually pay the interest. A backer with a debt rating of AAA is a safer investment than a backer with a rating of just A, so the AAA bond writer can offer their bonds at a lower rate of interest. In contrast, a bond issued by someone with a C rating will have to offer a very high interest rate to attract investors. Bond backers want to keep interest rates as low as possible, as that reduces their cost to borrow money.
The vast majority of bonds, corporate and government, are purchased in the primary market by banks, broker-dealers and other “market makers.” They are then brought to the open market. The current value of a bond is based on a number of factors, including the bond’s rate, how close to maturity is, and the current debt rating of the issuer. As a bond approaches maturity (the time when the backer must buy it back and return the original $1000 loan), its value decreases, as there are fewer interest payments left. If the backer’s rating is upgraded, then the value of the bond goes up, as it becomes a more desirable investment; if the rating is downgraded, the value of the bond goes down. Bond values also fluctuate inversely with other interest and market rates: if I can get more of a return by investing in Bond A, I will sell Bond B to get the capital to buy A. The price of B will stabilize when it reaches a point where it is again seen as a good investment.
Now. The main issue is that the United States has been one of the largest and strongest national economy for a long time, and the US dollar is the de facto global currency. Most countries without a free floating currency of their own have pegged the value of their currency to the value of the dollar. The main competitor to the USD is the euro, which is being dragged down by Greece, Cyprus, Portugal and some Eurozone members.
According to the Wikipedia, China holds 3.5 trillion USD, about 60% of its foreign reserves. Japan holds 1.25 trillion, about 40% of its foreign reserves. Altogether, the ten countries with the largest dollar reserves (counting the Eurozone as one country and Hong Kong separately from China) hold more than 12 trillion US dollars. These foreign reserves, in effect, “borrow” the US’ economic stability: 60% of the yuan’s value, and 40% of the yen’s, comes from the fact that they are backed by US Treasury bonds pegged to the value of the dollar. With the US’ AAA bond rating, they are safe, stable and secure investments.
If the government suspends payment on bonds, our rating will be downgraded. This will make it much more difficult for the US to borrow money and the USD will sink in value on the currency exchanges. The US economy will begin to slide. Large bond holders like China and Japan will begin selling their Treasury bonds, out of a legitimate fear that their economies will suffer, too. If China were to sell off just 1% of is dollar reserves, the market would be flooded with 3.5 billion USD in bonds: if there are no buyers, the value of the bonds will plummet. Part of the security of Treasury bonds is that the Treasury will buy the bonds back in order to keep the market price from dropping too low. So suddenly, the US Treasury is spending billions of dollars to stabilize the bond market and, consequently, stabilize the US economy. We don’t have that kind of money, so the US will be forced to issue new bonds with a higher interest rate. If we default on those…. You see how this can become a big, sucking black hole.
Worse, countries with large dollar reserves will be forced to either dump those reserves at an accelerating rate, or face their own economic collapses. If the US economy falters too badly, it will likely bring down China, Japan, Saudi Arabia and most of the Eurozone as well.
@10
Thanks for that, definitely explained it clearer than I did :P
Trucreep and Gregory in Seattle,
Thanks for taking all that time to explain those things to me. I now have a mental model of what the debt ceiling is and why raising it is important and how that is different from just promising to pay our bills.
Trucreep: I wasn’t aware of that aspect of the French Revolution. It’s always portrayed as people fighting for equality, liberty and yada yada. I’m sure they were, but the debt story rounds the picture out. Also, the previous winter (1787-1789) was extremely harsh and so wheat and then bread were scarce. So, climate was also a factor. Had the winter been more clement… Had the King been more frugal…. Had the x been more y…
Gregory: your last two paragraphs were particularly helpful.
Conclusion: default is pulling the pin on a grenade.
Again, thanks!
CGP Grey has a great breakdown of how the debt limit works: http://www.youtube.com/watch?v=KIbkoop4AYE&feature=c4-overview-vl&list=PLqs5ohhass_QZtSkX06DmWOaEaadwmw_D
Am debating as to whether or not to read the current NYTimes OP Ed entitled “No Comment Necessary: What if the Government Defaults?” As I’m not a subscriber, I can only read 10 articles a month and have to choose them well.
There is an easy way to get around that 10 articles limit. Just open another copy of your browser and paste the title of the article into Google. Chances are you can then read it unmolested.
Bicarbonate (#8) –
Think back to the old “Sylvester and Tweety” cartoons for this analogy.
Money in hand is like Sylvester standing on a building rooftop. You don’t have much reach, only to the end of your hand or paw, but you’re safe enough if you don’t do anything stupid.
Regular loans and credit systems are like Sylvester nailing a board to walk on and extend his reach. There’s some risk, but if it’s secured properly, it can be safe.
Government bonds and banking systems before 1999 are Sylvester nailing a second and third board. It should only be used and depended on for short times, and only when really necessary. It is NOT suitable for everyday use.
Rand Fail is like Sylvester wanting to nail a fifth and sixth board to cover the gap between two high rises. He can’t grasp that the materials and poor structure won’t withstand the strain. His desire to get to Tweety blinds him to the reality and consequences of gravity and a poorly designed system.
How well Rand Paul pays attention: ,”We haven’t had a big debate about Obamacare really …”