Tuesday, July 26, 2011

Who benefits from US default?

Let's review the consequences of US default, even a brief default, on the economic universe:
  • interest rates rise
  • t-bill prices fall as their interest rates rise
  • gold/silver prices rise
  • dollar falls
Thus we are looking at inflation, driven by higher interest rates and inported commodity prices. We are also looking at another recession, due to higher costs of investment and material: stagflation. Welcome to the wonderful, wacky world of 1974.

Now, one nice thing about inflation is that it does erode away the value of existing debt, so good news for you students worried about paying back student loans (if you can find a job that would allow you to pay anything to anybody). Also good news for those with money in the bank, since interest rates will skyrocket in your favor.

Another beneficiary of default will be the ratings cartel, including Moody's and S&P. They will assume the role of dictating US policy by holding US bond ratings hostage. An unexpected recovery of power and prestige after their  reckless bond ratings drove the global economy to collapse just a few years ago.

Who are the other potential winners from default?

(edited to add): Here's another winner---whoever collects the extra 100 billion dollars a year in extra interest payments from the US government. A direct transfer of $ from taxpayers to treasuries investors.
from Zero Hedge :
Earlier today, while discussing the implications of a US debt downgrade on a SIFMA call, JPM head of fixed-income Terry Belton told listeners that a US downgrade could cost the US an additional 60-70 bps in incremental interest. That's per year. He also added that US asset managers are unlikely to sell Treasurys on a downgrade, but that's irrelevant. Nobody can predict what all the knock off events from a US downgrade would be, as the Citi presentation from yesterday indicated. Should there be a downgrade, investors may not sell Treasurys, but they sure will be forced to sell other lower rated instruments to keep the overall rating distribution of their portfolio in line with mandated rating requirements. Which in turn, following margin calls, will result in, you guessed it, selling of Treasurys. Yet this debate is the topic of another post. What is more important is that on the same call, Belton said that a 70 bps increase in interest would result in an incremental $100 billion in interest expense each year.

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