The WSJ points out that in the summer of 2011

Outlook:

The problem is not that nothing will get done to avert default--something will—but rather that the US is failing to pass the classic sovereign risk test—not only the ability but also the willingness to pay its debts. Companies in countries like Chile that choose not to repay banks during the Latin American debt crisis, despite having the ability, got tarred with the same brush as the government of Argentina. A lot of people say “the US is not Argentina or Greece,” but in proper bank credit analysis practice, if it quacks like a duck, it’s a duck. All those fear-mongering press articles last week about diversification out of the dollar, permanently higher T-note costs, etc. are all too likely correct.

But you’d never know it from the finance professionals commenting to the press these days, most of whom are complacent and declining to freak out over something that will not, cannot, happen. Again, it doesn’t matter whether the US actually defaults—the US has already shown its “leaders” are willing to default.

We are amazed that markets are not delivering an appropriate response to the possibility of US default and/or the awful political process that allows those willing to default to hold the power to default. Credit default swap prices on US Treasuries more than doubled over the past two weeks, but remain lower than the summer of 2011, and the S&P is down only 2.8% from the mid-September high, according to the NYT.

Nobody quite knows why, but the reasoning seems to be that it would be just too stupid for Congress to allow default. Warrant Buffett said “We’ll go right up to the point of extreme idiocy, but we won’t cross it.” And yet watch these bozos on TV and you must deduce that Congress is, obviously, that stupid. The failure of both markets and voters to pressure Congress makes default more likely.

Only slightly less stupid is the prioritization discussion, in which the Treasury pays bondholders first and defers other payments, like Social Security or paying the troops. This might be favorable for Treasuries—for a while. The WSJ notes the Treasury will have $30 billion on Oct 17 and can pay the interest due then, but “A bigger question is what happens on Nov. 1, when $50 billion is due for Medicare, Social Security and military pay. On Nov. 15, a roughly $30 billion interest payment comes due.” You can just imagine the Republicans saying that the president preferred to pay the Chinese and Japanese over paying our own citizens and soldiers. The hypocrisy is breath-taking. It’s becoming ever more difficult for non-crazy conservatives to associate with the Republicans.

As for the economic effect, we can’t find any serious estimates. The WSJ points out that in the summer of 2011, when the final outcome was a ratings downgrade, consumer sentiment and PMI’s fell sharply, but more importantly, Q3 GDP grew by less than half of the June forecast, 1.4% vs. 3.3% expected. And that was without default. The shutdown alone is costing the US about $160 million per day or $1.6 billion last week, according to Bloomberg, but let’s not forget the multiplier effect that has yet to kick in, not to mention the higher cost to the Treasury if rates rise anywhere on the yield curve. So far they are rising only at the short end but once the dust settles from the immediate default crisis, US rates will be permanently higher because the world will know that default is not off the political table.

We always like to joke that the old saw “the market is always right” is simply not true. It’s true in the sense that a single player can’t influence the market and we are all price-takers, but for the markets not to price in the credible threat of default is an analytical error. Eventually it will get priced in properly, but for the moment, many players in various markets just want to be positioned properly to take advantage of the crisis ending. Those downward spikes in the pound and euro over the past 24 hours almost certainly mark an effort to get that ball rolling. And it’s true that resolution will have a tremendous announcement effect favoring US assets and the dollar, and we can all go back to wondering about when the Fed will taper. One thing is highly likely—tapering is postponed from year-end or January far, far into next year. Instead of QE ending by June, it may not end until the following year, pushing out a rate hike even further. Equity guys will love it, just one of many ironies to be found in public life today.

Note to Readers: Next Monday, Oct 14, is a national holiday in the US (Columbus Day) and we will not publish any reports. Markets do not close early this Friday but we will publish the traders’ advisories starting at 2 pm.