Default Isn’t The Only Danger; A Global Depression Is

Markets Watch As Government Shutdown Continues

If the debt ceiling isn’t raised, a Goldman Sachs paper argues that the Treasury could probably prioritize debt payments and avoid default. Krugman is not reassured:

They don’t sound too confident. But even if they’re right, the government would still go into arrears on many other payments, from contractor bills to medical bills. And it would be forced into savage spending cuts, around 4 percent of GDP, that wouldn’t just cause hardship (Surprise! No Social Security for you this month!) but amount to a severely contractionary fiscal policy, sending us into recession if it lasted any length of time.

I think this is important. Lots of people have been focusing on the possibility of a mega-Lehman event, but even if we somehow avoid that, this will be a catastrophe.

Neil Irwin cautions against finding comfort in the relative calm of the financial markets:

Market sentiment can barely move for a very long time — and then take a dramatic shift all at once.

There were warnings that Lehman Brothers could collapse throughout the summer of 2008, but only after its bankruptcy on Sept. 15 of that year did the financial world come unglued.  In 2011, the warnings that the debt ceiling negotiation could get ugly had been sounded for months — but only turned into an extraordinary bout of volatility about a week before the bill came due for the U.S. government.

Markets are prescient, in other words, except when they’re not.

Ezra’s take:

Analogies between the finances of families and government are typically pretty flawed. But there’s one worth drawing here: That moment when a family realizes it’s broke and stops paying their mortgage, credit card bill, etc? It’s not a good moment for them. It’s a moment that wrecks their credit score and makes it harder for them to be “not-broke” ever again. To try and improve the U.S.’s finances by sharply and permanently increasing its borrowing costs is like trying to prove to your sister that her house is a firetrap by actually setting it on fire.

(Photo: A trader works on the floor of the New York Stock Exchange on October 7, 2013. As the impasse continues between the Republicans and Democrats in Washington, the Dow Jones Industrial Average, the S&P 500, and the Nasdaq all dropped by nearly 1% Monday. By Spencer Platt/Getty Images)