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A government shutdown could happen on March 4 if the House and Senate cannot agree on a budget. Meanwhile, the Senate is on a 10-day vacation, meaning negotiations will not resume until next week. However, this potential shutdown is small potatoes compared to the battle over raising the debt ceiling that will come in April or May.
There has been a lot of hyperbole surrounding the raising of the debt limit, with talk of Armageddon if the U.S. defaults on its debt. However, this depends entirely on what one considers a "debt". After reading about the issue, it seems that there is a mix of issued Treasury bonds that trade in financial markets vs. accumulated debts within the government, such as in the Social Security system.
In simple terms, the U.S. government is a long way from a bond default. Interest payments on the debt are sizable, but it is a manageable portion of the federal budget. In April, May and June of this year, interest expenses are projected to be $5 billion, $37 billion and $8 billion, respectively -- hardly an immediate problem for a government collecting more than $100 billion a month in revenues.
There is no financial reason for the U.S. government to miss a bond payment, and failure to raise the debt ceiling will not stop the federal government from rolling over existing debt. The Treasury could also print more U.S. dollars and pay off the bonds with cash; however, there could be serious repercussions if Treasury took that route, but it is an available option. Therefore, if the U.S. government were to outright default on its bonds, it would be a choice, not a necessity.
Where the issue becomes cloudy is with obligations, such as Social Security. Currently, the U.S. federal government is borrowing $0.40 out of every $1.00 it spends, and mandatory spending accounts for 56% of the budget. Mandatory spending includes Social Security, Medicare and other benefit programs whose spending is set by law. Congress can change these laws, but in most years, it spends the bulk of its time debating the level and allocation of discretionary spending.
What are the implications for investors if the debt ceiling is not hiked? There is no way that Treasury Secretary Geithner or President Obama will allow the U.S. to default on interest payments. Therefore, the outlook on U.S. Treasuries would be very bullish. First, supply would be cut because no additional bonds would be issued. Demand for Treasuries remains high, and the Federal Reserve is still buying them due to QE2.
Second, the bond market would likely view such a move positively, since it means the U.S. is dealing with its financial problems. In the very short run, the market could do anything, but if it appeared that the U.S. government would make serious cuts, U.S. treasuries and the U.S. dollar would become more attractive. The biggest gains would come from the longer end of the maturity curve, with ETFs such as
iShares Barclays 20+ Year Treasury Bond
leading the way. However, all treasuries should do well.
At the time of publication, Dion Money Management held no positions in any of the securities mentioned.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.