U.S. federal debt default better than a bum deal

” ‘A financial crisis is surely going to happen as big or bigger than the one we had in 2008 if we continue to behave the way we’re behaving,’ says Stanley Druckenmiller, the legendary investor and onetime fund manager for George Soros.  Is this another warning from Wall Street that Congress must immediately raise the federal debt limit to prevent the end of civilization?  No – Mr. Druckenmiller has heard enough of such ‘clamor and hyperbole.’  The grave danger he sees is that politicians might give the government authority to borrow beyond the current limit of $14.3 trillion without any conditions to control spending.” James Freeman, ‘What If the U.S. Treasury Defaults?’, The Wall Street Journal, May 14, 2011

Mr. Druckenmiller outlines two options. First, suppose that one owns a 10-year Treasury.  In return, one receives an income stream over that period. As a result of default that income stream will be delayed for some period of time, until market pressures force the government to clean house.  In return for that delay, one receives significant cuts in entitlements and the government gets its house in order.  In consequence, one’s income stream almost 10 years out is much more assured. 

 Second, suppose that one owns the same 10-year Treasury. However, in this scenario, the debt limit is quickly raised to avoid any disruption of payments.  One receives one’s income on time.  But the government continues to pile up trillions of dollars of debt, and a Greek situation emerges say six years down the road.  One’s income stream is rendered worthless.

Which of those two pieces of paper would one prefer to hold?  The answer to that question is a no-brainer!  It is the piece of paper number one!

Tags: debt default superior to bum deal, default and be damned