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Debt ceiling debate raises default worries

  • Article by: CHRIS FARRELL
  • July 2, 2011 - 11:51 PM

QMy wife and I are too close to retirement and are willing to trade safety for income so that our 401(k) is totally invested in T-bills. Unfortunately, I believe there is a real risk of our government defaulting. If its does, what happens to the money in T-bills?

BOB, MAPLE GROVE

AFirst of all, it's a disgrace that we even have to address the issue of whether the United States will default on its debts. Ever since Alexander Hamilton, the first treasury secretary and a brilliant financier, the world's wealthiest nation has always paid its debts. Every investing primer published by mutual fund companies and investment textbooks describe U.S. Treasuries -- bills, bonds and notes -- as default-free investments. Translation: That's as safe as it gets.

Yet there's serious talk in Washington about letting the United States default on its debt. The trigger for how the unthinkable became at least remotely possible is the government's $14.29 trillion debt ceiling. The risk of default sharply increases unless Congress raises the debt ceiling by Aug. 2. Now, the immediate danger if the debt ceiling isn't raised is that the government won't be able to borrow money to pay for commitments it has already made. The government could scramble for a time, but eventually it could run out of room to maneuver. Long before then, the markets could lose confidence in U.S. Treasurys.

The outcome? Interest rates on U.S. Treasury securities would soar. Treasurys are the benchmark for setting rates elsewhere in the economy, from commercial loans to home mortgages. A U.S. default would send a fragile global economy spiraling lower. The outcome could be toxic.

That said, the political saber-rattling hasn't upset global investors yet. How do we know this? Because the yield last week on three-month Treasury bills was at 0.02 percent and the 30-year Treasury bond was at 4.32 percent. The market isn't buying Washington's rhetoric -- yet.

The nation would be entering uncharted financial territory with a default. But I wouldn't panic. It's important to remember that the government will eventually make good on its debt even if the unthinkable comes to pass. The pressure from investors -- from American retirees to the Chinese government -- will be too great. In this sense your investments in U.S. Treasurys remains safe. And there are alternative investments, ranging from FDIC-insured savings accounts to blue-chip dividend paying stocks.

Chris Farrell is economics editor for "Marketplace Money." Send your questions to cfarrell@mpr.org.

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