United States Treasury securities have enjoyed a unique position at the top of the credit ladder. The credit rating of the United States stands apart, even from other rich Western countries. We aren't just AAA-rated, we are the United States. Treasuries fill a role all over the world when rock solid security is required--in many cases nothing else will do. If you are looking for an example of American Exceptionalism--this is it.
In order to keep this competitive advantage all responsible policy makers have understood that they must not do anything that even hints at the possibility of a default. The day that the United States Treasury becomes just another ho-hum investment-grade security, we lose our exalted status and we don't get it back. Ever.
When that happens the shock to the world financial markets will match and possibly eclipse the recent Great Recession as sovereign funds, money market funds, pension funds and trust accounts holding trillions of dollars in Treasury Securities take a hit and start unwinding their exposure to US debt.
Failing to raise the debt ceiling creates a risk of the unthinkable--a default by the United States. Even the suggestion of such a move is hopelessly irresponsible. If you are a Member of Congress and you don't get this, if you are willing to play chicken with this critical national advantage, you are in the wrong job.
Let's start with a basic fact--most money in the world isn't money in the paper and coin sense. It is electronic. A huge amount of that money isn't even cash; it is held in the form of debt instruments issued by governments and corporations around the world. It is held by banks, trust companies, governments, the Social Security Administration, not to mention individuals looking for a safe place to stay liquid and get a little (very little these days) interest on their holdings.
Rating agencies evaluate the safety of different financial instruments and assign a rating to each, based on the likelihood of a default. At the bottom is the high-yield debt. It is either unrated or rated below investment grade. Nothing wrong with that, necessarily. You'll get a higher yield on that paper, but you run the risk of losing some or all of your investment. Next comes investment grade (BBB- or better at Standard & Poors, Baa at Moody's). The low end of investment grade is still somewhat risky, but as you rise into the A and AA-rated paper you become more and more confident of the issuer's ability to pay. At the top of the official rating system is the coveted AAA rating. Some big banks and insurance companies have it (though not as many now as a few years ago), some states and large cities do too. Any many national governments enjoy a AAA rating, including much of Western Europe, Hong Kong and Oceania.
And then there is the United States. It enjoys an official AAA (or Aaa) from all the credit rating agencies. But in fact it is special. It almost stands apart from all other entities. Investing in the debt of the United States is a very different thing from investing in the debt of Australia or the Isle of Man. That is neither a political statement nor a boast. It just is.
Treasury securities are used as the benchmark--they are considered essentially zero-risk and many other financial instruments around the world are priced based on their risk relative to US debt. An IMF report from 2001 listed a number of roles that US treasury securities play, including:
•benchmarks for pricing and quotation in U.S. and international bond markets;
•important component of global bond indexes used by portfolio managers;
•major instrument for hedging fixed-income positions in U.S. dollar and international markets;
•collateral for domestic and international financial transactions;
•main tool for liquidity management by private sector, especially by banks;
•large share of foreign exchange reserves held by other governments
•main monetary intervention vehicle used by the U.S. Federal Reserve;
•domestic and international safe-haven.
(Incidentally, this IMF report, issued two months into the G.W. Bush regime, was exploring the implications of a shrinking supply of U.S. Treasury Securities--how times change).
What this means is that the worldwide financial markets depend to a great extent on Treasury securities remaining safe. The United States is--dare I say it--too big to fail.
An actual downgrade of US debt would be a financial cataclysm. It would have the immediate impact of causing massive uncertainty in the world economy, huge shifts of capital and a meltdown in the global financial system. But a downgrade from AAA is not really at risk. There is no chance--as in zero--that the United States will default on its debt in my lifetime (which I hope to last another half-century).
The real risk is that the United States could lose its unique position as the financial benchmark. If that happened, the gilt-edge would start to tarnish. Over time we would lose the competitive advantage we enjoy. We could become just another AAA-rated country.
How could this happen? Easy. As they said during WWII: "Loose lips sink global confidence in US debt instruments." Or something like that. I submit that when Members of Congress, including then-Senator Barack Obama, start to play political football with the debt ceiling, world markets take notice. When politicians who are on the short list of likely presidential candidates explicitly say that Congress should not raise the debt ceiling, as Michele Bachmann, Mike Huckabee and Tim Pawlenty have done, some of the gilt edge rubs off.
There are few things that should be sacrosanct in American politics. Keeping the United States as the benchmark of financial stability in the world should be one of them.