Can We Afford a ‘Technical Default’ on the Debt?

The debate over raising the federal debt limit – which the government reached today, according to Secretary Timothy Geithner – has morphed into a question of “compared to what.”

In the Wall Street Journal’s “Weekend Interview,” Wall Street legend Stanley Druckenmiller argued that what he called a “technical default” – a delay of several days or perhaps a week or two before the federal government paid bond investors – would be better than having policymakers raise the debt limit in time to avoid a default but fail to also take serious steps to control spending.

The Wall Street Journal’s editorial page, which argues vociferously for cutting spending, was only too happy to run the interview as well as its own follow-up editorial to heartily endorse Druckenmiller’s views.

Let’s take a closer look.

Druckenmiller offers a choice of two scenarios. In the first, the federal government is late to pay bond holders but, when it finally does, it also enacts “massive cuts in entitlements” as part of a return to federal fiscal sanity. In the second, the federal government makes its payments on time but doesn’t do anything to control spending.

“To me, it’s a no-brainer,” Druckenmiller said, arguing the first scenario is far superior to the second.

Druckenmiller’s analysis, however, rests on two questionable premises.

First, he says investors are sophisticated enough to read the tea leaves in Washington and that, as a result, a “technical default” of a few days would not rattle the bond markets and, in turn, hurt the economy.

Actually, Druckenmiller himself disproves his own contention. He says that, in investing his own money, he bought more Treasury securities in light of House Budget Committee Chairman Paul Ryan’s calls to dramatically cut spending, saying, “I heard some serious things that I hadn’t heard in a long time.”

Did he really think Congress would pass, and President Obama would sign, legislation to turn Medicare into a voucher, turn Medicaid and food stamps into block grants, and reduce the federal government to its smallest size since the early 1950s? If so, then no one should assume markets are very sophisticated.

Second, Druckenmiller talks about the dire need to reduce deficits and debt by dramatically cutting spending. You’d think someone as concerned as he claims to be also would propose tax increases – especially on those who can pay more, especially with top marginal tax rates at historically low levels.

Druckenmiller, the Journal says, is worth about $2.5 billion but, in his concern about red ink, he didn’t volunteer to pay higher taxes.

How concerned can he be? And how seriously should we take his argument?

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