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The Debt Limit: When Will It Be Raised?

Gillian Tett has a good column:

Can we believe Geithner’s patter on debt?: Don’t panic. That, in a nutshell, was the soothing message of Tim Geithner, US Treasury secretary, as he did the rounds of Washington on Thursday, the day after President Barack Obama called for a fiscal reform deal, together with $4,000bn cuts. Never mind that President Obama’s plan sparked a furious response from Republicans; this could further rile Tea Party politicians who are so opposed to letting the US government raise its debt ceiling that they are threatening to force a US bond default this summer.

If Mr Geithner is to be believed, bond investors should know that this default chatter is just part of the normal political process.... Can this reassuring patter be believed? Up to a point, m’lud. On the surface, the current behaviour of the bond market appears to support Mr Geithner; though the government came to the brink of a shutdown last week, due to fiscal brinkmanship, 10-year Treasury yields were on Thursday trading at just 3.48 per cent. There is little sign of foreign selling; bond auctions remain well covered.

However, what is less visible – and more ominous – is that, behind the scenes, some large asset managers and banks are already discreetly debating contingency plans... [for] a technical default....

[On] the “acknowledgement” question – there has been progress. In late 2010, when Mr Obama’s bipartisan fiscal commission first issued a report on the debt, the White House hoped that tough fiscal debates could be delayed until after the 2012 election. That thinking, however, has now changed.... However, Mr Obama’s speech this week may – ironically – have actually undermined this constructive debate, by alienating Republicans. Sensible dialogue remains the exception, not norm. And that makes it that much harder to produce the third item... a credible fiscal plan. Optimists in Congress insist that the main players in the fiscal debate now accept that any eventual plan “will look something like Simpson-Bowles, plus or minus twenty per cent,” as one leading senator says... $4 trillion-$5 trillion [over ten years] range. However, the two sides remain bitterly divided about the fiscal mix.... [T]hat long delay may not be entirely disastrous for market sentiment if the first two factors on that checklist are in place. At the very least, Congress must have enough “process” in place to raise the debt ceiling...

It is an interesting expectational dilemma. My view is that Republicans in congress will not vote to raise the debt limit until there is an interest rate spike. But once there is an interest rate spike they will raise it very quickly--and interest rates will go back down--so that those whose bond sales are the interest rate spike will lose a lot of money: they will have sold their Treasuries cheaply at prices that make them look like fools in retrospect.

The way to make money is then to buy Treasuries when interest rates spike... thus keeping them from spiking enough to trigger enough panic in Washington to produce an increase in the debt limit...