While markets aren't perfectly efficient, they are generally correct directionally
The proof is in the pudding - higher market rates means that is
The government can raise taxes to cover debt obligations
If the US defaults, the companis would also be in trouble
The government can always print more money to get out of their debt
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Luis Perez Nov 07, 2012
I trust the markets and the fact that it is cheaper to lend to these companies as opposed to the government means that investors, taking into account (we hope) all risks, value the risk of default by the government to be higher than that of these companies.
The chances of the US defaulting, at least while it remains the reserve currency is almost non-existen. Borrowers could worry about the value of the dollar they lent out depreciating in value, but the risk of default is unlikely.
Joe El Rady Nov 09, 2012
US government can print money... end of story. The fact that you may be getting paid back in inflated dollars doesn't matter... especially when we compare the payback from Exxon and other companies since they too will be paying you back in inflated dollars. The fact that market reflects lower rates for certain companies that for US TSY provides further evidence that markets are not efficient (just ask George Soros... how would he have made all that money if markets were truly efficient).
Luis Perez Nov 09, 2012
But even if the US can print money, what if individuals/foreign government stop buying US debt? If I as an investor expect the US dollar to drop and the security is paying me 0.5%, I am not going to buy that. As investors require a higher yield the price of the bond decreases.
Joe El Rady Nov 16, 2012
The question asks about "risk". There is no risk as the government can print more money to pay you. So the risk is 0. It doesn't matter that yields will rise or that investors will be paid back in depreciated money... the risk remains 0. Furthermore, the question compares US Govt debt to Exxon etc... remember, those companies can't print their own money, so of course they are more risky than the US Govt.
Luis Perez Nov 16, 2012
While inflation is under control they can print, but as soon as inflation starts to rise there is a ton of political pressure to being able to continue to print. The US is in a privileged position with the US dollar as a reserve currency with debt issued in USD, but there is always the risk that investors will shy away from buying its debt. Yes, you can print to pay out current obligations, but when you run a deficit that money has to come from somewhere. Right now it comes mostly from US citizens and foreign governments. How do you roll-over your debt when foreign markets start to close?
E Jay Chavez Nov 13, 2012
Most investors focus on real returns. Converting default risk to inflation risk doesnt' eliminate the risk and doesn't improve real returns.
It doesn't matter what investors focus on or what yields do. Risk remains 0 because of the government's power to create money from thin air. You will always be repaid. The risk of not being repaid is 0. Now, you might get repaid in money that isn't worth anything, but you are still getting repaid. Also, the question here is: which is more risky, private companies, or US Govt. Remember, those companies issue debt in dollar denominated bonds... so whatever inflation risk occurs hits them as well. That risk moves in lock-step.
E Jay Chavez Nov 16, 2012
Of course getting paid back in inflated dollars matters. JNJ can't print its way out of debt so the total RAROC is a better, hence yields are lower than the US debt where RAROC isn't so nice because of the potential for debt to be paid in worthless currency. It is sorta like giving someone a Chicago MBA (4 time champs) or a Wharton one, the Chicago one has a higher RAROC. :-). j/k of course, Wharton is a great school.
The government has traditionally been able to raise taxes in order to debt obligations. The government can raise taxes to increase revenue in the short run (not talking about long-term implications to the economy of raising taxes).
Agreed, the US Govt enjoys significant untapped taxing capacity. Not making a political argument and not stating whether or not those taxes would hurt the economy; however, if the US needed to repay it's debt... it could easily collect the taxes to do so. Remember, the top 1% of Americans possess US$40Trillion of wealth.
Luis Perez Jan 09, 2013
Yes, especially in the short term. However, the question is not whether there is untaxed capacity (every country could raise taxes) but whether 1) those increases could truly be implemented and 2) whether does increases would make the country more economically sound in paying off long-term liabilities.
E Jay Chavez Nov 08, 2012
While markets aren't perfectly efficient, they are generally correct directionally. Rates are lower for these corporates because of the inflation risk that (as of Tuesday) became much more concerning.
Michael Song Nov 09, 2012
If J&J or Exxon are in danger of being insolvent due to a company specific event, I doubt US rates would be significantly impacted, if at all. On the other hand, if there is a serious doubt the US will be able to pay its debts, we are all in deep shi.... including Exxon and J&J
I agree somewhat. However, when a country defaults most of the companies in the country do not fall into bankruptcy. Many of them are better positioned that the government to survive a recession and thus the reason why their debt trades at a lower yield than the sovereign debt. I do agree that a US default would impact companies a lot more than a a corporate bankruptcy affecting the company.
Michael Song Nov 17, 2012
I do see your point. But if the question is specifically US debt, think about that scenario. If the US is considered a safe haven currency and it defaulted, think how much the US dollar would decrease. Thus, J&J may be able to technically pay back your bond, but you are essentially being paid with worthless paper. I know we have seen other countries default, but I don't think there is a precedent for what might happen if a safe haven currency defaulted in such a global economy. I mean that is why you have some really smart folks keeping bars of gold underneath their bed, right?
A default does not mean a complete collapse of the economy. It is like a bankruptcy. There will be significant confusion, but it all gets worked out and the economy continues.
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