Bernstein Private Wealth Management’s Chief Economist, Eric Winograd, joins Senior Investment Strategist Matt Palazzolo to discuss what to expect—and what’s at stake—when it comes to Congress’s debt ceiling negotiations.
Matt Palazzolo: Eric, I want to begin by highlighting that you’re not a policy expert. You are an economist, and so you look at the world through that lens. But as you think about the debt ceiling debate that we’re going through at the moment, what’s the likelihood that we actually do default on our debt?
Eric Winograd: Our view for a long time has been that the probability of an actual default is really quite low. And as you say, Matt, I’m an economist, not a policy expert. So I don’t have a specific view about the process by which we avoid a default. But we have a general sense of confidence that policymakers will eventually find a way out of the quagmire that they’ve gotten themselves into and avoid a default. This isn’t the first time that we’ve had a debt ceiling debate: in past instances, Congress and the administration have always gone right up to the deadline and then figured something out. And we have a pretty strongly held view that that will happen again. It’s not a guarantee, but that’s what we think is the most likely scenario.
Matt Palazzolo: So the issue is around debt and how much debt is too much. Currently, US debt-to-GDP is roughly 120%. In your mind, what are the implications of having too much debt?
Eric Winograd: I don’t really like the phrase “too much debt” in the sense that it implies that there’s some sort of number or level that we can point to and say, “If you get to this amount or that percentage of GDP, that causes problems.” The truth is that there isn’t a specific number or a specific quantity that we can point to and say, “Below that number, you’re okay, but above it, you have a problem.” I think that it’s better to think about the implications of having a relatively large debt burden by historical standards. For the US, the primary implication is that it is a headwind to future growth. Every dollar that is spent servicing the existing debt is a dollar that the government can’t spend on something more productive. The larger the debt is, the more it’s going to cost to service it—particularly in an environment where interest rates are higher than they have been for the better part of the last decade. So we look at the debt burden as a headwind to future growth. We don’t look at it as a sign that a crisis is imminent or that US government debt is no longer desirable. If there is a crisis here, we will have caused it ourselves by breaching the debt ceiling, not because the quantity is suddenly too high.
Matt Palazzolo: Back in 2011, Standard & Poor’s downgraded the US in the wake of that year’s debt ceiling debate. What are the implications of that downgrade for investors today as they think about the issues that we’re going through?
Eric Winograd: Honestly, I don’t think that there are any implications. We’ve looked back at that episode when the US was downgraded. It’s very difficult—if not impossible—to find any meaningful impact that that downgrade had on asset values, on the economy, or on anything else. Again, it largely comes back to the idea that US Treasuries have generally been perceived to be without credit risk, even after that downgrade. Nobody took the action as a serious signal that the probability of default had gone up meaningfully. And it is the probability of default—rather than what a ratings agency says or doesn’t say—that matters most to investors.
Matt Palazzolo: I want to highlight what you said earlier in our conversation before I ask you this next question. You said that there’s a very low likelihood that the US defaults on its debt this time around. But what if we do default? What are the implications on the US economy if it does happen? And what if that default isn’t resolved in a matter of days? What if it takes a few weeks?
Eric Winograd: The scary thing is that I don’t really have a great way to answer that question. The most frightening aspect of a potential default is that we don’t really know what that would look like. We don’t know what the consequences would be, and we don’t know how severe the impact would be on financial markets or on the real economy. There simply isn’t a history that we can rely on to give us a guide. Our general thinking is that if it’s what we would think of as a “technical default” (where the US government breaches the deadline but investors assume that they will be made whole in fairly short order), the implications might be quite small. If the government ends up delaying T-bill payments for a couple of days but the market isn’t forced to seriously contemplate the idea that it won’t get that money back, we may have a very limited impact. Certainly, money markets and the funding of the financial system could be vulnerable, and we would want to monitor that very closely. But the presumption would be, at least for me, that a fairly short-term breach of the debt ceiling would not be catastrophic.
But if it lingers much beyond that, it could be catastrophic. I think that money markets and the plumbing of the financial system—which might be resilient in the very short term—would not be resilient in the long term. The ability to use Treasuries as collateral underpins significant parts of our financial-market infrastructure. If you have to take seriously the prospect of not getting money back on Treasuries, that whole edifice starts to crumble. And once that happens, as I always say, “The financial system is where small crises go to become big crises.” If the financial-market plumbing and the financial-system plumbing freeze up, the real economy freezes up, too. And I think that we would fall into a nasty recession in fairly short order.
Matt Palazzolo: Fair point, Eric. I can’t let you go without asking you about the economy in general in the United States—absent the whole debt ceiling issue. Assuming that we move past the debt ceiling, and we have a resolution, what do the next six to 12 months look like in the US?
Eric Winograd: Absent a debt ceiling crisis, things actually look reasonably good and better than we would have expected a couple of months ago. You recall that we were very worried about issues in the small and regional banking sector and the impact that that crisis would have on the economy. The data that we’ve seen since then—in terms of the behavior of depositors in those banks and the behavior of those banks in extending credit—suggest that there has certainly been some impact but not the sort of collapse that could have precipitated a broader slowdown. We look at the next six to 12 months, absent a debt ceiling, as a continuation of where we’ve been, which is a glide path toward a more normal economy. Inflation is working its way lower. We expect that will continue. Growth is slowing. We expect that to continue as well, largely thanks to the now more than 5% of rate increases that the Fed has put into place. But there’s nothing in the data or in the environment right now that suggests an imminent collapse or a hard landing. Our forecast calls for growth to be around zero this year—which, if that’s the worst it gets, would count as a pretty soft landing, by historical standards.
Matt Palazzolo: Eric, we appreciate your insights. Thanks for joining us today.
Eric Winograd: Thank you.