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Bruce Bartlett on the risk of a U.S. government debt default

In his column today, he says - and I completely agree:

"[M]arkets have always assumed that the federal government would raise taxes as much as necessary to prevent a debt default. That's the primary reason why U.S. Treasury securities are assumed to have zero default risk.

"This was a reasonable assumption in the past, but I'm not sure if it is going forward because the Republican Party is now totally dominated by anti-tax fanatics utterly opposed to raising taxes for any reason. Although most Democrats would probably raise taxes if they could, they are terrified of being attacked by Republicans if they do. Barack Obama is so fearful of such attacks, he insists that taxes will never rise on any group except the rich, even if this means extending most of the Bush tax cuts.

"I don't think financial markets have yet priced into interest rates the possibility that Republicans would rather default on the debt than raise taxes. Although they may not control Congress or the White House any time soon, it is clear from the health care debate that they and their allies at Fox News and talk radio effectively dominate the policy agenda even on issues like health that are generally favorable to the Democrats.

"If Republicans gain seats next year, which is very likely at this point, they will have veto power over any tax increase. Should Democrats attempt to raise taxes, we will see a replay in Washington of the budget debacle that recently transpired in California, where the state was reduced to paying people with IOUs.

"In short, the fiscal situation going forward is even more precarious than it appears at first glance--and that's extremely bad. If I am right about Republican opposition to tax increases, default on the debt has to be considered as a real possibility."

Time to get a massive short position in U.S. government bonds. Or, since that's prohibitively costly, do what? Buy inflation-indexed bonds on the view that they'll eventually be paid? (Don't bet on it.) Buy gold?

Full post as published by Start Making Sense on September 11, 2009 (boomark / email).