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Home Publications Blogs Beat the Press The WSJ Gets Scary With Debt

The WSJ Gets Scary With Debt

Wednesday, 01 June 2011 05:09

The WSJ had a chart alongside an article on the House vote on raising the debt ceiling. The chart shows the debt ceiling through time. The ceiling is shown in nominal dollars. By not adjusting for the growth in the economy or even the rate of inflation, the chart makes the ceiling look hugely out of line with past levels.

That's a good practice if the point is to scare readers about the size of the debt. It is bad journalism. The debt ceiling was higher relative to the size of the economy during World War II and its aftermath.

It's also worth commenting on its reference to credit default swaps (CDS) as a reference to the risk that investors assign that the U.S. could default on its debt. In fact, the price of CDS on the U.S. debt imply nothing of the sort. If the government actually defaults on its debt, the issuer of a CDS on the debt will almost certainly be bankrupt, so the CDS would itself be worthless.

Rather than being a bet on the government defaulting on its debt, the price of a CDS on U.S. government debt should be viewed as a bet on how much people will be willing to pay for the CDS tomorrow. In this way the price of a CDS on U.S. debt can be viewed as comparable to the price of an awful painting by a very famous artist. No one actually wants the painting, but it may hold great value because other people are willing to assign it great value.  

Comments (4)Add Comment
written by izzatzo, June 01, 2011 7:20
No one actually wants the painting, but it may hold great value because other people are willing to assign it great value.

Exactly. Any economist understands the 'winner's curse' in CDS markets will eventually reward those holding them at below market prices their just due for encouraging the moral hazard of crippling debt.
Our WWII Debt has been a Real Killer of the Economy
written by Paul, June 01, 2011 8:30
If only our grandparents had not been so foolish to run up the huge debt to fight WWII, we wouldn't have all the problems we now face. For example, Republicans would be completely wiped out, as would Democrats and in fact we would not be having any debates about the debt ceiling now.

Also, stupid Pres.Eisenhower (a Republican!) should not have run up the debt to build the interstate highway system. That caused us huge problems too.
written by pete, June 01, 2011 11:10
Debt for highways, or apparently Rachel Madows fave, damming the Colorado, are actually humoungous costs...these types of projects should be resisted. Interstate highways vastly increased our dependence on oil, and facilitated white flight and urban decay.

Paving our national parks with roads is a travesty, and damming the Colorado completely screwing up the west with reliance on water which is not there....

written by skeptonomist, June 01, 2011 12:27
Dean makes a good point about CDS's - they and other derivatives are based on guessing what other people think "the market" will do. Meanwhile in the real bond market, the news of the failed vote on the extension of the debt limit seems to have inspired a new wave of buying - Treasury yields are down again today. If bond yields have any relation at all to the relative confidence that "the market" has in the debt, that confidence is higher than ever now and has been increasing as the WaPo and others yammer about the dangers of debt.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.