The WSJ Gets Scary With Debt

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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.