Dan Drezner says he's been "flummoxed" by the lack of market reaction to the stalemate over the debt ceiling. He suggests that it might be because U.S. bonds are mostly held by central banks and sovereign wealth funds who aren't likely to sell them in a panic regardless of what happens. So default isn't as big a deal as we think it is.
Maybe. But I think it's because we're throwing the word "default" around too casually. There are two ways people have been using the word lately:
Beyond this, there's the idea that bond markets should be troubled by our long-term financial problems. But they haven't been in the past, they aren't now, and Standard & Poor's to the contrary, nothing happening now really suggests they should be much more troubled about it than they've ever been. Maybe someday they will be, but that day is a ways off.
In other words, maybe there's just not much reason for bond markets to be panicking yet. A downgrade by the ratings agencies would be a more serious thing, especially since it would have knock-on effects on state and local bonds, but I suspect investors are treating that as a completely separate issue. Not: are U.S. bonds in trouble? but: what are S&P's analysts going to do? And for the moment anyway, investors apparently think their downgrade talk is just bluster. Perhaps they know something we don't?