20101230 erasing debt
Erasing debt - 

Kai Ryssdal: Congress has about two weeks left to figure out what it wants to do about the debt limit. It'll be, as Lizzie and Sudeep said, topic one when Congress gets back to town.

Neel Kashkari is a managing director at PIMCO -- the big bond firm. He spent time at Goldman Sachs and, more publicly, in the Treasury Department running the TARP for Henry Paulson. So we've called him to get a sense of the market's view of the debt limit debate. Neel, welcome to the program.

Neel Kashkari: Thanks for having me.

Ryssdal: How much tolerance do you think the market has for all this debt ceiling shenanigans?

Kashkari: I think that the market has a fair bit of tolerance. I think that there's an important distinction between when the government reaches the debt limit and when the government would actually stop paying interest on the debt, or actually default on the debt. Stopping paying interest or defaulting would be catastrophic for financial markets and for our economy. Reaching the debt limit would put some constraints on Treasury and make them make choices on where they spent their money that they did have. But the two are different, and it's not a catastrophe when we reach the debt limit.

Ryssdal: It's a perception thing as much as anything else, right?

Kashkari: In part. The Treasury market and the dollar depend on investors having the perception that the U.S. government is going to do the right thing, that we're going to get our fiscal house in order, that we're not going to continue to spend, spend, spend much more money than we generate. And so ultimately, it comes down to confidence. We don't have that confidence yet, and the debt ceiling is becoming a litmus test for whether or not politicians can actually come together and make hard choices.

Ryssdal: How are we going to know when the market has said, 'You know what, United States, we're done.'

Kashkari: You know that's a very hard question. I'm asked that a lot -- how much time do we have? And it's impossible to know because investors around the world can decide, 'we want to invest in America, we want to invest in Europe, we want to invest in Asia or emerging economies.' So our relative position compared to these other markets is also very important. If Europe gets its house in order more quickly than America, then Europe could become a more attractive place for capital and investors could change and decide to take money out of America and put it into Europe. So we don't know exactly how much time we have, but there are market indicators that we're watching very closely.

Ryssdal: What are some of those indicators, then?

Kashkari: Federal government debt to GDP -- so how much debt we have relative to the size of the country. That's very high now, and climbing. Another indicator is the dollar -- relative to the Euro, relative to the yen. The dollar's under more and more weakness. Another indicator is long-term inflation expectations, and those are also climbing.

Ryssdal: But if you look at the bond market, you can go to the Treasury and get a 10-year T-Note and pay like 3.5 percent interest -- which by any measure, is quite reasonable, and shows no sign of these bond vigilantes, you know, the bond market slamming shut and saying, we're not doing this anymore.

Kashkari: Yes, but that's a false indicator because the Federal Reserve has been buying about 85 percent of the Treasury issuance. And the Federal Reserve is not a cost-sensitive buyer. They're buying it at almost any price. And so we can't take much comfort from the prices of Treasurys today because there's an artificial buyer. So what we at PIMCO are very focused on is what happens to the Treasury market when that artificial buyer goes away. And we think Treasury prices are going to fall when that giant buyer goes away.

Ryssdal: How much damage have we done merely by the fact that we have to have this debate about the debt ceiling, and we can't figure it out?

Kashkari: You know, honestly I don't think much lasting damage. On the other hand, I think it's a good thing that we're talking about the deficit. I think there's a lot of noise and bluster around the debt limit, but to the extent that it is a catalyst for us to get serious about controlling our deficit spending. I think net-net, it's a good thing.

Ryssdal: So full faith in credit is still there, it's just get this spending under control?

Kashkari: Absolutely.

Ryssdal: Neel Kashkari of PIMCO, the bond management fund down in Orange County, Calif.; lately of Goldman Sachs and also the Treasury Department, where he ran the TARP. Neel, thanks a lot.

Kashkari: Thanks for having me.