Debt ceiling is a side show versus the riskiness of Treasury debt as measured by a discounted pricing model

The US has unusual fiscal dynamics with the regular battle over debt ceilings. A fight may occur, but eventually the addiction to debt continues. The drama unfolds; however, the ending is still much the same. Approval for an increase allows for another sequel to the current drama. For investors around the world, this does not make sense. We end with a potential crisis which adds uncertainty that is not necessary. There is still little fiscal prudence. Of course, deficits are necessary but so are surpluses over the long run. 

It is, however, more important to think through the strategic dynamics of debt and not the legislative tactics. In a recent working paper, The US Public Debt Valuation Puzzle, the debt problem is looked at from a different perspective. The authors attempt to price Treasury debt like any other asset using some classic asset pricing models. This provides some fresh perspective but also introduces a puzzle - why are rates so low when Treasuries should be considered a risky asset.  

From an asset price perspective, the market value of government debt should be equal to the present discounted value of fiscal surpluses. If the value of the debt exceeds the priced surplus claim, there is a debt gap. The authors find that the yields on Treasuries are lower than the relevant interest rates that investors should be earning on the risky claims. Hence, there is a puzzle for why there is this different.

The cyclical and long-term dynamics of spending and tax receipts makes for a risky claim. The primary surplus is pro-cyclical like stock dividends. Hence, Treasury debt has substantial business cycle risk and the relevant interest rate for discounting should have a risk premium. Debt occurs at inconvenient times from a consumption perspective. This risk premium is greater than what could be the convenience yield of holding Treasuries. 

The model and arguments presented may not make you money in the short-run, and the dynamics of buyers and sellers and the impact of the central bank are not considered, but the core arguments are useful. As long-term deficits increase and the cyclicality of deficits continue, there is less chance of future surpluses. The discount or appropriate interest rate for pricing these future claims should be higher. There should be a bias to higher real rates based on tax and spend behavior.