StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



Another Dumb Right-Wing Idea: Default on the Debt

20 Feb 2010
Posted by Bruce Bartlett
Over the years I have heard a number of conservatives suggest that defaulting on the national debt wouldn’t be such a bad thing. Today Prof. Glenn Reynolds of the University of Tennessee Law School (better known as “Instapundit”) suggests the idea once again. Says Reynolds:
 
“SO HERE’S A QUESTION: Would a default on Treasuries accomplish what the Balanced Budget Amendment was supposed to achieve, by forcing the government to spend no more than it takes in? With more collateral damage, of course. . . .”
 
There are an absurd number of false assumptions and premises inherent in this point that I don’t have time to go through, but here are a few.
 
1. The Treasury can never default on the debt; it’s simply impossible. (Editorial note appended below.) Here are some reasons.
 
            -- First, unlike private borrowers who are constrained by the amount of interest they are willing to pay, the Treasury has no such constraint. It will always pay whatever the market requires, crowding out all private borrowing if necessary.
 
            -- Second, the Federal Reserve will always step in to ensure the success of a Treasury bond sale. Although by law the Fed cannot buy Treasury securities directly from the Treasury, it can assure primary dealers that it will soak up any excess supply in the secondary market.
 
            -- Third, long before we ever came even remotely close to a situation in which markets even suspected the possibility of default we would have economic conditions that would guarantee some sort of massive fiscal tightening. In particular, interest rates would be vastly higher than they are today, which would make even the most painful deficit reduction measures—crippling tax increases, in particular, as I have explained elsewhere—seem painless by comparison.
 
2. Even if the Treasury somehow defaulted—that is, failed to make a timely interest payment—it would not achieve what Reynolds and other conservatives wish: an end to all federal borrowing and de facto imposition of a balanced budget by cutting all spending in excess of revenues. Unless one also posits that all federal taxes would simultaneously cease, the Treasury will still have cash flow with which to make interest and other payments required by law.
 
Not being an expert on the law regarding federal spending I don’t know the precise priority of claims. But certainly, interest on the debt would be first in line for whatever cash flow the government had. (See Stan's comment here.) That means that interest on the debt would have to be close to 100% of federal revenues before the possibility of default would occur.
 
Keep in mind also that the Federal Reserve is, in essence, the federal government’s bank. When one cashes a federal check, the Fed pays it from funds the Treasury holds on deposit. In theory, the Fed could simply decide to give the Treasury some float and continue to cash federal checks even if sufficient funds were not immediately available. Since the Fed turns over all its earnings to the Treasury anyway, it could call this float an advance to get around legal restrictions. Keep in mind also that given the Fed’s vast holdings of Treasury securities, with which it conducts open market operations, any rise in interest rates will necessarily increase the Fed’s income enormously.
 
3. The disruption to financial markets, commerce and the well-being of all Americans from a Treasury default are really beyond my ability to fully describe. But here are a few points to ponder. Interest rates would skyrocket to unprecedented levels, which would cause a collapse of private borrowing and massive capital losses for all bond holders, which include pension funds, insurance companies and foreign central banks, among others. It might be impossible for pension funds to make payments to millions of individuals depending on them for life itself.
 
The economy would really grind to a halt long before interest rates got so high that default was even on the radar screen. And insofar as the Fed was forced to monetize the debt in order to support the bond market it would lead to hyperinflation. Is Reynolds really willing to turn the U.S. into Zimbabwe just to make a point?
 
In conclusion, the idea that we should default on the debt rather than raise taxes to deal with a looming fiscal crisis is simply absurd and, frankly, irresponsible. But considering how many absurd and irresponsible ideas are now common currency among the sorts of people who read “Instapundit,” I have to worry whether dimwits like Glenn Beck, Sarah Palin and Michele Bachmann won’t soon be parroting the idea that a default on the debt is preferable to any tax increase whatsoever. This is an idea that needs to be nipped in the bud.

Addendum

In my haste to write this post I forgot about the debt limit. If Congress failed to raise it then default becomes a realistic possibility because the Treasury would lose the legal authority to issue new bonds. Since the debt limit would have to be increased at some point lest the government fail to have the cash to make Social Security payments and such, the only consequence of this temporary default would be to permanently raise the Treasury's borrowing costs due to the addition of a risk premium.

Mark Thoma thinks I am taking Reynolds too seriously. He's probably right that Reynolds himself was not serious in his suggestion. But I have heard the same idea advanced seriously on numerous occasions among conservatives. I would note that a Fox News poll on October 1, 2009 found two-thirds of Americans saying that the debt limit should not be increased.

Martin Wolf comments here.

A remake of a mid-90s "classic"

Gingrich threatened debt default during the 1995 budget impasse. That gambit failed because everyone knew that the consequences would be so dire, there's no way the GOP could have stayed united behind it.

But conservative commentators don't remember anything (or at least assume, rightly, that their intended audiences don't remember). Part of the problem is that the conservative movement is that, since 1994, they have lurched from one debacle to another: they blinked first on the budget debacle, they squandered an immense amount of political capital trying to impeach Bill Clinton, and then of course the epochal catastrophe that was the Bush presidency, especially from 2003-2006. So they keep having to find new voices that aren't tainted by participation in, or endorsement of, the previous catastrophes.

BTW, that's a large part of the point of the tea party movement, to be able to disclaim what nearly all of them voted for. The perception is that they are a bunch of sore losers unwilling to accept an unfriendly election result, and that's true as far as it goes. But equally it's about distancing themselves from the Bush years, which (since, again, they all voted for him) is even more illegitimate than not accepting the 2008 outcome.


mid 90's dedux

BTW, that's a large part of the point of the tea party movement, to be able to disclaim what nearly all of them voted for.

Yep!!!!

Fiscal responsibility has always been one of my overriding political issues when voting. I went for Bush in 2000 mainly for one reason - he was endorsing the abolition of base-line budgeting. OK, two reasons.... he wasn't Al Gore! :-)

It became clear early on that the Bush administration was not going to make any effort what-so-ever to address that issue, and instead showed themselves to be more of the same as usual type administration as far as spending is concerned. I didn't vote for either Bush or Kerry in 2004, and I was so ticked at the economic stupidity on display for the 2008 choices, I wrote in Paris Hilton for President. I figured it couldn't have been much worse.

You would think I would be a prime candidate for the Tea Party recruiters.... None.

I liked the idea, but it quickly became obvious that the weakened Republican party was laying the groundwork for massive infiltration. Running on the ideal of "smaller government" and "less taxes" is fine, but my question is always this: "What are you going to cut?".

I usually get a response such as: "Well, entitlements are a huge reason why we're going broke!"

"OK. So how much of the medicare and social security benefits are you going to cut?".

"Well, we won't know until we have our guys in office".

Note that's not really an answer, and I know I won't get one. So I go to a different topic - George W Bush. He is universally derided for he spending policies. So I pose this question: "We both know that Bush spent way too much and was a "big government" President. Which of the Bush big government add-ons are you proposing we cut? Medicare-D? No Child Left Behind? Department of Homeland Security?"

I never get an answer.

The fact that the Republicans scored political points against ObamaCare by opposing cuts in medicare is all you need to know about how serious they are about reducing spending.


rofl

Which of the Bush big government add-ons are you proposing we cut? Medicare-D? No Child Left Behind? Department of Homeland Security?"

I will, I will!

All 3. Medicare - D is an absolute atrocity and giveaway to big Pharma. No Child? Ever talk to an actual educator that is bound by the rules set up there? They are doing nothing anymore but "teaching to the test." Not to mention Bush's refusal to fully fund his own freaking idea. That money could've been spent much more efficiently and actually accomplished some reasonable goals. Homeland security? LOL The fascist name is enough to tell you the brain power surrounding that department. Sure it addressed some issues while leaving huge gaping holes in others all the while enriching campaign contributors.

How about Defense. Its absurd. Seriously. Medicare costs could be cut significantly if anyone had the balls to reign in Pharma.

When you are a single issue voter, you seem to be blinded by the realities.


A remake of February 3rd 1919?

That's the date that the Bolsheviks renounced the debts of Imperial Russia and of the provisional Russian government that existed after the Tsar abdicated but before the Bolsheviks took power.

"...conservative commentators don't remember anything (or at least assume, rightly, that their intended audiences don't remember)."

Those who forget Lenin's actions are doomed to repeat Lenin's actions?


The inherent problem with all

The inherent problem with all of the "starve the beast" arguments is that deficits do not hurt the government.

Rather, they hurt the private economy by forcing up interest rates.

So the starve the beast strategy is really a strategy of cutting off your own nose to spite your face.


"First, unlike private

"First, unlike private borrowers who are constrained by the amount of interest they are willing to pay, the Treasury has no such constraint. It will always pay whatever the market requires, crowding out all private borrowing if necessary."

whoops. what if the interest on the debt becomes greater than revenues? aint that a ponzi scheme?


There is some experience with

There is some experience with this under the states. During the canal building era some of them, particularly some southern states defaulted seriously harming their long term growth prospects. It was one of the reasons the south was slow to industrialize. In the panic of 1893, congress tried to force Cleveland to issue silver by denying Treasury access to the credit markets but he circumvented them through JP Morgan. People think of default as relatively painless, but it merely spreads the pain differently.


Other Conservative "Ideas"

You know Mr. Bartlett, I've been trying hard to resist succumbing to your pessimistic attitude towards the low intellectual state of contemporary "conservatism" and the various contemporary Republican proposals for governing, but, alas, it's getting harder and harder to disagree with you.

The National Review Institute just announced the winner and honorable mentions of their "American Challenges 2010" contest. This is a time of real national difficulty full of profound and urgent challenges. I was eager to see what suggestions would rise to the top.

Here's what won (please excuse the snark in my summaries):

Give states the ability to propose single amendments.

Yes, really.

Honorable mentions:

1. Move tax day to 30-Sept to coincide with the federal fiscal year and avoid illusion "refunds".
2. Medical malpractice / tort-reform for federal health plans (Medicaid, Medicare, VA, etc..)
3. Online college.
4. "Support the family", by replacing federal family programs with a large child tax credit.
5. Inflation-adjust federal benefits every 20 months instead of every year.
6. Reduce the pay and union power of public employees.
7. Constitutional Literacy Tests (And which law professor's version of the meaning of that constitution is going to be the standard)
8. Amend state constitutions to require states to decline unfunded mandates.

Yes, really.

Am I alone in finding these winning entries to be hopelessly trivial? I am frankly astounded by the un-seriousness, insignificance, the limitation in scope, the lack of urgency, the political unrealistic-ness, and the lack of any meaningful probable impact that motivated any of these suggestions.

These feather-weight selections are a disaster in public relations and operate as a libel against thinking conservatives with real ideas. It makes conservatives look like the dumb, substance-less, anti-intellectuals the left already thinks they are. You can already imagine how they're going to react:

"This is the best they could come up with? HA HA! Just what we expected. They're not really serious are they? They're not only incapable of governing, clearly, they don't even really want to. They just want to complain about high-taxes and "online college". Just ignore them. Their 'ideas' are nugatory, and not worthy of serious consideration or respect. Debate would be a waste of time. They are a *joke*. A really funny one we can laugh about when we're among ourselves and don't have to be polite. If you must, unavoidably, engage at all with these simpletons, just try casual dismissal in a condescending tone and disdainful manner, as an elder would correct an annoying brat."

I realize the contest is supposed to be about a "practical step to promote the restoration of the federal government to its constitutional dimensions", and so is going to heavily weighted with federalism issues. But 7 out of the 8 honorable mentions have nothing to do with federalism and are just 'tinkering' suggestions that apply exclusively at the federal level.

It's like these people haven't been around for the last 9 years. You wonder if you have to shout, "Listen up folks! America is facing some *really seriously difficult and urgent issues right now*, you know, in case you have been living in a cave for a decade. These also happen to be precisely the problems that deal with a runaway expansion in the "scope of government" that imperil our welfare and survival as a superpower.

To name a few: Spending and Debt. The explosion of welfare-state costs. The continuing extraordinary intervention in the private sector. Our do-everything but nothing well foreign policy and the war on terror. The bureaucratic and special-interest rent-seeking capture of government policy. The out-right implosion of our social and family structure and unrelenting decline in the inner city.

Our economy is unhealthy, unemployment is high, public and private debt are bloated beyond all sense. Our military, intelligence, and national security capabilities are stretched dangerously thin all across the world while our rivals and enemies outlast our waning determination. 80% of our urban poor are born out of wedlock and are being raised by single mothers, and going to decrepit schools that are all but indifferent to their ability to navigate life's challenges. Defeat of health-care reform was not a victory when our system is still so awful and broken and expensive and we have no apparent alternative ameliorative compromise on the table. We are slowly but surely running out of oil while China is adding tens of millions of vehicles to the global fleet annually, etc, etc.

And where are any of the ideas that address any of these "American Challenges"?

Honorable mentions: Online College. Change tax day. Inflation accounting tricks.

Pathetic... because I know we can do so much better than that.


default on the debt

Dear Sir,

There is another and more fundamental reason why the U.S. cannot default on federal debt. As far as I know, the U.S. is the only country in the world that has an explicit constitutional prohibition of such an action (14th amendment, section 4)


Just like the paper money...

the U.S. is the only country in the world that has an explicit constitutional prohibition of such an action

Well, if you read the Constitution you'll see that only gold and silver are authorized as money -- paper "fiat" money was universally deemed unconstitutional from the Founders on. This was no accident, the Founders had terrible experiences with paper money (both personally and nationally) during the Revolutionary era.

This changed post-Civil War when President Grant needed to use paper money to pay off US bonds issued for gold -- as the US couldn't afford (using politically possible tax rates) to repay with gold as promised. Nevertheless, even then, the Supreme Court upheld the gold payment requirement, deeming payment with paper money unconstitutional.

Then Grant engaged in the first presidential "court packing" exercise, more successfully than FDR would be. He appointed two new justices to the court, they had it immediately re-hear the already decided case, and they reversed the decision. (See the "Legal Tender Cases".)

Thusly the Constitution always bows to hard reality. This is hardly the only provision that's changed in such a way.

BTW, this was *absolutely* a *default* on US bonds under the laws of today, as any change in terms uniltaterally imposed by the borrower on lenders to the lenders' cost is a default. (The lenders took a real hit here.) So the US has already defaulted once. (Then there were the similar events of the 1930s...)

That was after the adoption of the 14th Amendment, yet the US still got out of repaying on the terms it had promised to when borrowing.

If the hard necessity arises for the US to do such a thing again, you can be very sure the courts will equally find a way to deem whatever occurs constitutional.


14th Amendment

Interesting point, but the wording is a little vague: "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."


14th Amendment

I believe this provision is merely a regulation of judicial branch jurisdiction. For "the validity..." to never be "questioned" seems to be an explicit ban on the ability of the judiciary to permit any cases presenting that issue to be heard.

It serves the same purpose as the phrase "shall be deemed" would in a statute - it is an order to the courts that clearly communicates that judges are not empowered with any discretion in these matters.

This section of the 14th amendment was primarily drafted in order to nullify civil-war-era confederate debt, prohibit its honoring by state governments, and to ban the collection of any outstanding claims related to slavery.

The first sentence seems like typical, extra-careful legalism assurance to antsy creditors that the effect of the provision would never be interpreted to cover their loans to the United States incurred during the war while the nation was divided. Article VI of the constitution did the same thing for debts incurred prior to ratification under the old Articles of Confederation.


"...shall not be questioned."

The US govt had just run up a whole lot of debt. The amendment was proposed right after the War (1866), with Section 4 intended to assure all -- including international bond markets -- that the US would not try to aborgate any of its debt. It was ratified in 1868.

In 1870 with the Legal Tender Cases the US govt promptly knocked down the value of the debt it had to repay -- but in doing so never questioned the "validity" of the debt. It's argument was about the "regulation of money", how the valid debt was to be repaid.

Near exactly the same issue came up again in the Gold Clause Cases in the 1930s when FDR ended all gold payments on bonds that the US had promised to repay with gold.

This time the Supreme Court specifically said that as per the 14th Amendment the US Congress cannot pass a law refusing to pay a bond debt. However, as the US was not refusing to pay a bond debt, but was only changing the manner of payment in a regulatory manner, its action didn't violate the amendment and was legally permitted.

(Although the Chief Justice did say that the government's action in reneging on paying its debt in the manner it had explicitly promised, while legal, was "immoral".)


What complete ignorance!

What complete ignorance! Under a fiat monetary system, it's impossible to default on debt unless the government does so for political reasons. Paying off bondholders is a question of simply typing the requisite entry on a keyboard. Moreover, if the government decides put an axe to government spending, that's money that the non-government sector does not get and this "starves" the private economy! The right wing are total nincompoops!

I want to add something else - default may be impossible (unless a political decision is made to do so, not because there's no money available), but the price for creating new money to pay off bondholders and expand the deficit is the price of inflation. However, inflation also depends on aggregate demand. The US, weighed down by the millstone of private debts, the 30-year downward pressure on wages and the FIRE sector, has depressed aggregate demand. They can go into huge deficit and debt and this will barely eat into the deflationary pressures. Japan has a 200% debt to GDP ratio and they still have deflationary problems there. So even this inflation price is overstated.


This reminds me of the 'let 'em fail' arguments

Basically, there seems to be a real will among Republicans for some sort of Ragnarok situation. Most of them seem to be willing to espouse proposals that ensure the utter destruction of the economy they claim to love.

I am continually amazed at the ignorance that thumps its chest as the voice of maturity and principle. I am told repeatedly that I am a hopeless lefty by people who forward all sorts of gossip without checking any facts.

I should be used to it by now. I've been lectured for years about competition by people who stayed in red states and said 'Thanks Dad!' when they got their jobs while I've been busting my hump in truly competitive environments in big cities.


Reynolds has FAR too much influence, debt idea just another...

Glenn Reynold's thinking is often far more screwy than the overly heralded Instapundit site is given credit for.

For example, remove the partisan lens, think about our national security and ethics from a global perspective (the only one that works, since it involves global challenges) and what then does Reynolds merge into?

Re the inane debt default idea, it does seem like Reynold's was just throwing up the question, but it seems like a pretty bad question.

Reynolds says he was just looking for an answer "Bruce, I’m not trying to turn the United States into Zimbabwe. That would be the guy in the White House, whom you seem surprisingly anxious to defend."

But why is he influencing so many people with often highly misleading posts, if he doesn't know the answer to this question, and poses it seriously?

And once again, in his response to you (Bruce), notice the classic knee jerk partisan spin response -- impugning Obama with "turning the U.S. into Zimbabwe"-- that makes Reynolds' site so popular, because it is certainly not his objective command of the subject matter.

I want to support this claim. I don't make it idly. Reynolds is chock full of misinformation. He is a huge supporter of the Tea Party movement, for example, but says he doesn't want to turn the U.S. "into Zimbabwe." What dos he want to turn it into? How large is the disconnect between the rhetoric and the reality here? Yet Reynolds, whose partisan spin and misleading posts often create a similar, if often smaller gap, is a huge national cheerleader for Tea Party politics.

What does that tell us?

Why are people being mislead by Reynold's "Insta B. S." site. Why is he being treated as some sort of credible voice, or authority? He's not. He's a blindingly partisan zealot, and he does as much to add to the incredible amount of misinformation out there in America today, as anybody.


Overdrafts

Bruce usually knows far more about what he is talking about than I do. So I usually don't comment on what he says.
But I know he's wrong on one thing. The Federal Reserve cannot allow an overdraft on the Treasury. It is prohibited from extending direct credit to the Treasury, although it is perfectly free to buy Treasury debt on the open market. This is not only the law: it has been deeply embedded in the Fed's DNA since the 1951 Accord with Treasury.


Fed

Actually, I think there is precedent for the Fed giving the Treasury some float to pay Social Security benefits when the debt limit hadn't been increased in a timely manner. Anyway, I was positing an extreme situation of the sort we saw in late 2008 when the rulebook goes out the window.


It's similar to allowing inflation

A similar result to defaulting on the National Debt would be accomplished by allowing inflation, without the fiscal Armageddon.
I can see a positive side to some inflation, the Chinese debt becomes devalued. If they won't revalue their currency eventually the rest of the world's currency will have to lose value. The National Debt would be relatively less
The hit on people's savings would not be good. Social Security would be the best way to protect yourself, if Republicans haven't privatized it


Inflation

Inflation doesn't do much to reduce the burden of the debt when so much of it consists of Treasury bills. Interest rates will rise very rapidly to compensate for the inflation, thus increasing spending for interest payments, which will have to be borrowed leaving the real value of the debt relatively unchanged.


The problem with

The problem with hyperinflation situations like Zimbabwe is not about debt, is not about printing money, it's about a crash in supply. Zimbabwe's hard currency-earning tobacco-export sector was damaged by the chaotic land reform, and this followed years of IMF austerity and this was compounded with the financial sanctions imposed over the land reform. The damage caused to the ability of the economy to supply caused the problem. In Germany, their problem happened when the French grabbed a major industrial part of Germany - they shut down the production there but the workers continued to be paid. So as long as the federal government does not order the shutting down of a large part of the economy whilst continuing to pay people as if they hadn't, hyperinflation is not a possibility nor should it be suggested.


glenn reynolds

GR is just a guy that arrived at the beach early and so got a good space for his blanket. For a while he was one of the first political blogs out there, but that is his only qualification. There is no reason to read him anymore, just like there is no reason to use a Commador 64 anymore.


*DING DING DING* You are

*DING DING DING*

You are correct, sir.


Eesh

Shame, shame. Glenn posed the question. He neither advocated for nor against defaulting on the debt.

You should know better.


interest rates

"Interest rates will rise very rapidly to compensate for the inflation."

The dreaded inflation occurs at or near full employment. Currently, we have a situation of massively underutilized resources and concomitant deflationary pressure. The fed has 'inflated' its balance sheet immensely, and the resultant flood of money has not led to inflation. Furthermore, interest rates continue to be at or near historic lows.

Inflation hawks continue to insist that recovery from financial folly come at the expense of those at the lower end of the income scale....an assertion that turns the concept of responsibility on its head. Garbage collectors, plumbers, janitors, etc., did not cause the mess we are in, yet somehow having a large percentage of them go unemployed for a while, lest we have inflation, strikes some as the appropriate price for our society to pay.

I respectfully disagree in the strongest possible terms.


Bruce (and/or anyone), I am

Bruce (and/or anyone),

I am certainly strongly opposed to the idea of defaulting on our debt or getting anywhere close to the point at which markets consider that a substantial risk, but if you can spare the time for it, please help me understand a few things. The following questions are based on theoretical scenarios that I realize are probably not realistic, and the questions are not at all rhetorical – I’m just seeking a better understanding of your points and of this question.

1) Are you asserting that we could indeed default on the debt (i.e., any necessary changes to laws and other decisions could be made), but that those who could block default certainly would not decide to do so, either because default could not ever possibly be the least bad among bad options or because they would take other remedial action before we reached the point at which default became the least bad among bad options? And your #2 in your post and Stan’s related post seem to boil down to “Yes, we could, but we wouldn’t”, correct? For example, we could change the law to revoke the primary claim of bond-holders on tax revenues.

2) If the answer to the “could” question is “yes”, and if the federal government did default and ceased borrowing (i.e., ran balanced budgets), why would interest rates in the private sector necessarily “skyrocket”? The federal government will, I assume, have destroyed its credit rating and I assume would thus either be literally unable to borrow or would have to pay high interest rates, but the credit ratings of borrowers in the private sector would not have been damaged (correct?). Assuming we have defaulted rather than monetized the debt (the latter of which would causing great and I assume also somewhat unpredictable levels of inflation), why would real or even nominal interest rates in the private sector necessarily “skyrocket”? Why would federal default necessariliy dramatically drive up either repayment risk of private debtors or inflation risk or currency (exchange rate) risk, or am I missing a factor in the determination of interest rates, such as the losses creditors will have experienced on the Treasury debt they had held or the reduction in total available debt capital if taxes are increased (rather than the budget balance entirely by spending cuts), or something else?

3) Would the direct effect of default be significantly deflationary, since dollar-denominated assets would become worthless? If so, could the Fed simply offset that somehow (by “printing money” in ways other than buying Treasuries; I guess just by crediting reserves at banks or lowering the discount rate, but I only have superficial knowledge of the Fed’s tools)?

4) Re: “given the Fed’s vast holdings of Treasury securities, with which it conducts open market operations, any rise in interest rates will necessarily increase the Fed’s income enormously”, wouldn’t the Fed’s bonds, along with those other creditors, be voided via default, assuming we are talking about outright default and not a restructuring of the debt.

5) If the answers are that federal debt default would NOT cause private sector interest rates to rise dramatically and would NOT spark disruptive inflation, would the following be harms and would be the only harms (and by “only” I certainly don’t mean to belittle them)…

(A) the inability (or high cost) of any subsequent borrowing by the federal government – and thus lesser ability to make worthwhile investments, address a crisis (e.g., go to war amid a legitimate threat), combat future recessions via fiscal stimulus or even automatic stabilizers (which, among other drawbacks, would leave us more vulnerable to the “paradox of thrift” and downward spiral).

(B) loss of private net worth of bondholders (a harm in itself) and a suddenly balanced budget shocking the economy into recession/depression (and causing many great hardship both as a direct result of spending cuts and tax increases and as a result of recession).

(C) Harm to our international relations and potential retaliation, such as reciprocity (voiding bonds of other nations that are held by our federal, state, and local governments and private American entities), withdrawal of cooperation on foreign policy, erection of trade barriers, etc.

(D) Loss of efficiency in debt markets (and more broadly capital markets) due to the loss of a “risk-free” benchmark (if it were still considered “risk-free” immediately prior to the default, which I realize is unrealistic).


What's already happened is probably possible.

The Treasury can never default on the debt; it’s simply impossible.

This is just flat wrong. Words have meanings. "Default" occurs at law when a party fails to pay its debt obligations by the terms agreed upon when borrowing -- including when not repudiating debt outright but instead unilaterally imposing new terms to the detriment of the lender and more generous to oneself.

Not only is it possible for the US govt to do this but it already has done it. Post-Civil War, President Grant "packed" the Supreme Court to get it to reverse its prior decisions and all prior constitutional precedent, to hold the US could break its sovereign promise and pay back its gold-denominated borrowings with greenbacks of much less real value, because it couldn't afford to pay in gold.

As default goes, that was no different than Russia and Argentina solemnly promising to pay their obligations denominated in dollars when due and then, when the due date came, deciding otherwise, to pay less/later. Saying that something is "simply impossible" when it's already happened is .. well, mistaken.

And of course it could happen again -- Congress could unilaterally change the terms of its borrowings to its lenders' detriment, as it has in the past, with the courts upholding the change, as they have in the past.

The fact that you may believe it is very unlikely to happen in the nearish future in no way, shape or form makes it "simply impossible" to happen. And -- being that the issue is not the nearish future but 20+ years from now (when S&P project the credit rating of the US to be "junk", unless income tax rates increase 50% or some revenue equivalent) -- it is frankly totally specious.

First, unlike private borrowers who are constrained by the amount of interest they are willing to pay, the Treasury has no such constraint. It will always pay whatever the market requires, crowding out all private borrowing if necessary.

Bunk. Long before then the damage to the economy would be so great the politicians would bail from the pain. If governments could borrow and tax without end, what government would ever default? And yet they do! By the scores, even in recent decades.

long before we ever came even remotely close to a situation in which markets even suspected the possibility of default we would have economic conditions that would guarantee some sort of massive fiscal tightening

Sure: market turmoil and rising interest rates assured Russia wouldn't default, Mexcico wouldn't default, Argentina wouldn't default each and every time, etc. etc, ( I could make a pretty long list).

Alas, your "long before becoming even remotely close " is factually wrong. Reinhart & Rogoff impressively document that the excessive debt that leads to default typically is built up during a bubble period of "it can't happen here -- we're different!", which then bursts suddenly. Then it's too late. There is no long period in which to adjust. (Perhaps we've recently become more familiar with the concept of bubbles bursting suddenly? )

It should be self-evident that there typically is no long period of gradually rising pain that automatically drives remedial fiscal tightening before defaults occur -- or the defaults wouldn't occur!

But hey, don't worry about it, it can't happen here, it's impossible, we're different. ;-)

The US had well over $60 trillion of accrued liabilities, and rising about $3 trillion a year, before the recession and all the debt additions that have followed. (The S&P projection of the US being headed to a "junk" credit rating by 2027 was pre-recession too). Starting circa 2020 all that starts becoming explicit debt owed to the public in a big way.

Oh, but that's only the start! Because as R&R document, when the "it can't happen here bubble" bursts, over-indebted governments typically massively expand their liabilities immediately to pick up great amounts of "hidden", "implicitly guaranteed" debt that was previously kept off the books. (Think of the GSEs, General Motors....) No time to adjust -- it is a *shock* event.

And what happens when a govt owes debt service beyond what it is politically capable of financing through tax collecions? Look to the Russians, or Argentines, or President Grant of the USA. It re-writes its debt obligations to owe less. Default.

We can work to be sure it won't happen here. But the historical record is very clear that saying it can't happen here, it is "impossible" to happen here, only increases the risk that it will. People are foolish enough to believe it, and then you get your bubble.

(BTW, as long as the govt continues to run deficits and thus needs to roll over its debt, contrary to popular mythology, inflation is no way out.)


We are their debtors

One of the most obvious problems with defaulting on the debt, even if the technical aspects were overcome, is that most of the debt is owned by Americans.

I personally have Federal savings bonds as part of my portfolio. Retirement funds regularly invest in US savings bonds. Banks hold many Federal debt obligations. Should the government default on its debt, banks would be in serious danger of failing, and the US government would be in no shape to rescue them.

The main power of US Savings Bonds is that they are the most safe investments imaginable. Pulling the plug on this would mean that the US government would never be able to borrow again, at least not without paying punitive interest rates. Right-wingers may pretend to hate the government, but they love DoD. How do they expect us to fight a war without money?

Republicans dream of a day without government. They are able to tap into the people's loathing of paying taxes, but they cannot convince people that we don't need the myriad of public services they provide. Instead, they go on this dangerous myth that if they spend without revenues, some day the people will wake up and demand their bankrupt state goes away.

Everyone wants a free lunch, no one likes paying the bill, but given the choice of eating or starving, people will always opt for buying lunch.


GLENN REYNOLDS, JUST ASKING QUESTIONS

Like the birthers when they don't feel like defending
the indefensible: "hey we're just asking the hard
questions" or "just throwing it out there to get at
the hard truth".

IMO, the real message behind this is, I can say
just about anything and get away with it.

Reynolds is an impressive guy when you hear him speak.
You would never figure him as anything but a lawyer.
He frequently teams up with Michelle Malkin and still
is taken seriously. Both are very effective liars-4-hire.
Both have signed on to do what they are told regardless
of where it leads. There is no going back for these
two even if they wanted to.


Reply

It's more complex than that. I think bloggers learn very quickly which of their posts get a positive response in terms of hits, links, number of comments, positive v. negative comments, and so on. Whether consciously or not they tend over time to stay away from ideas that get no hits and engender negative comments. That's what I think has happened to Glenn. Since he is probably paid very well for his gig and his pay is probably related to the number of hits he gets, this just reinforces the tendencies I have noted. Better to pander to your core audience than try to lead them in a direction they haven't already decided to go. Once they have decided to go in a different direction, run as fast as you can to get in front of them and appear to be a leader. It's a pathetic but nevertheless successful strategy, monetarily.


A different question

I didn't think the question was whether or not the U.S. could default on its debt, but rather whether defaulting on the debt would force the U.S. to "live within its means" because no one would lend to sub-prime, low FICO America any longer, or would only lend at terms so draconian, that the government couldn't borrow. I'm going to guess that the answer is no, defaulting on the debt would not have the benefit of forcing congress to pass a balanced budget. The consequences of defaulting on the debt appear to be serious, any benefits meager, and those benefits do not include a forced balanced budget.


Treasury default and the Fed

The government certainly can default on the debt. It certainly wouldn't do it any time soon, but if debt/gdp got to 150 or 200% or more, it's a possibility (albeit very unlikely). Somebody (I don't remember who) said countries don't go bankrupt. In virtuallly every case where there has been a sovereign default, it has been a voluntary choice. Basically, the nation decides to default because the costs of default are less than the costs of extreme fiscal tightening and/or the inflation or hyperinflation that would come with monetizing the debt. Sovereign default is most attractive when all of the debt is held by foreigners, because most of the immediate costs can be exported. However, when nations choose to default, the consequences can be severe. Most people don't recall that Newfoundland was an independent country before it ran up enormous debts during the depression and was taken over by Great Britain and ultimately ceded to Canada.

The US probably wouldn't choose default for a couple of reasons. First, most of our debt is held by domestic entities, like financial institutions that hold treasuries as their safe asset. A default would precipitate a financial crisis much worse than the recent unpleasantness. Second, foreign governments would likely sieze private US financial assets, creating crippling losses for US multinationals and investors.

Your argument that interest rates would rise signalling the need for fiscal tightening is an optimistic view. There are several models where interest rates on the debt stay low for a long time and then overnight soar to astronomical heights. Government borrowing may even become impossible. At that point, we'd have a serious solvency problem as we have no way of repaying government debt when it comes due without additional borrowing. (That's true even now.) I think you're right that the Fed would likely come to the rescue, but the consequences of monetizing the debt are nearly as severe as default. Extreme inflation, or hyperinflation, is tantamount to a partial default, and it devalues all dollar-denominated assets, not just government securities. Reinhart and Rogoff, in their book, This Time is Different, report that the average price level after a debt crisis is 9000% of the price level before the crisis. That is, when the dust settles, a dollar is worth about a penny.

Since everyone would want to avoid such an outcome, the most likely result is probably some kind of debt workout agreement with our major foreign lenders. (The answer to the question, "When does the US get a VAT?" may be "when the Chinese make us do it as a condition of further lending.") However, if our debt gets very large before this happens, it would not be a happy outcome since the extreme level of fiscal tightening required to go from a large primary deficit to a substantial primary surplus (large enough to repay our lenders) would likely plunge us into a deep and prolonged recession or depression.

I call the horrible set of options we might face if we don't get our budget under control "catastrophic budget failure" and do not believe it to be hyperbole. It's not a future that either a conservative or liberal should relish, as it would mean confiscatory taxes (even from a lefty perspective), an eviscerated government, and a wrecked economy. I suppose Grover Norquist could celebrate that government would finally be small enough to drown in the bathtub, but the private sector would go down the drain along with it.

A final note: one doesn't have to look far to find an example of the Fed buying treasury securities. At one point during the Great Recession, the Fed was holding two months worth of federal borrowing because they didn't want interest rates to rise as a result of the giant deficits the government was running to try to stimulate the economy. (See Wessel, In Fed we Trust.)

Cheers,

Len




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