StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Debt Default: It Can Happen Here

14 Jun 2010
Posted by Bruce Bartlett
The recent financial crisis in Greece has led to a lot of discussion about whether the United States might one day have a public debt so large that default becomes a real possibility. While the sort of problem Greece is experiencing is impossible here, we have another problem that, to my knowledge, no other nation on Earth has: a legal limit on government debt that Congress must raise periodically. This peculiarity of our fiscal system could indeed lead to a default on the debt, with repercussions that advocates of default — yes, they exist — have absolutely no clue about.
The main reason the U.S. cannot suffer the sort of debt problems of Greece and other eurozone countries is that all our debt is denominated in dollars, of which we essentially have an unlimited supply. Because its monetary policy is controlled by the European Central Bank, Greece can’t just print euros the way we can print dollars. And the Federal Reserve will always ensure the success of a Treasury bond auction. De facto monetization of the debt could be inflationary, but default resulting from a lack of demand for Treasury bonds is not really possible.
This does not mean that default is impossible, however, because there is always a danger that Congress will not raise the debt ceiling in a timely manner, meaning that the Treasury may not have sufficient cash to make interest payments or redeem maturing securities. If that happens, there would be a technical default.
As of right now, outstanding debt subject to limit is a little over $13 trillion and the debt limit is $14.3 trillion. At the rate the Treasury is borrowing, it can continue for about 10 months before the debt limit must be raised again. It has been difficult enough, politically, to raise the debt limit when Democrats control both houses of Congress. But next year there is almost certain to be a very substantial increase in the number of Republicans in both the House and Senate, with Republican control of the House being well within the realm of possibility.
The party opposite the White House always demagogues increases in the debt limit to score cheap political points. Economist Donald Marron calls the vote on raising the debt limit a tax on the party in power. Barack Obama knows this very well. As a U.S. senator he voted against a debt limit increase in 2006, saying that the necessity of raising the limit was “a sign of leadership failure.”
To be sure, the debt limit has always been raised in time to prevent a default, although Treasury sometimes had to push the limits of the law to move money around to pay the government’s bills. However, I believe the game has changed because Republicans have become extremely bold in using the filibuster to make it extraordinarily difficult to pass any major legislation without at least 60 votes in the Senate.
Furthermore, a growing number of conservatives have suggested that default on the debt wouldn’t be such a bad thing. It is often said that default would lead to an instantaneous balanced budget because no one would lend to the U.S. government ever again. Therefore, spending would have to be cut to the level of current revenues.
Writing in Forbes last month, the Cato Institute’s John Tamny was enthusiastic about the prospects of default. Said Tamny, “It’s time we learn to love the idea of a U.S. default . . . For Americans to worry about a debt default is like the parent of a heroin addict fearing that his dealers will cease feeding the addiction.”
While acknowledging there might be some pain from default, he dismissed it as trivial compared to the enormous blessing of a massive reduction in federal spending.
Tamny is not an isolated crackpot; reputable conservative economists have been writing sympathetically about the idea of default for decades. These include Nobel Prize-winning economist James M. Buchanan, whose 1987 essay, “The Ethics of Debt Default,” defended the morality of default on the grounds that deficits weren’t financing public capital but current consumption, with the bills being passed on to future generations.
Other prominent conservatives who have been favorable, even enthusiastic, about debt default include Murray RothbardDan PillaJeffrey Rogers Hummel, and Christopher Whalen. In 1995, then House speaker Newt Gingrich publicly warned the Public Securities Association that he was prepared to default on the debt unless Bill Clinton acceded to Republican demands for budget cuts. “I don’t care what the price is,” Gingrich said.
Consequently, it is becoming increasingly common for the idea of default to be discussed as a realistic possibility even by responsible analysts. Last year, The Economist’s Greg Ip wrote an article in the Washington Post saying that financial markets were placing the risk of default at 6 percent over the next 10 years. “Default is unlikely,” he said. “But it is no longer unthinkable.”
My purpose today is not to make the case against default or explain all of its ramifications — that would require a separate column. Rather, my purpose is simply to alert readers to the consequences of increased Republican membership in the next Congress, a Democratic administration, the need for 60 votes in the Senate on major bills, and a debt limit that will run out early next year. I believe we could be in for the biggest debt crisis we have seen since Alexander Hamilton was Treasury secretary.
One way of forestalling such a crisis would be for Congress to require that bills breaching the budget resolution’s revenue floor or spending caps — those designated as “emergency” legislation — would have to include an increase in the debt limit equal to the increase in the deficit. This won’t eliminate the need to raise the debt limit eventually, but it would at least put members of Congress on record as accepting the consequences of deficit spending, rather than trying to have it both ways — voting for deficits but then scoring political points by voting against an increase in the debt limit.
Cross posted from The Fiscal Times.
David Henderson takes a bit of a cheap shot here. Apparently, he is unaware of the concept of space limitations and believes that every ramification of every issue can fit into 1,000 words. I will get to the absurdity of the debt default position in due course. My purpose here was simply to document that there is a growing body of foolish conservative thought that advocates default. In the future I will be sure to include David among its supporters.

A few corrections

You are wrong in saying that the US can't default because it can print its currency. There are many examples of countries that have defaulted in local currency they controlled. Jamaica is the most recent, but there are others.

Many countries have debt issuance that is limited by Congress and so subject to "approval risk". Usually that's done as part of the budget.

But you are correct that a politically motivated default is not beyond reason.

When has monetization NOT been inflationary?

"De facto monetization of the debt could be inflationary"

I would like to see historical examples of debt monetization that has NOT been inflationary.

Are you sure that we don't

Are you sure that we don't have inflation and deflation simultaneously?

Right now is a fiat inflationary period

I think you need to distinguish what you mean by inflationary.

There are at least eight different kinds of inflation/deflation that need to be distinguished to understand what is going on. Seven important ones right now are productivity driven price deflation, population driven price deflation, currency adoption deflation, sovereign debt accumulation deflation, fiat deflation, fractional reserve deflation, and government reduction driven deflation. All these have their inflationary counterparts, and I only listed the deflationary side even when we are currently experiencing the opposite (for example government spending is going up which is inflationary).

Several forms of deflation are good. For example, productivity driven price deflation is always good. We are experiencing that now, however it can be counter balanced by bad types of inflation. For example, the government could consume all the benefits derived from productivity deflation merely by keeping prices stable via fiat inflation. It's no different than if a counterfeiter were to buy up all the additional product created by the productivity increases with phony money. Such fiat based consumption is bad because it prevents the restructuring of the economy to take the new productivity into account.

The major deflationary factors right now are 1) Fractional reserve deflation (caused by the exposure and collapse of the temporal pyramid scheme based on mismatched maturities between savers and borrowers. 2) Productivity increases driven by the opening of third world countries to trade 3) Increasing sovereign debt of the US pushing inflation into the future. This has been abetted by China's accumulation of US notes.

Of the above only 3) is bad.

The main inflationary force right now is fiat inflation, which is bad, and sovereign debt accumulation inflation, bad, and government spending inflation, bad. Even if prices continued to decline very slowly, or stablized that would be bad if the reason they were not dropping was because of an accumulation of sovereign debt (like Japan), or immediate fiat inflation. Price "stability" accomplished in this fashion robs the private sector of it's property to feed the gaping maw of government waste, and often consumes the real capital that would otherwise sustain us in the future.

The fact that the social security trust fund has not been used to actually purchase real capital assets means that there is going to be no actual capital structure backing payments in the future and so it will have to be monetized (or the capital of others taxed to pay the false promises of the government). This ponzi scheme has resulted in a reduction of interest rates in the present and driven (productivity reduction driven) inflation into the future by causing a reduction in productivity in the future in relation to what it would have been otherwise.

Price deflation/inflation is always the tail of the dog and not the dog itself. All of these other forces have effects that are not uniform over all prices. A single category can have an inflationary price effect in one sector while being deflationary in another, and the temporal impact can be spread differently in both cases. Sovereign debt can be increased by buying junk assets at bubble prices to exert an inflationary force on those assets immediately while at the same time pushing inflation on other prices into the future. The government could sell assets in one class to raise money to buy in another to get immediate deflation in the one and inflation in the other.

The point InSearchOfHistoricalEvidence was making is that debt monetization is always an inflationary factor all other things being equal. It is always bad because it is in fact stealing from the governments creditors, and also has the effect of allowing all borrowers who have loans denominated in the currency to steal from their creditors. On top of that is steals the savings of people who haven't even lent out their money to anyone via price inflation.

Even someone who has not invested their money deserves any increased purchasing power of their holdings of currency due to productivity driven price deflation. That is because it is their delay in consumption that allows the excess goods they produced to be used by others to drive up productivity. After all the money in their mattress was accumulated by creating goods that others needed and postponing consumption. Those goods were then available as capital goods within the market, and are purchasable by entrepreneurs via the price deflation the excess goods cause (even without the saver lending out the funds).

Short term we are going to have deflation because of the fractional reserve deleveraging. Using it's current strategy the government is going to have to print more and more money to pay.

Any attempts by the government to bail out institutions and prop up prices merely changes who the losers are, since the damage to the economy was already done during the boom phase of the fractional reserve monetary inflation. It pushes the bad consequences of bad actions from those who deserve those consequences onto those who do not. Furthermore, it pushes the economy further into an imbalanced structuring by rewarding that same bad behavior, and setting current and future incentives in the wrong direction.

Holy Mackeral, what a great

Holy Mackeral, what a great post! Where's your blog? Start one immediately. Right now.

Thanks but I don't have time

Thanks but I don't have time to manage a blog and keep people interested. I do comment under my real name at other blogs on various topics. I do so sporadically. Since you liked this particular topic you might be interested in some conversations I had on fractional reserve banking over at Samizdata. There were actually one, or two conversation on the topic that you might be interested in. Search for my name at the link and then you will first have to read the comment I was responding to to pick things up.

I generally don't proofread because I am lazy. I noticed that some of those comments have "can insure fraud" when I meant "can't insure fraud".

Another default alternative

The government does have another alternative to default, simply slowing operations so that they do not exceed income.

You posit a world where the Congress has said, spend X, tax Y, and don't go into debt more than Z. When Z has hit its limits and X is greater than Y, the executive cannot avoid breaking the law. The only question is which law. You assume that X is inviolate and Z will be breached by promised money that will not come. But what if it is Z that is inviolate and what is broken is X? It would be instant austerity until Z is raised once more. So long as there are 41 votes to keep it unraised, the painful measures we take will not include breaking our word that the US pays its debts.

Much foolish analysis rests on the simple error that in a situation with multiple variables, one or more variables are falsely held to be constants. X, Y, and Z are *all* variables and nothing is predetermined about which one is going give when we hit that moment of supreme irresponsibility and public policy folly when our contradictory laws hit their moment of truth.

Hmmm, default on the one hand massive inflation on the other

So what you are saying is that those nasty republicans are going to default while those nasty democrats are going to raise interest rates to disastrous levels by monetizing the debt (what makes you think China is going to continue to lend to us if we do that in the first place? and what makes you think China would accept either option peacefully...).

Hmm, if those are my choices, I go with default. At least its a sudden shot to the head and not a slow bleed over many decades. I'd rather take the lumps now than have my two year old son suffer for my sins.

As a call to action to warn people about the conservative monster, this is not a strong argument.

Better for the government to

Better for the government to default than for it to destroy the savings of the people via inflation. People need to break out of this "government ueber alles" thinking.

Debt Default

Debt default is scary stuff despite arguments in favor like those of John Tamny which are pretty reasonable but where will this lead us? I say this probably will not happen because if I understand it right, we can always print some money (with dire consequences of course) unlike Greece who couldn't do it because of the euro thing. Well, I will leave this problem to experts like the author of this excellent article who should be on President Obama's cabinet especially so he won't try to solve this problem just to score political points.

Evelyn Guzman (If you want to visit, just click but if it doesn’t work, copy and paste it onto your browser.)

Perfect Start For Spring 2011

A great way to kick off the 2012 campaign season. The GOP runs ads quoting Obama and then asking - Go ahead Barack, admit you're policies are failures. Support sanity in spending.

The GOP can block the debt ceiling increase since they should have a workable number in the Senate meaning they can gather enough votes even if they have a few RHINO running over to Obama.

Getting out of debt by creating more wealth

Government is the problem, free enterprise is the solution;
The necessary and sufficient action by the government is to
away with _all_ the bureaucratic restraints on the creation
of new wealth, starting with the deliberate delays in the
building of nuclear power plants, as the classic example.

This is a drastic defense against an existential threat;
If the world goes through a 2nd Great Depression, the US
will come out of it with an authoritarian government.

Perfect Start For Spring

Perfect Start For Spring 2011
A great way to kick off the 2012 campaign season. The GOP runs ads quoting Obama and then asking - Go ahead Barack, admit you're policies are failures. Support sanity in spending.

What policies? The next budget will essentially be GWB's budget. There have been no large-scale unpaid continuing programs under Obama so far. IT IS BUSH who is responsible for the structural deficit we now have. Let the GOP start suggesting cuts. Oh wait, that would require them to act like adults. They showed their true colors when Judd Gregg and others wouldn't sign on to their own suggested idea of a bi-partisan group to attack the deficit.

Here is the first cut: a

Here is the first cut: a rollback to the 2004 budget (including federal salaries), adjust for population and inflation, then start eliminating worthless spending such as farm subsidies and the dept. of education, pbs, npr, nea and eliminate the Davis Bacon Act and civil service employees unions. Scale back their pensions to the average of their base pay for the last 15 year average of their career without overtime, sick days, vacation days and personal days and pay them starting age 65. Just with that alone the budget is nearly balanced. And there is plenty more to cut that never should have been funded to begin with.

The estimates I hvae seen on

The estimates I hvae seen on the magnitude of the sturctural deficit are $400 billion - $700 billion. I can imagine that pbs, nea elimination will be huge, maybe $500 million. The GOP will eliminate farm subsidies over their dead bodies (even tea party hero Michele Bachman feeds off this trough).

By the way, I live in Maryland, where we pay much more than we get back in federal taxes, so I'm all for cutting much of the spending. Southern states get a disproportionate amouint of education aid. Cut it all, let them fall further behind then they are now. Ther SAT/ACT scores are already so far below national average its stunning. After all, school spending can be cut drastically with no loss of performance.

Since drastically increasing

Since drastically increasing education spending doesn't correlate with improved performance, I don't think we can assume that drastically cutting education spending will correlate with decreased performance.

Cutting and Decrease

I agree with this comment. We should see more common sense approaches to cutting consequences. Decrease of competitivity it's not geometric consequence of educational cuttings . CASINO

Spare us the canard about we

Spare us the canard about we paying more to the feds that we get back. There ain't no we, it's only me as in the individual net taxpayer, not the state of Maryland collectively. The State Of Maryland does not pay income taxes to the feds nor does it collect them for the feds. Your argument might have made some sense if this country was still governed under the Articles Of Confederation but that is not the case today. Furthermore as for the disproportionate taxes using your logic Florida and Texas by virtue of not taxing income are getting massively ripped off since those state's citizens have no state income tax to deduct from their federal taxes.In short they are subsidizing the democrat parasite states. The only disproportionate amount of federal spending in the Southern States (and in the Western States) is military spending since there is more federal land available for bases and a more accepting of the military culture in those states. However national defense is a core national requirement. Union subsidies, farm subsidies and the 'entitlement programs' are not. Now as for the federal income taxes collected in Maryland it's a disproportionately small percentage of the state's population that pays them and if polled most of those payers would poll anything but leftist and would rather keep more of their money than subsidizing parasites. It's not for nothing the more states that raise their income taxes the more they lose net taxpayers to lower tax states.

Maybe $500 million might be pocket change to you, but in the real world it's real money and in a $2 trillion dollar deficit there is no justification whatsoever for this spending. Since the creation of the dept. of education the public schools have gotten worse than they were before the the creation of the dept. there is no reason to keep propping up the NEA which appears the primary purpose of the dept. Please tell us just how wonderful the the public school systems of LA, Baltimore, Detroit, Chicago, Boston and other large northern school systems are. As for farm subsidies, the time has come. Enough TEA party people get elected and that too will be up for discussion. At this level of debt there are no sacred cows.

Spare me

Residents of states that have sales tax but no income tax (like mine, South Dakota) are allowed to deduct sales tax off their federal income taxes. Western states also have a lot of spending coming in from things like the National Park Service and Bureau of Land Management(because, shocker, a huge amount of western lands are tied up in national parks, BLM lands, Bureau of Reclamation projects that provide a steady stream of water for farmers and ranchers, etc.)

$500 million ain't pocket change, sure. But it's a drop in the bucket compared to the $300B deficits we were running up *before* the financial crisis. And that was the budgeted deficit; your boy Bush put all of the Iraq and Afghanistan war costs off budget.

And the 2 biggest entitlement programs? That would be Medicare and Social Security, which many of the tea partiers view as sacrosanct (because they're drawing on those programs). Even your hero Rand Paul says Medicare payments to doctors should be exempt from budget cuts (um, maybe because his practice gets a lot of revenue from Medicare?)

Bruce has addressed earlier the completely ludicrous way the Republicans funded Medicare Part D as well: No designated source of revenue, all of it put on the national credit card.

Spare us your leftist canards

Spare us your leftist canards as well. Sales taxes are deductible no matter what state. Other than business few people ever deduct them since most are fairly small transactions and in any event no one spends every last dollar of income on sales taxable items so even if you did deduct them the net effect is minimal to that of the state income tax deduction to the federal treasury.

As for medicare part D, your are correct. Bush and the republicans should have never implemented it to begin with, but what excuse do the democrats who voted for it have?

As for social security,it's a fraud from the jump, worse than Madoff. It should frozen, limited to those already collecting and those 50 and over for who its too late to start saving. Everyone else should have it privatized, given a tax credit for all of their 'contributions' and rolled into a private social security type annuity/savings plan that does not allow for early withdrawal prior to retirement. Again, the same for medicare. By the way those programs are funded with payroll taxes and even though they are already in a deficit (so much for the fraudulent 'lock box' (a scheme that if any business were to pull everyone involved would be facing massive prison time and rightfully so), the amount of borrowing to cover the social security deficit this year is loose change compared to all the money the democrat-communist have spent this year alone on utter junk. By the way the only reason medicare reimbursements to doctors hasn't been further cut isn't due to hypocrisy from republicans its due to the fact even the leftist idiot democrats know doctors are already dropping medicare for new patients and any further cuts and a majority of doctors will drop medicare altogether. Doctors are funny that way, they don't appreciate losing money. A mass defection from medicare under the democrats watch and the result will be the end of the democrats as a national party and the democrats know this.

Western States get pocket change from the BLM in comparison to the tax revenue they would get if the federal government didn't own so much of the west.

The war: perhaps you may have missed the news: the US was attacked on 9/11 and the enemy has not as yet been defeated. That is more important than spending money on unneeded and way overpaid and compensated bureaucrats and union subsidies and parasites. As for western irrigation, those states should pay the cost of the water (the actual users). Besides ever consider what the world would be like if Saddam was alive and in power? An Iraq under Saddam with nuclear weapons would be able to again have taken Kuwait and the Emirates and probably Saudi Arabia and if you think gas prices are high now and the economy bad, our situation would look golden compared to that. In the meantime these communist fools are on the verge of passing cap and trade, another massive fraud that has no scientific validity and will further damage the economy and add an even larger burden on the taxpayers.

Ever consider just how many net taxpayers it takes to 'contribute' $500 million in income taxes? Just think, all of those people worked and earned to pay taxes for nothing of importance. At the heart of the matter it is this fundamental lack of respect to the taxpayers that is the root of this country's fiscal problems along with the mindset that taxpayers are merely beasts of burden who exist solely to provide for others. Your problems are not my obligations (and vice-versa) and democrats have as yet not understood the differences between charity and compulsion and investment and expenses.


I believe that the law allows people deduct either state income taxes or sales taxes, whichever is higher. In practice, this affects only states that have no income tax. 

One Alternative

One word: seignorage. Currency is not counted toward the U.S. Debt. The president could order the Mint to strike off a special $1 Trillion dollar coin, and then deliver it to the Fed for deposit in the Treasury account. This would not require any change in law or even notification to congress.

Too cute.


It's a neat trick, but a

It's a neat trick, but a trick all the same. Printing money to technically avoid a default is simply devaluing the currency and hence the wealth of the nation. If one wants to create an Argentina of the North that would be the sure fire way of doing so. However most people won't stand still for getting robbed this way and to the extent they can will demand payment in other currencies other than a debauched dollar. First stop of this train is Argentina and the next stop is Zimbabwe. Just because today we are fortunate that all of our international debt is denominated in our currency does not mean that that will hold true in the future and what the government is presently doing brings us a lot closer to the day of reckoning when foreigners will not accept dollars. The Euro is dropping like a stone as Europeans dump the Euro and are buying Canadian, Australian and American dollars. But unlike Canada and Australia that have relatively strong economies and are fiscally sound we are getting foreign funds simply because for the moment we look less bad than the Euro. But sooner or later and probably sooner than later those funds will go elsewhere and then the treasuries funds and games will start.

Part of the problem with Argentina... they insisted on maintaining a currency peg to the US dollar (they didn't go to full dollarization like Ecuador and Panama did, though they did consider it). That actually helped them get inflation down to reasonable levels because it enforced budget discipline. At least, until spending by their states started eating a hole in the budget.

They still might have been able to get away with limited damage by devaluing early (but they didn't want to do that as many Argentines had taken out loans in dollars, but were paying them in pesos as a result of the currency peg) and actually listening to some of their *bondholders* who were saying the Argentines needed to tell them to take a haircut on the bonds.

Great book, if dry in places:

Sure, it's a trick, but it's

Sure, it's a trick, but it's a trick to get around an absurd technical requirement, and it is not, in and of itself, inflationary. Simply changing some numbers on the Government's books don't effect the real economy at all.

Like I said, the Trillion Dollar Coin is simply a way to get around existing law, which prohibits Treasury overdrafts and requires all spending to be "paid for". A proper understanding of our modern monetary system shows this to be an absurdity, a holdover from the gold standard that has no real relevance anymore. If I was changing the law, I would cease the issue of Treasury securities, and instead have all government spending done be direct issuance of reserves, which would accumulate in the banking system until they are taxed away. This would have the added benefit of setting the overnight interest rate at 0%, permanently, thus removing the subsidy of risk-free interest for the rentiers and allowing a more rational allocation of capital.

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