StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



RE: Another Dumb Right-Wing Idea: Default on the Debt

20 Feb 2010
Posted by Stan Collender

Bruce's excellent post on Glenn Reynolds dumb idea of having the U.S. default on its debt as a way to force spending cuts began to generate a good deal of buzz in the blogosphere almost as soon as it was up for all to see.  Here's Matthew Yglesias' and Mark Thoma's take, for example.

Let me add two things to Bruce's analysis.

First, interest on the national debt is paid as a result of a permanent appropriation and is the most mandatory of all mandatory parts of the federal budget.  It was enacted at the insistence of Alexander Hamilton (yes, THAT Alexander Hamilton), who convinced Congress that no one would lend the new United States government money unless they were sure that they would get it back when the time came.  Hamilton wanted to make it clear to the would be lenders (as I recall, it was mostly the Dutch at the time), that a future president and Congress couldn't refuse to pay because there were new priorities such as making sure that Saddam Hussein was out of Iraq, that no child was left behind, or that taxes were cut.

Because of this permanent appropriation, the only way a default could occur would be if Congress passed and the president signed legislation repealing it and making the interest payments discretionary.  While that's technically possible, the political likelihood of members of Congress voting for legislation that would be characterized as the "Let The United States Default And Instantly Become A Banana Republic Act" is relatively small.  This especially would be the case because of the virtually immediate increase in interest rates that would occur.

Second, there's no guarantee that spending would be cut as Reynolds is assuming if the U.S. defaulted on its current debt and found itself unable to borrow.  Tax increases would be at least as likely.

Can someone enlighten me as

Can someone enlighten me as to why the first article of faith in the GOP catechism is that regardless of circumstances, taxes must always be cut and never be raised?

Eisenhower was furious at Democrats for proposing a tax cut when we were still paying down debt; even Reagan signed tax hikes into law when the deficit ballooned in the early 1980s. And if history and facts are relevant, in addition to hero worship, there's always the experience of the 1990s, where Bush Sr and Clinton signed moderate tax increases into law in advance of a lengthy economic boom. (The tech bubble was nowhere near as ruinous and pervasive as the housing bubble).

So why is the notion that some tax somewhere might be raised considered a good enough reason to blow the country up in these people's minds?


Eisenhower

Actually, Eisehower opposed Republicans who wanted to cut taxes. Remember that they controlled Congress during the first two years of his administration.


Everyone is right!

Thanks very much for your reply.

I don't doubt that the GOP proposed tax cuts as well. But Eisenhower was furious with Democratic tax-cut proposals. From "The Presidency of Dwight D. Eisenhower" by Pach and Richardson, p. 107:

Eisenhower... thought no issue more flagrantly demonstrated [Democrats'] partisanship than their bill to cut taxes... Eisenhower considered such an idea reckless and dangerous at a time when he was trying to narrow the deficit in the federal budget. He urged Republican leaders to "denounce the Democrats every step of the way." If they succeeded, the tax cut would "bring back inflation and... cause the cost of living to skyrocket." Following his own advice, he condemned the tax exemption at a press conference on 23 February [1955] as "some kind of heights in fiscal irresponsibility." Although unable to persuade the House, Eisenhower won in the Senate, thereby stopping what he considered a sordid Democratic effort "to buy votes with the public's money."

'course, Ike also thought that "This country can choke itself to death piling up military expenditures just as surely as it can defeat itself by not spending enough for protection." So I guess he can be disregarded as a socialist leftist.


I am happy to oblige

"Can someone enlighten me as to why the first article of faith in the GOP catechism is that regardless of circumstances, taxes must always be cut and never be raised?"

Raising taxes is a political loser even if it is the absolute right thing to do. The GOP is convinced that Bush, Sr's decision to break his "No new taxes" pledge is the reason he lost in 1992. They have pledged to never raise taxes again come hell or high water in order to avoid a repeat of 1992.

It shoudl be noted Eisenhower, Reagan, and Bush, Sr. were conservatives although Eisenhower and Bush, Sr. were more moderate than Reagan.

Today, the GOP is not made up of conservatives; rather, the party's members are radicals masquerading as "conservatives".


Check your history -- and facts.

the only way a default could occur would be if Congress passed and the president signed legislation repealing it and making the interest payments discretionary.

False. A default occurs any time the borrower imposes any change of the terms of the debt on the lender, to the cost of the lender.

(Call your credit card company and tell them you aren't repealing your debt to it, nor refusing to pay interest, but you are changing the terms of your borrowing to reduce your interest rate and minimum monthly payment to something your can more afford. Then wait and see what the ensuing legal action is about.)

This is a matter of both domestic and international law, it's really not arguable.

As I pointed out under Bruce's first post, by today's legal definition the US clearly defaulted on its debt post-Civil War when Grant packed the Supreme Court to get it to reverse its prior decision, and all Constitutional precedent until then, which held that US govt borrowings denominated in gold had to be repaid in gold as per the US govt's promise to reapy them in gold when borrowing. (The Legal Tender Cases)

Borrowing gold and promising to repay in gold, then repaying in greenbacks with a real value only a fraction of the borrowed amount, while imposing these changed terms unilaterally at the cost of your lenders, because you can't afford to repay on the terms you originally promised, is ... default.

So let no one say the US *can't* default on its debt -- invoke Alexander Hamilton all you want -- it already has.

While that's technically possible, the political likelihood of members of Congress voting for legislation that would be characterized as the "Let The United States Default ..." is relatively small.

Today, of course. Although read the recent Reinhart/Rogoff definitive history and analysis of national defaults and you will see that of course ALL nations that borrow until they default claim *we will never default*, until the bills come due and they default. So that's not entirely logically persuasive.

Argentina said "We will never default". Then, "We will never default again!" Then...

Of course, the US is much bigger, and we know it can't happen here, because we are different!

Which Reinhart and Rogoff identify as major enabling beliefs speeding the road to default in case after case.

especially would be the case because of the virtually immediate increase in interest rates that would occur.

Hello? Increasing market turmoil is supposed to prevent default?? Bruce made this same strange argument. But how many defaults can you name -- of the 40-odd that R&R identify just since the 1970s (say, Russia 1998) -- that weren't preceded by growing market turmoil? How many of those defaults did the turmoil prevent? Did market turmoil and rising interest rates save Russia?

Increasing interest rates don't make it easier to avoid default, they make it harder. Another major point of R&R is that often market turmoil and rising interest rates occur not gradually but all at once at the end when the bubbble of "it can't happen here" belief suddenly bursts -- and it is too late.

As R&R make clear, default is always a political decision. When the political pain of sticking it to creditors is calculated to be less than the alternative option pain of raising taxes or greatly accelerating inflation, default occurs. *Nothing* stops it then.

Today, with interest rates at historic lows, of course default is unthinkable ... today.

But when continually piling up new obligations that will never be paid down but only serviced, one must think of what will be "thinkable" in the future.

Approaching 2030, when S&P projects the credit rating of the US on current policy to be "junk", today's more than $50 trillion of "implicit" unfunded accrued liabilities (growing at over $2 trillion a year, so they'll be closer to $100 trillion then) will be rolling over into the explicit debt owed to the public -- even as income taxes will already have to be 50% higher than today as per CBO. From there, both the debt and the tax rates grow forever. (And those tax rates will be applying to seniors pensions and Social Security benefits too, don't forget!)

Consider THAT world -- one most of us hope to live to see.

Do you really believe that *then* it will be, in Bruce's word, "impossible" that the US govt will seek to unilaterally change the terms of some obligations it made in the past?

After all, it's not like the US govt hasn't done it before.

"It can't happen here" ... "This time it's different!" ... words that grease the skid into default case-after-case.


No Idea is to Nutty

Yesterday, Glenn Beck, as CPAC's keynote speaker, in his talk denounced Roosevelt. I should clarify the Roosevelt he denounced was Theodore. I am actually somewhat surprised that he did not denounced Lincoln as well, but give him and CPAC time, it will happen. So apparently, Glenn and CPAC wanted to return to those halcyon days of 1857-59. We could certainly relate since that to was a time of a bank panic and corrupt elites making behind the scences bargains and talking loudly of secession. That 40% of the country finds tihs stuff plausible is somewhat sickening to comtemplate.


Jim, Do R&R control for the

Jim,

Do R&R control for the monetary system? IIRC they do not, and thus it is hard to read their analysis onto current realities. Fiat money and floating FX means that the government can always supply more currency. In fact, if you look hard to Reynold's typically specious post you can see the poor stitching: if the government can create hyperinflation, how does it make sense to talk about it defaulting?

vimothy


Also: S&P's credit ratings

Also:

S&P's credit ratings are clearly worthless and should be ignored.

Interest payments on public debt are just corporate welfare anyway. It is kind of amusing that the financial system, after swallowing huge amounts of public wealth and plunging the world into a deep recession, now casts itself as the voice of moderation. "Look, we think you need some deflation and more unemployment or we might have to demand more money from our risk free assets." With friends like these, etc, etc...




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