"Zero possiblity of the United States going bankrupt"?
In conversation about Rob's post on Americans preferring bankruptcy, member Goyomarquez muses that there is zero chance of the U.S. defaulting on our debt.
That claim is entirely bogus. It is impossible for a country that prints its own currency to reach a point where it cannot pay the debts it owes in that currency.
What we have in our modern world is fiat money. It's money by government decree. If the US government decrees that it will print $14,000,000,000,000 in new $100 bills tomorrow and pay everyone off with those pieces of paper, it could. It would create a jump increase in prices, and all those who held dollars currently would suffer. It is in effect a repudiation of the debt. Those new bits of paper you got will not buy more than a small fraction of what they did before. Lest we forget, Weimar Germany printed its own currency.
What's that risk today? There are credit default swaps you can buy to insure, say, $10 million of U.S. Treasuries from default over the next ten years. They currently sell for around $45,000. That might overstate the risk of default of the United States by a fair amount, but they do tell us that people place a non-negligible probability of default on those bonds and put their money where their mouths are.
To anticipate one argument, the position of the US as the world's reserve currency gives creditors a little less worry, but only a little. On one hand, it's harder for the US to repudiate via inflation because the rest of the world demands our dollars as backing for their own currency (including the Chinese.) On the other, there are incentives for the US to take advantage of that position to export a little of its inflation elsewhere in the world ... and it does.
Goyomarquez then adds this zinger:
Cutting government spending during a recession is exactly equivalent to raising taxes and is therefore a mistake. Conservatives have yet to explain how balancing the budget is going to reduce unemployment, I assume that's because they know it won't.
In a very simple Keynesian world, this viewpoint might work (though if taxes are paid for by reduced savings, a simple Keynesian would say spending cuts are MORE harmful than tax increases.) But most economists would also recognize that public investment can crowd out private investment. If you are spending and borrowing you are taking funds that could be used by the private sector and diverting them to the public sector. By reducing government spending, workers and firms have space to find other mutually beneficial exchanges that produce goods and employment.
Government cannot create wealth directly. It diverts resources from private to public use with the assumption that its use is better than the former wealth holder's. It has little incentive to consider the private costs of those public funds it diverts. And when the government is as hyperactive as the present one is, those private costs may dwarf the public benefits.
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Re: "Zero possiblity of the United States going bankrupt"?
King, what do you think of the various initiatives to replace the US dollar as the world's reserve currency? I worry that a major move towards, say, the Euro because of continued feckless fiscal policy in Washington would result in accelerating inflation as dollars are repatriated from abroad, thereby reinforcing the trend. Could an international crisis of confidence bring forward our national day of reckoning or am I watching too much cable news?
Edited on March 2, 2011 at 11:25pmNov '10
Re: "Zero possiblity of the United States going bankrupt"?
Goyomarquez's pithy piece abounds in infuriating fallacies. But just one is this. Merely because a democratically elected government can in principle print money to pay its debt doesn't mean that those progressively impoverished by the inflation this produces will let the government do so indefinitely. Goyomarquez is presuming an eternally meek populace (or the emergence of a totalitarian state) under every conceivable inflationary scenario.
Nov '10
Re: "Zero possiblity of the United States going bankrupt"?
My first question to Goyomarquez was: How is a trillion dollar coin any different from the trillion dollars of denominated pieces of paper that they already possess? Unless the "coin" were gold or platinum or something else of real value, they would be indifferent to the coin or paper. The paper they have is already a debt instrument so replacing it is merely "new lamps for old". The only way to retire the debt in reality would be for China to buy a trillion dollars of our stuff and use the bits of paper to pay for the stuff.
King rightly points out that a defaced and devalued currency is a major problem. If you don't think so, I know where you can get truck loads of Zimbabwe dollars whose value would not exceed the cost of renting the truck to transport them.
Edited on March 3, 2011 at 1:28amJul '10
Re: "Zero possiblity of the United States going bankrupt"?
Promm beat Me to it.
Edited on March 3, 2011 at 1:54amJun '10
Re: "Zero possiblity of the United States going bankrupt"?
Cutting spending is an effective tax hike. But a tax cut during an economic slowdown is also effective. Government spending is NOT constrained by tax revenues. Federal taxes are what give our fiat currency value. Deficit spending is non-government savings to the penny by accounting identity. So deficit spending and tax rates are political decisions. Solvency is NEVER an issue. Bernanke has admitted that spending is nothing more than changing a number on the computer. Social security checks will never bounce. We can all agree that big government is nothing but a bureaucratic mess and the epitome of inefficiency. But we should also agree we are not broke.
Oct '10
Re: "Zero possiblity of the United States going bankrupt"?
King Banaian:
What's that risk today? There are credit default swaps you can buy to insure, say, $10 million of U.S. Treasuries from default over the next ten years. They currently sell for around $45,000. That might overstate the risk of default of the United States by a fair amount, but they do tell us that people place a non-negligible probability of default on those bonds and put their money where their mouths are.
And yet it is worth noting that those credit default swaps are denominated in U.S. dollars which means, neglecting counterparty risk, that they only hedge against default in repayment of the principal by the borrower, not depreciation of the currency in which they are repaid.
If things continue on the current trajectory, I'd expect derivatives linked to a plausible proxy for cost of living (not the laughable U.S. CPI which excludes energy and food) to become a common instrument to protect against depreciation of the Yankee greenback.
Nov '10
Re: "Zero possiblity of the United States going bankrupt"?
King Banaian:
What's that risk today? There are credit default swaps you can buy to insure, say, $10 million of U.S. Treasuries from default over the next ten years. They currently sell for around $45,000. That might overstate the risk of default of the United States by a fair amount, but they do tell us that people place a non-negligible probability of default on those bonds and put their money where their mouths are.
So, play this one out. I have $10 million in Treasurys. I buy "insurance" for $45K. In 9 years 364 days the Gov says: We can't pay! Then the guy who insures me pays me what??? Dollars that are worthless because the US government has defaulted on their debt to me?? Ahhh... does anybody see a problem here?
Edited on March 3, 2011 at 2:22amDec '10
Re: "Zero possiblity of the United States going bankrupt"?
Unless I am totally FOS, this statement can only be true if the people being paid are the ones also paying the taxes.
However, it is easily found that those who pay the most taxes use the least services, and pretty much vice versa.
Cutting .gov spending may reduce the income of those being paid, but it will not increase the tax burden of those who are paying the taxes. That is not a tax increase, unless you are just going to define tax increase as "any reduction in size of any household's income".
Jan '11
Re: "Zero possiblity of the United States going bankrupt"?
Robert Promm
So, play this one out. I have $10 million in Treasurys. I buy "insurance" for $45K. In 9 years 364 days the Gov says: We can't pay! Then the guy who insures me pays me what??? Dollars that are worthless because the US government has defaulted on their debt to me?? Ahhh... does anybody see a problem here? · Mar 2 at 5:15pm
Edited on Mar 02 at 05:22 pm
Wikipedia is so awesome. So it seems that if you buy into a CDS, then you need to make periodic principle payments during the life of the contract. If the guy who owes you money defaults on you, then the guy who sold you the CDS contract will make up for the difference, and you get to stop paying the periodic premiums. So with one day left on contract at the default, you're not getting very much.
I'm not sure about this, but I suspect that if you got defaulted on day one, the seller of the CDS would not pay you the $10 million lump sum, but rather assume the defaulted one's payment schedule. But that may depend on the CDS contract.
Jan '11
Re: "Zero possiblity of the United States going bankrupt"?
CoolHand
Unless I am totally FOS, this statement can only be true if the people being paid are the ones also paying the taxes.
However, it is easily found that those who pay the most taxes use the least services, and pretty much vice versa.
Cutting .gov spending may reduce the income of those being paid, but it will not increase the tax burden of those who are paying the taxes. That is not a tax increase, unless you are just going to define tax increase as "any reduction in size of any household's income". · Mar 2 at 7:28pm
If you're FOS on this, then so am I.
I forgot to mention this WSJ article last night when talking about the potential destruction of the US economy in the event that the dollar ceases to be the de facto global currency. It talks about how that might happen and its consequences on the US.
Edited on March 3, 2011 at 5:41amDec '10
Re: "Zero possiblity of the United States going bankrupt"?
Robert Kelly: Sure. But the US has to use it's currency to buy things such as oil and other resources. If the currency devalues due to oversupply, it may not bankrupt the Fed, but it will bankrupt users of the currency.
Fiat money is worth what users think it is worth. Stewards of the currency who forget that, or worse, who actively try to decrease it's value are fools.
Nov '10
Re: "Zero possiblity of the United States going bankrupt"?
fullfrontal
Wikipedia is so awesome. So it seems that if you buy into a CDS, then you need to make periodic principle payments during the life of the contract. If the guy who owes you money defaults on you, then the guy who sold you the CDS contract will make up for the difference, and you get to stop paying the periodic premiums. So with one day left on contract at the default, you're not getting very much.
I'm not sure about this, but I suspect that if you got defaulted on day one, the seller of the CDS would not pay you the $10 million lump sum, but rather assume the defaulted one's payment schedule. But that may depend on the CDS contract. · Mar 2 at 8:13pm
Sorry, not the problem I was expressing. If the the Treasury defaults, it's the currency that's worthless. So, the bond insurer pays back my $10 million with $10 million "other" dollars which are just as worthless that those on which the Treasury defaulted. Catch 22.
Nov '10
Re: "Zero possiblity of the United States going bankrupt"?
That would mean that the Weimar Republic was not broke and neither is Zimbabwe. Yah, your right. Don't believe your lyin' eyes.
Edited on March 3, 2011 at 7:37amFeb '11
Re: "Zero possiblity of the United States going bankrupt"?
Money is so confusing. At this point nobody agrees and nobody seems to really know what to do. Take the interest on the debt, now a staggering sum. Can somebody tell me why we can't get a loan for this, say from a new entity, Central Virtual Financial? I.e, as long as people are being fed, the important thing is development ideas and projects and will---not money. Think of Stonehenge or the Pyramids. They weren't reliant on derivatives swaps, or even an advanced money economy, to get moving.
Create lines of credit, get things moving. Then close the account. I'm facetiously arguing here, for discussion's sake, for a ballooning of the debt via shell games---then just wipe it off the books and start over.
Maybe I'm naive, but it seems to me credit is the key. And if that's the key, why not make the sky the limit?
Feb '11
Re: "Zero possiblity of the United States going bankrupt"?
The US has been in this spot before. After World War II. There are three important differences between now and then, however: (1) then debt was held by Americans for the most part, but far less so now; (2) the savings rate was much higher then than now; and (3) there was not an imminent retirement of a large proportion of the population who are expecting retirement benefits because they are entitled. There is no reason to believe that on Jan. 1, 2012 or some other date the government will print 14 billion in currency. The best we can hope is that the Fed and the govt. will bring down the debt as proportion of GDP as it did back then partially through inflation and partially through constraints on future spending. This will be a large drag on future growth rates so will be harder to bring down as a proportion of GDP because the dollars for principal and interest will not be used to buy domestic consumer goods as it largely was after World War II.
Jan '11
Re: "Zero possiblity of the United States going bankrupt"?
Robert Promm
Sorry, not the problem I was expressing. If the the Treasury defaults, it's the currency that's worthless. So, the bond insurer pays back my $10 million with $10 million "other" dollars which are just as worthless that those on which the Treasury defaulted. Catch 22. · Mar 2 at 10:15pm
Google is so awesome. According to the article I linked, Bank of America had the following to say about sovereign CDS's:
1) The US isn't going to default. It'll debase currency before it decides to not pay coupons or principles.
2) In the event that it does default, it's unlikely that a bank would be able to pony up the money to pay you. You're much better off hedging with a currency put, or a gold call.
3) Robert, you are a winner. The currency would be worthless, so you wouldn't denominate a sovereign CDS in the same currency as the government you bought that CDS on. You want a CDS on the US government in Euros or something.
I like the conclusion of the author:
A rather blunt translation: Stop preparing for Armageddon, you’ll all be dead anyway.
Dec '10
Re: "Zero possiblity of the United States going bankrupt"?
If printing more money is the best way to finance massive deficit spending then it must also be the best way to create a prosperous economy and great wealth, right? If not, why not?
Aside from concerns about runaway Weimar-style inflation, in either situation try using that money to buy things from foreign companies and governments, assuming they will even accept such dollars in exchange for goods and services.
Jan '11
Re: "Zero possiblity of the United States going bankrupt"?
Hang On,
I would say there are several more differences.
1) The post WW2 era had some major growth in American business, right in the face of conservatism's arch-nemesis, a 91% marginal tax rate. There was a lot of low-hanging fruit that they could achieve that I don't think we have in front of us. What are we going to expand to? Energy? Space travel? (I don't think we've even paid off the debt from WW2. Our economy grew so big that debt-to-GDP was manageable even if we ran big deficits -- up until recently.)
2) Half of the world's industrial world was destroyed. The other half was us.
3) Most of Europe's geniuses came the US, as it was the safest place to live, giving us their world-changing services.
When we cease to be the best place in the world to live and do business, we can expect to see things here get worse, and the new best places to live and work surpass us.
Nov '10
Re: "Zero possiblity of the United States going bankrupt"?
fullfrontal
1) The US isn't going to default. It'll debase currency before it decides to not pay coupons or principles.
2) In the event that it does default, it's unlikely that a bank would be able to pony up the money to pay you. You're much better off hedging with a currency put, or a gold call.
3) Robert, you are a winner. The currency would be worthless, so you wouldn't denominate a sovereign CDS in the same currency as the government you bought that CDS on. You want a CDS on the US government in Euros or something.
I like the conclusion of the author:
A rather blunt translation: Stop preparing for Armageddon, you’ll all be dead anyway. · Mar 3 at 6:23am
This is what I was pointing to which gets me back to: why would I spend $45K to "insure" the $10 million of US Treasuries that I hold? (I don't of course. Purely hypothetical.)
Edited on March 3, 2011 at 4:30pmFeb '11
Re: "Zero possiblity of the United States going bankrupt"?
A few points in response:
Cutting government spending versus tax hikes. Imagine that instead of cutting government employees salaries by 10% we passed a special tax that taxed only government employees by 10% could you then see that a government spending cut and a tax hike are equivalent?
Edited on March 3, 2011 at 5:10pm