The Pony in Defaulting on the National Debt
Nick Gillespie | March 18, 2006, 9:18am
As the federal debt level gets jacked into the troposphere, "Cicero" over at To the People lays out the upside of defaulting on same:
Could defaulting on the national debt hurt the overall economy? Yes. It would likely crash the stock market. But, it would most certainly shake people's faith in government. And that would be a good thing. Once people realized that the federal government could default on bonds in the future, they would be less likely to loan money to the federal government. That would prevent the government from racking up a huge credit card bill ever again (or at least for several decades). Knowing this, investors would become quite bullish. The American economy would rebound and flourish. Without the federal government driving up interest rates through massive borrowing, companies could afford to expand like never before. And the federal government would free-up the $350 billion it spends every year just paying the interest on the national debt. Congress could give this money back to the American people through major tax cuts, further stimulating the economy. (Bone to socialists: Congress could also spend that money on health care, welfare, etc.).
Whole bit here.
cicero | March 18, 2006, 2:50pm | #
Since a number of people have attacked my proposal to default on the national debt, I should respond. Arguments generally fall into one or more of the following categories:
1) It would wreck the economy. I agree. At least in the short-run. The question is would the long-term benefits outweigh the short-term suffering? I say yes. Having a government that is never able to borrow money again is a vast improvement over what we have now. Leaving hundreds of billions of dollars in investment money a year in the private sector is extremely beneficial, as is avoiding the massive tax increase that is inevitable if we don't default on the debt (yes, yes, Congress could enact massive spending cuts to solve the problem, but it won't).
2)Defaulting on the debt will lead to hyper-inflation. I don't see how. It's paying off our national debt that will lead to inflation. When the government reaches near bankruptcy (when it can't afford to pay interest on the debt without massive tax increases or spending cuts), it could start printing money to cover it. Better to avoid that mess now by defaulting on the debt.
3) The real issue is spending. I agree, which is why the federal government should spend less. A good start is to stop paying $350 billion a year just to keep up with the interest on our national debt.
4) There's nothing really wrong with national debt. Then why not borrow the entire $2.8 trillion the federal government spends every year. The debt cannot be economically sustained at the rate we're going. Also, there are moral issues at stake. Public debt is not like private debt. The people borrowing the money are not the people who will be required to pay it back. The national debt is inter-generational theft. Why should the majority of Americans who don't own bonds be required to pay taxes to upper-middle class and rich people so that the federal government can continue to give money to politically-connected interest groups?
5) It's not right to not pay people back. Sorry, I disagree. It's not right to make people pay other people's debt. People who colluded with the government to rip-off future generations deserve to be screwed. And screwed badly.
6) Defaulting on the debt will shake things up so badly that people worse than Bush could take power and expand government. Possibly. But, this depends on how the debate on the issue plays out. The next administration could float a trial balloon. More importantly, the American people are increasingly worried about the national debt. They know that it cannot be sustained. They want a way out. Default is one way. I think they might respond positively. Of course, if the economic consequences of default are severe enough, then that could cause a massive clamor for big government. But, this assumes default would be catastrophic for a long period of time. I don't think it will be. Maybe there are half-measures that could be taken. Such as agreeing to give people back their principal without interest. This would be a loss to investors and they wouldn't like it. But, it would limit the impact on the economy, while making the debt more manageable, and making investors less likely to loan money to the federal government in the future.
When I posted my argument in favor of defaulting on the national debt I knew the idea would be universally attacked, even by libertarians. But, the moral and economic consequences of the debt cannot be ignored forever. Something has to be done. And whatever it is has to be radical. The federal government cannot continue to pile on hundreds of billions of dollars in new debt a year for eternity with no consequences.
Thanks for your thougtful criticisms.
tarran | March 18, 2006, 6:17pm | #
But, surely cicero has a point;
The people paying the debt are not the people who incurred it. Let us say that I wished to borrow three times my annual salary from my neighbor. So I approach my neighbor and propose the following contract:
In return for $X today, my son will repay $3X in ten years' time.
Would the contract be valid? Absolutely not, I can not bind my child to this contract. Yet in a way that is what we are doing with the national debt.
Let's say I did offer such a contract to my neighbor, and he in turn accepted it. Let us then say that he approaches my son when my son is a young man and asks for repayment, and my son refuses to pay. Now, if my neighbor were to sue my son for the money, and you were sitting on the jury would you find for my neighbor? Or would you rule that the contract was invalid and that my son therefore owed my neighbor nothing?It would be one thing if liability for paying this debt was taken on voluntarily, but it isn't - Certainly I want no part of it, my son and daughter who were both born in the past five years have not asked for it, yet they will be saddled with it.
Personally, I have little sympathy toward those who invest in treasury bonds. They should be aware that they are investing in an organization that takes wealth by force rather than creating it by production. They seek to share in the plunder, and deserve contempt.
Additionally I don't think trust in governmental institutions is propping up our economy. Admittedly our economy is very deformed from the 40% of its production that is plundered by government officials. Removing the plunder could be like removing the stick used to train a tree leaving the deformed trunk unable to bear its own weight. Little that the government does assures confidence that one's property rights will be respected. That is the crucial element of a prosperous economy and a happy society. Institutions that build this confidence need not be governmental. They are often cultural and social and in fact wither in the face of activist governmental action.
To continue the arboreal simile, once sufficiently deformed nothing will be able to set the trunk right, and only collapse and planting a new tree will fix the problem. Whether we are too deformed to spring back is debatable, and I tend to lean toward the 'yes' camp.
JD | March 18, 2006, 6:39pm | #
I'm glad to see this idea getting some discussion, even though I think it's a bad one. But first, one thing: Joe, if you have something other than a moral argument, please make it, and if you only have a moral argument, please flesh it out. Because all you've said so far really boils down to "You're just like Bolsheviks! Jacobins! Al Qaeda!" That's not an argument, that's poisoning the well.
Part of me likes the idea of default, just because it would remind people that the feds aren't all-powerful, but I'm extremely sceptical of the idea that it would lead to any benefits of any permanence. We have, after all, lots of historical examples of governments defaulting on payments. If any of them led directly to rebounding and flourishing economies, I'm not aware of them.
I also don't think that Cicero's argument is very well thought-out. Yes, the feds are competing for lenders' dollars, so that should increase rates, but the prime rate has been between 4% and 10% in recent years. That's hardly extraordinarily high, so I'm not seeing the huge harm done by the existence of federal borrowing. I think almost everyone will agree that the government sometimes needs to do some borrowing, and if it defaults, future rates will go way up, which only means we'll be paying more interest on anything we do borrow in the future. And, as I think has been mentioned, if we defaulted, the dollar would flop, and that's not going to be good for too many people in the US. Hope you were holding a lot of non-dollar-denominated foreign debt!
Last comment: debt as a percentage of GDP is only about where it was in the 1950s, not at some historic high. I agree that the recent increase is troubling, but the debt isn't really any worse than it's ever been.
Ron Hardin | March 18, 2006, 6:45pm | #
I think cicero has not understood that US government debt is nothing like debt.
Not a penny has gone to pay for interest, and not a penny has gone to pay any off.
The debt is just a mechanism to take money out of private hands.
When the Fed wants to increase the money supply, say to match the needs of a growing economy, it buys back government debt.
When the Fed wants to reduce the money supply, say when the economy shrinks, it sells government debt.
Period. That's all there is to it.
If the government has to ``pay interest'' on the national debt, it writes checks (launching new money) and simultaneously sells debt (scrubbing out money), a complete wash. No transaction has occurred, the economy has as much private money as before, and no goods have been exchanged.
Now, in the meantime, the politicians are doing dirty things and spending money for actual goods; this is new money, and the Fed offsets the new money by selling debt, soaking it back up.
When tax receipts come rushing in on April 15, the government buys back debt so that the money doesn't disappear from the economy.
In short, debt transactions keep the money supply exactly what it should be for the condition of the economy ; and a few of the things it accommodates are irregular tax receipt flows, government spending, interest payments, and so forth.
This is nothing at all like private debt, because private debt has no effect on the money supply. Here it is the entire point.
If you want to lower the debt, spend less, or raise taxes.
The latter has the disadvantage that it's involuntary and so inefficient. It has the advantage that you only get to spend on things that people are willing to support.
Except that most people don't pay taxes, thanks to progressive rates, so you get to spend on things people mostly don't support, since they don't pay for them.
An argument for a universal flat tax, no exceptions, no deductions, no credits.
(Where does it break down, if it gets too big? On the spending side. Too many people want to spend rather than save at once, relative to the amount of saving needed to sell debt; ameloriated by a growing economy requiring a larger money supply, and so less debt in reaction to new money from government spending.)
Ron Hardin | March 18, 2006, 7:37pm | #
Look, the invariant hard cold fact is that the economy will have exactly the amount of money circulating that it requires. The Fed buys and sells debt to achieve this, basing it on leading indicators of inflation.
Dollar money is a ticket in line to say what the US economy does next, presumably something for you.
If too many tickets are outstanding, too many people bid for services compared to what the economy can do, and they bid up prices. Inflation.
If too few tickets are outstanding, parts of the economy go idle. You'd get falling prices except people won't accept wage cuts, preferring unemployment. (There's a deflation trap here, too, where the Fed loses control of the money supply, which is why the Fed always builds in a little inflation to be safe.)
The Fed supplies needed new tickets and soaks up excess ones by buying and selling government debt, so that inflation is as low as it dares to make it.
The money itself, the tickets, are not wealth. They're crowd control tokens.
Nothing in this token scheme depends on the ``size'' of the government debt. There is no size.
The trouble comes when government wants to spend and there aren't enough people to give up their turn by buying debt, ie. not enough savers to match the spenders. (saving requires spending and vice versa, a paradox but true.)
With taxes, there's no problem. You make them give way by taking their money outright.
With debt, you need it to be voluntary, so you hit the problem.
In either case, government spending being too big for the economy is the problem, not the size of the debt.
tarran | March 18, 2006, 8:24pm | #
I'm sorry, Ron, but whoever is teaching you economics is messing you up.
1) Traditionally money is not a ticket, but rather some commodity. It could be gold, cigarettes (if you are incarcerated in a U.S) prison), bread rations (German concentration camp), salt (Ancient Rome hence the word salary).
2) What makes a commodity a money is that it has fungible qualities such as divisibility, durability, uniformity and portability.
3) US dollars ape such voluntary currencies by two means:
a) The government uses coercion to force citizens to do business in them (the legal tender laws)
b) Some states that mine oil have announced that they will only buy dollars with that oil. In return the U.S. government defends those states from military attack.
4) The role of the FED is to permit fractional reserve banks to be able to pyramid debt on their deposits without fear of defaulting.
5) The Fed does this buy acting as the guarantor of last resort and is backed in turn by the treasury of the U.S. government. Thus banks are free to lend money profligately without having to worry about failing when too many depositors try to withdraw their money at the same time.
6) The credit expansion thus enabled inevitably leads to price inflation as the banks signal a larger supply of dollars exist than actually do.
7) However, the credit expansion does not create new deposits. Thus inevitably some of the loans made as part of the credit expansion will not be paid back, since the deposits to repay them do not exist.
8) This leads to a bust as the guys who can't pay their loans back go out of business or liquidate their assets.
9) To avoid this, the Fed prints more money and buys assets with it to make up for the apparent shortfall in deposits.
10) This of course increases the actual supply of dollars leading to further price inflation.
Why does the fed do this? Because it makes the cartel members rich! They are shielded from losses by the U.S. government, allowed to keep their profits, and most importantly shielded from competition.
Of course their benefit comes at expense of everyone else. People are denied a choice in what they use for currency. Additionally the currency that they use is currently eroding in purchasing power.
Thus, to confuse people into not hanging them from the nearest flagpole, the cartel has constructed an elaborate mythos that states that they stabilize the economy and preserve us from suffering the evils of the "Great Deflation Monster."
After all, a deflationary currency will still permit an economy to function. You will still want and need to consume goods and services. You will go to the store to buy bread, the store will purchase bread from the baker, the baker will purchase the wheat and water he needs and the capital equipment he needs to bake it etc.
The notion that people will give up working does not match historical experience. When given the choice between lower wages and unemployment, most people choose lower wages since that is preferable to none. They still need to consume, and must produce to give something in trade.
cybernion | March 19, 2006, 4:19am | #
Brian24: I blieve that 30 year bonds are back, as of just recently (first auction was Feb 9).
I am not conviced about the argument that the debt is "intergenerational theft." After all, we 'will' the bonds to our kids when we die, so they are the ones both paying them off and receiving the money. So, the debt is more a means of redistributing wealth, now and again in the future.
Forget about money for a second and think of the goods instead. The debt does not make goods transport themselves in time. Most goods one consumes are produced at roughly the same time as they are consumed. If you forgo a pizza today, someone else eats it. Thirty years from now someone, your heir perhaps, will present a note and expect to get a just-baked pizza (or two). Goods are not set aside now for the future generation to be paid back with. There is a redistribution of today's goods today, and another redistribution of future goods in the future.
So, who gets todays wealth and who gets future wealth?
The government (borrower) and those close to it get to use todays resources. This reduces the resources available for private purposes. Of course, the savers have forgone consumption they might have done instead of saving. This means that instead of producing things that ordinary people and businesses want, many of us are producing bombs to be used in, and military bases located in Iraq, for instance. We are also producing more items for consumption by bureacrats and welfare recipients and all those others close to the government, leaving fewer resources for producing goods for those not so well connected.
If and when the savings bonds are retired, the savers and their heirs will be the ones doing the consuption, and they will determine what we all produce at that time. They may also want to exchange their savings from bonds to things like factories. Taxpayers will be the ones foregoing consumption at that point, and the previous savers (bond holders or factory owners) will be the ones doing the consuming.
post pc | March 19, 2006, 10:14am | #
JD: "debt as a percentage of GDP is only about where it was in the 1950s, not at some historic high"
look at it on an accrual basis:
http://www.fms.treas.gov/fr/index.html
"Back in the mid-1970s, what were then the big 10 accounting firms decided in good public spirit that they would help the federal government set up its books on an accrual basis so that it could prepare financial statements and report its business the same way that a company does...
"[T]hey tried, and actually got a system going. Into the Reagan Administration, they were actually putting out prototype statements. But something was throwing the statements off—accruals for Social Security. It was decided during the Reagan Administration that dealing up front with those liabilities was really too political. They backed it off and Social Security got thrown into the footnotes. Even so, the accounting system continued to evolve and in 2001, the first annual Congressionally mandated Financial Report of United States Government, for 2000, was published by the Treasury. It is prepared using generally accepted accounting principles, or GAAP, except for Social Security and similar accounts, such as Medicare, Medicaid and the Railroad Retirement Fund. Every year since then, these statements have been published, and to the credit of the Bush II Administration, the recent ones have even included indications of what the Social Security numbers would look like, if they were included in the accounting, similar to the way corporations show pension and retiree benefit liabilities. These financial statements are audited by the Government Accountability Office. But the GAO won’t certify them. They include all sorts of disclaimers and discussions of material reporting issues—things like the fact that Defense Department and Homeland Security can’t track the money that they are spending. Still, those are separate issues. They at least do put out a financial statement. It’s the best they can come up with. Treasury Secretary Snow and his predecessors have signed off on it. Keep in mind, now, that while other than in the footnotes, this financial statement doesn’t include any accruals for Social Security or Medicare liabilities down the road, in general, it is an exercise in accrual accounting. It includes accounts receivable, accounts payable. If they buy a building, it is capitalized and depreciated. Weapons go into inventory. The business of government is treated just like any business. This near-GAAP financial statement stands in sharp contrast to what I call the gimmicked reporting of the government’s budget which is commonly reported. The budget deficit numbers you hear announced at White House press conferences are from accounts kept on a cash basis, with no accruals made for monies owed by or due to the government in the future. Even though the surplus of FICA payments it currently receives over Social Security payments it makes are counted as a cash infusion, there is no offsetting liability for future outlays, so Social Security taxes have been artificially lowering the deficit level for years—actually, going back to the days of Lyndon Johnson. Faced with growing opposition to the war in Vietnam, he decided he had to do something to make the budget look a little better, so he got Congress to go along with changing the accounting of Social Security receipts. And that lopsided accounting has persisted ever since...
"[I]f you look at 2005, the official deficit was reported at around $319 billion. Using generally accepted accounting principles, the 2005 Financial Report of the U.S. Government published by the U.S. Treasury, showed a deficit of $760 billion. That’s without considering Social Security and Medicare. However, in the 2004 report’s management discussion and analysis section, the Bush II Administration basically said, “Hey, guys, you’d better be aware of how these numbers work.” Where the official federal deficit in 2004 was reported at about $412 billion, and the GAAP-based deficit was around $616 billion, they said that if you added in the net present value of the underfunding of Social Security and Medicare, the one-year deficit in 2004 was $11.1 trillion. That’s trillion, not billion. That amounted to almost 100% of GDP at the time. Now, that $11 trillion included a one-time spike of about $8 trillion, to account for what Congress and the President did in setting up the Medicare drug benefit without funding it going forward. But you can see that if you back out that one-time charge, that on a GAAP basis, accounting for Social Security and Medicare, in 2003 the deficit was around $3.7 trillion; in 2004 it was $3.4 trillion; and in 2005 it was $3.5 trillion. We’ve had three years in a row here where the GAAP deficit has been basically $3.5 trillion. So the deficit and the total obligations of the federal government are increasing by roughly the amount of GDP every three years. In fact, the fiscal 2005 statement shows that total federal obligations at the end September were $51 trillion; over four times the level of GDP. It is unprecedented for a major country to have its actual obligations so far out of whack... It’s beyond control. Keep in mind that 2005’s $3.5 trillion GAAP deficit is roughly 10 times bigger than the “official” deficit."
