Okay, full disclosure, I wrote this last Friday and by the time this post hits, I'll be on a beach with a drink packed full of booze and tiny umbrellas. So, if anything has happened on this front since last Friday, I apologize if this topic has become obsolete.
The topic of America's potential upcoming default seems to garner some annoying factoids about how we have never defaulted. Not just from the talking heads on television, but from finance professionals as well. In the Washington Post, James Grant, editor of Grant's Interest Rate Observer, has written an article debunking this myth, starting with a certain finance professional who should probably know better.
“There is precedent for a government shutdown,” Lloyd Blankfein, the chief executive officer of Goldman Sachs, remarked last week. “There’s no precedent for default.”How wrong he is.
Very wrong, indeed.
One particular refrain I hear regularly, in one form or another is, "America has never defaulted on it's obligations, and therefore, doing so would cause tremendous economic harm". Whether or not a default will cause economic harm doesn't change the fact that we've defaulted several times during our history. The earliest example, unsurprisingly, came during the birth of the country.
Things were very different when America owed the kind of dollars that couldn’t just be whistled into existence. By 1790, the new republic was in arrears on $11,710,000 in foreign debt. These were obligations payable in gold and silver. Alexander Hamilton, the first secretary of the Treasury, duly paid them. In doing so, he cured a default.
While this isn't applicable to the current situation, it is instructive when put into context with a more recent default on behalf of the US.
Hamilton’s dollar was defined as a little less than 1/20 of an ounce of gold. So were those of his successors, all the way up to the administration of Franklin D. Roosevelt. But in the whirlwind of the “first hundred days” of the New Deal, the dollar came in for redefinition. The country needed a cheaper and more abundant currency, FDR said. By and by, the dollar’s value was reduced to 1/35 of an ounce of gold.By any fair definition, this was another default. Creditors both domestic and foreign had lent dollars weighing just what the Founders had said they should weigh. They expected to be repaid in identical money.
This isn't some technicality either. The author discusses "gold clauses" that commonly existed in debt contracts at the time, citing a reaction from the London Financial News.
“One of the most egregious defaults in history,” judged the London Financial News. “For repudiation of the gold clause is nothing less than that. The plea that recent developments have created abnormal circumstances is wholly irrelevant. It was precisely against such circumstances that the gold clause was designed to safeguard bondholders.”
The author, expanding upon this logic, takes issue with Nixon's abandonment of the gold standard in 1971 as another such default. In addition, the author appears to view the current Fed policy as another, more continuous form of default, with a rather novel viewpoint.
[T]he value of money has become an instrument of public policy, not an honest weight or measure. In such a setting, an old-time “default” is impossible.Let us confront the implied message of the Federal Reserve’s pro-inflation policy: We will default in the future, though no lawyer will call it “default.” And let us preempt the world’s flight from our intangible money by taking steps to fashion a 21st-century improvement.
I'm sure many of you have noticed that the author's instances of default all align with instances of political tinkering with the (now defunct) gold standard. It should come as no surprise that the author ends his piece advising (implicitly) a return to the gold standard. Personally, I think basing your currency on a metal is just as arbitrary as basing it on faith printed on paper. Plus, why gold? What does gold have that thulium doesn't? Thulium is just as rare and far more valuable. However, the point the author makes about money transitioning from a weight or measure to a policy tool is a strong point. The dollar's transformation from a standard unit of money to a flexible tool of policy has also transformed the concept of default. Previously, "you lend me gold, I pay you back in gold" was, for all its limitations, simple and equitable to the two parties. While I'm not of the opinion that we should be running back to the gold standard, there's something to be said about simplicity.
What do you monkeys think?
I disagree with this article. By the author’s logic, unexpected inflation can also be considered a default because bondholders receive less money in real terms than what is contracted in the bond indenture. The author’s historical examples hold little relevance to modern times, as they all focus on changes to the gold standard. Furthermore, going back to the gold standard would severely limit the power of central banks around the world, and that will never happen.
I agree with Blankfein on this one: a U.S. default in today’s world would truly be unprecedented.
Anyone who doesn't think that we are going to keep "kicking the can down the road" has zero idea of how our central banking system works. There's no "getting our financial house in order." The system is either going to collapse under the weight of itself, or through deflation.
Keynes even knew of this and was vocal about it. There have been countless debt jubilees going back to Babylonian times because this is the natural end state.
We bitch about the debate over the debt ceiling. Just wait until the markets make the decision for is.
Let's raise a glass to rising interest rates and the onward march to $20T in debt. Neither party won. We all lost.
We all lost but the dems are still gloating... even if society were to collapse tomorrow and there were riots in the streets the dems would still be happy with themselves for the humiliation they laid on the republicans. The entire debate was almost a personal bickering in nature.
I think this begs a bigger question... is the US treasury bound to just become the worlds largest official ponzi scheme? In other words, are we bound to hold some multi-trillion dollar pool of debt for the indefinite future? If each bond was paid off at it's maturity creditors wouldn't become pissed and it's possible that it could be, errrr, "sustainable" even if total debt outstanding was astronomical.
As long as the economy grows faster than new debt, debt as a percentage of GDP will not grow. Some people have forgotten that debt is supposed to be paid off in good years and issued in bad years.
That the US gov't would have financial difficulty isn't unprecedented at all, but the amount of global and domestic damage that a credit event would do at this point in history IS totally unprecedented. The US gov't is currently too big to fail, and I think this has become extremely obvious....if not to Americans, then to the rest of the world. Thankfully the gov't decided that running an annual $1TT deficit is preferable to immediate global financial meltdown. If you think that interbank swaps contracts were complicated, imagine how much more tangled public finances are. It doesn't matter that some agencies may or may not have been able to shift money into tiered payment priorities...this would ripple immediately through every market on earth in ways we definitely don't want to see and I'm personally very relieved this is over.
You could probably look at the numbers a bunch of different ways, like considering the amount of intra-government debt or whatnot. You could also look at GDP to debt, at 107%. In those terms, it's like having an income of $100K and a mortgage of $107K....totally manageable. The federal gov't is currently running an income to debt ratio of 670%, or basically the equivalent of owning a $200K house on a $30K salary. Either way, it's mathematically feasible for only a few more years and then something has to give. I'm not a fed budget analyst and that's some major boring shit that I'm not paid to look at, so I don't know how long.
One major point though: servicing the debt is currently costing the US $223BB per year, about 6% of GDP. That's 1/3 the military budget, just to put things in perspective.
I stayed in the market during the shutdown was pretty sure it was just a matter of time before the Senate put a muzzle on the Tea Party...I did get a bit nervous today though! It blows my mind to think that there are people currently in elected office who think the best way to reign in the debt is to cause a credit event...the ensuing depression would not only deprive the gov't of revenue and just make things so much worse, it risks plunging the world into war and all the terrible things that come when economies collapse. The GOP had neither the leverage nor the balls [or sheer fucking stupidity] to take their ideology that far.
But they do have a point: the debt has to start coming down, or there will be a global economic collapse, and then war and all those terrible things. We all know this. It's not like it's rocket science, it's just a matter of will. If this president doesn't run a debt reduction agenda in the next year or so, then I forsee the 2016 federal election cycle as being a pissing contest of who can sell their budget cutting schpeel to the public.
Will the US screw the pooch on its finances? I think today illustrates basically how the US rolls: we'll put off dealing with it until the last possible moment, and then the US will probably become one of the more fiscally sound nations after that point. I think Churchill said, "You can always count on the Americans to do the right thing after they have tried everything else.”
Republic were never going to default, but they wanted some concessions. This is what happens with a president that rammed healthcare through. I still remember Obama promising to cut spending if he got tax increases. Republicans go along with it and he refuses to cut spending.
We can't grow ourselves out of this and deflating our currency has it's own issues. We're lucky that we are the reserve currency of the world. One day that won't be the case. Unfortunately we the people only care when things become too late to so anything.
There was never going to be a default. The 14th amendment doesn't allow it. Fear mongering at it's best.
Constitutional laws cannot defy the laws of economics.
So you're saying the USA doesn't have enough revenue coming in to pay interest on debt?
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