Would a Debt Default Really be the End of the World?
For the time being, it looks like the Republicans are sticking to their guns. Good for them! They aren't caving in to Obama's pressure to raise the debt ceiling after token deficit cuts. They are insisting on a balanced budget amendment as a condition to any debt limit raises.
I'm very pleasantly surprised by their principled dedication. America is on their side too. Only 22% of Americans want to see the limit raised. The American taxpayer is no longer fooled by Bernanke's Keynesian stimulus plan.
Of course, President Obama is making dire predictions about what will happen if we fail to raise the ceiling. He predicts a default so dramatic that Social Security may grind to a halt in August of this year.
As I've written before, such claims are simply dishonest political grandstanding. We can still spend 2.1 trillion annually without raising the debt limit. All leaving the ceiling in place means is that we can't borrow additional funds. 2.1 Trillion is more than enough to cover social security and military spending and interest payments on the debt with hundreds of billions left over.
I won't disguise the fact that this would be unpleasant for a great many people. Federal Deficit spending currently accounts for about 12% of GDP. Eliminating that spending would cause an instantaneous drop in GDP of at least that amount. Economic declines over 10% qualify as depressions.
However, we need to be very clear about something. Doing this would be recognizing that we are in a depression, it wouldn't cause a depression. The formula for GDP is simple but also deeply flawed. GDP = private consumption + gross investment + government spending + Net Exports.
Which one of these figures isn't like the others? Government spending of course. The government can borrow and spend tremendous amounts of money. Today, the federal reserve has taken the game one step further. The left hand is lending the right hand money that it has created out of thin air. This "quantitative easing" doesn't actually reflect increased productivity or a healthier economy but it adds to GDP nonetheless.
It's like a homeowner who gets laid off and pays his mortgage with a credit card, and then pays the first card with a second. From the outside everything looks ok. However, we all know that the homeowner is digging an ever deeper hole, not actually fixing the problems. Similarly, the government can deficit spend or print enough to give us increasing GDP numbers, but they cannot print their way to a healthy economy.
Now, I'm going to ask a new question. What happens if the United States does default? Well, obviously it isn't a course that is going to win us many friends. Individual investors will be ruined when the value of their investments plunges to zero. Entire countries will see similar problems. China currently holds around a trillion dollars of US government debt, and they will not be best pleased to see that evaporate.
As a consequence, the government would find it impossible to borrow again within the next generation at anything approaching a reasonable interest rate. The value of the dollar would take a substantial hit as well, and millions of Americans would lose a tremendous amount of wealth as a result.
As for the first half, that is precisely what America needs. Our system of government financing is fundamentally broken. As a nation we have convinced ourselves that we are entitled to whatever we want...right now....at someone else's expense. We've been able to pull it off for a stunningly long time, but the math is simple. Debt and GDP growth are both exponential functions. If debt systemically rises faster than GDP, the system must blow up eventually.
If the spread is small, it may take decades, but it absolutely will happen eventually. No amount of will power can change the math. No amount of demanding the status quo continue can make it so. No amount of saying that America is the greatest country in the world can change the fact that we must obey the laws of reality.
As a nation, we need to accept that fact that we must spend within our means or perish. A debt default would cause exactly the sort of enforced austerity that we need.
The lower value of the dollar would make exports more affordable in the rest of the world, assuming they had functioning economies after the US debt they held disintegrated.
This isn't to sugar coat the situation, it would undoubtedly be extremely ugly. Dire poverty, and perhaps even starvation in America would be almost certain. War abroad and revolution at home are entirely conceivable. However, just like deficit spending causes a fraudulently healthy perception of the economy would this default cause the problems or would it simply reveal them? I argue the latter case, and if I'm right the longer we wait, the worse it will be.
Rational Public Radio is an Objectivist podcast and blog, a.k.a., the rallying center for reasoned warriors in the fight to gain and keep individual freedom.
Comments
Be that as it may, I think default is simply going to happen eventually anyway.
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