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  • The Coming Debt Repudiation

    Posted by Chicago Boyz Archive on August 30th, 2009 (All posts by )

    In-Cog-Nito sent me a pair of links, to an article entitled Why Default on U.S. Treasuries is Likely, and a shorter summary of the article. Troubling reading indeed, but still, RTWT.

    It is not literally impossible that the Federal Reserve could unleash the Zimbabwe option and repudiate the national debt indirectly through hyperinflation, rather than have the Treasury repudiate it directly. But my guess is that, faced with the alternatives of seeing both the dollar and the debt become worthless or defaulting on the debt while saving the dollar, the U.S. government will choose the latter. Treasury securities are second-order claims to central-bank-issued dollars. Although both may be ultimately backed by the power of taxation, that in no way prevents government from discriminating between the priority of the claims. After the American Revolution, the United States repudiated its paper money and yet successfully honored its debt (in gold). It is true that fiat money, as opposed to a gold standard, makes it harder to separate the fate of a government’s money from that of its debt. But Russia in 1998 is just one recent example of a government choosing partial debt repudiation over a complete collapse of its fiat currency.

    Zimbabwe option, anyone? Or the alternative of tax rates exceeding the peak from World War II — forever.

    Have a nice day.


    23 Responses to “The Coming Debt Repudiation”

    1. ted blows Says:

      Happy days are here again with the no limit Obama credit/default card.

    2. Plumpplumber(balding) Says:

      I’ve been wondering about this monsterous debt. Deep down the only thing that has figured is default. Obama can play fast and loose when he knows it’s not gonna be repaid. Zimbabwe or Argentina? The Chinese must be really nervous about being left holding the bag. BTW, what does RTWT mean?

    3. Dan from Madison Says:

      RTWT = read the whole thing.

      I for a long time have also wondered what the end game is and when it will be. I do know that the Chinese will not like the results.

    4. david foster Says:

      I think this is unlikely–more probable is a combination of high inflation (Carter-level rather than Weimar or Zimbabwe-level) with endless grinding tax increases..many of the latter taking the form of levies on corporate profits or intermediate goods so that they will appear in the form of higher prices, which can then be blamed on greedy businesses rather than on government.

      If default were to occur, I don’t think it would be across the board. Rather, it would be directed against the American “rich,” with the interests of foreign sovereign investors protected (the drug addict dare not antagonize his pusher)…also protected would be the Treasury investments of politically-favored entities such as union pension funds.

    5. Shannon Love Says:

      I think it important to not that we paid off the huge deficit of WWII because of an explosion of productivity in the decade following WWII. There were several unique attributes of the time which we do not have now.

      (1) The U.S. had the sole remaining unscathed industrial base in the free-world. We rebuilt the industrial bases of Japan, Korea and the free-half of Europe.

      (2) Because of the depressions and WWII there was enormous pent up consumer demand in the U.S. and everywhere else. For example, no civilian cars were manufactured between early 1942 and late 1946.

      (3) Technological advances during the war lead to productivity increases following the war as did technical training given to millions of service men. Men trained to repair radar came back with the skills needed to build and repair almost any electronic device of the time.

      All this combined to create an unprecedented boom in productivity that paid of the WWII in 20 years. We see no such productivity surge and/or unique economic position in the next 20 years today. Instead, we see the opposite with government policies specifically designed to punish investment and innovation.

      I think our best bet would be to create a specific tax on income dedicated to paying down the superdebt. It would hurt and hurt bad but if we create a specific long term plan to deal with it, we can assure ourselves and foreign markets that it will do less damage than feared.

    6. Plumpplumber(balding) Says:

      Shannon, ain’t gonna happen. Obama is out to destroy capitalism once and for all. As I understand it, debt repudiation would fit the bill. As I’ve mentioned in the past, China would come out on top, and while the economic losses would be severe, but it would be cheaper than fighting a war. And America would never be a threat again.

    7. Carl from Chicago Says:

      I think that the debt would likely be exchanged for longer dated debt and in the longest term the power of inflation would erode that burden.

      I don’t think that the Chinese really think that they’ll be repaid all of that money… they need to soak up those dollars to keep the trade imbalance moving so that their export based economy can keep humming along.

      But someday the US will have to face up to its competitiveness gap for once and for all. There are solutions to our problems. We just have to tackle them.

      Sadly enough our current government is only making the problem worse, but this will likely flip in the mid term elections back from left wing activism to gridlock.

    8. Jim Bennett Says:

      Repudiaton — partial, negotiated, and disguisd by inflation, but repudiation none the less — is in the cards. Obama saw supply-side Reagan run up the debt so that Democrats wouldn’t be able to afford the welfare state when they got back in power. It worked on Clinton. So he is trying to run up the debt so astronomically that taxes can never be lowered again. But the level of taxes needed to service the debt he will leave is so high that it will be politically unsustainable.

      Ross Douthat published a column not long ago saying that Republicans shouldn’t defend Medicare against Obama’s rationing plans, because Republicans need to be fiscally responsible. Wrong. If the Dems continue along Obama’s course and the Republicans fail to defend Medicare, it will just mean the political death of the GOP — it will be replaced by an opposition party that does defend Medicare. And the price of that will be some kind of repudiation.

      I’ve thought that somebody should start a Repudiationist Party and publish full-paage ads on the Financial Times and other major financial papers, warning bond-buyers that if they get elected, they will repudiate Treasury bonds. The US electorate will not tolerate European-level taxation or European-style rationing. Period. And the party that advocates either will be wiped out.

      If we are lucky, the repudidation will be partial, and negotiated. The entitlements gap will be addressed by a combination of raising the age of start of benefiit (the most rational approach) and very aggressive medical R&D to reduce the cost of old age. (Cure Alzheimers, and you reduce the number of seniors in nursing homes. Each condition you cure — and the cures are in the queue right now — shifts another chunk of seniors from dependence on nursing homes to active retirement in place.) Cure is cheaper than care, by a long shot.

    9. Phil Ossiferz Stone Says:

      You people are on drugs. The US has one of the very few solid gold credit ratings on the planet. Uncle Sam has NEVER defaulted on a debt. Ever. We may see some bad inflation and high taxes; we may see a contraction in our standard of living; but not ‘debt repudiation.’ Wall Street would shit a brick at the mere mention of the idea. So would Treasury.

      I swear to God, you guys with your nightmare right-wing fantasies about OMG OBAMA IS GONNA DESTROY AMERICA are a mirror image of the sort of paranoid BS we had to endure from the uberlefties under Bush. Get a GRIP.

    10. TMLutas Says:

      We’re what, a 14.3T economy? 1% of that is 140B. Change the regulatory regime to grow at 4% instead of the post WW II secular trend of 3% along with balanced budget fiscal discipline and the entire debt gets paid off in a generation, faster in fact than the debt was accumulated.

      It’s not inevitable that we default nor even go through a massive inflation. The question is what political changes are needed to increase our rate of growth and make fiscal discipline possible. That’s a little long of a topic for a comment but I think that rating federal expenditures so we create some sort of consensus “bottom 10%” of the federal budget would be a good start.

    11. JohnK Says:

      Jim Glass’s Six ways the U.S. won’t escape its national debt may be worth a look. He points out, e.g., that no amount of inflation will pay off the Medicare/Medicaid/Social Security debt, which dwarfs everything else.

    12. Jim Bennett Says:

      Phil, inflation is a disguised form of repudiation. It’s more likely repudiation will be disguised than overt. I suspect bondholders would prefer a form of negotiated repudiation, such as a refinancing into very long-term securities, than the general sloppiness of inflation. And such a refinancing would also be a disguised repudiation, because it would be done under the unspoken threat of overt repudiation.

      TM — “We’re what, a 14.3T economy? 1% of that is 140B. Change the regulatory regime to grow at 4% instead of the post WW II secular trend of 3% along with balanced budget fiscal discipline and the entire debt gets paid off in a generation, faster in fact than the debt was accumulated.”

      Well, yes. But nobody mentioned that we were talking rational strategies.

      Bottom line remains — the US political system will not sustain high taxes or a “substantial contraction of their standard of living.” Period. There will always be a political party that will offer an alternative.

    13. Jim Glass Says:

      John K, thanks for the mention.

      Good news: Krugman reviewed the debt situation two days ago and said he is “sanguine” about it. He compared 2019-29 to 1950-60 when the debt fell in real terms and said, don’t worry, be happy! Hey, a little debt never hurt Ozzie and Harriet.

      Bad news: Krugman reviewed the debt situation a while before that and said “I’m terrified! … we’re looking at a fiscal crisis that will drive interest rates sky-high … a looming threat to the federal government’s solvency … the conclusion is inescapable … the task is simply impossible … the fiscal train wreck has already begun.”

      A Krugman versus Krugman grudge match!

      Guess why the difference?

    14. Mrs. Davis Says:

      As the article points out, we will not tax ourselves out of this mess. Obama’s mistake has been to arouse the Jacksonians by his clumsy handling of health care, the only time they have been awakened by a domestic issue except the Civil War or the Great Depression.

      Much will happen between now and the time we have to face this problem. A problem resulting from boomers aging without a larger boomer generation coming behind. A problem that has been apparent since 1964 at the latest.

      Among the many things I expect to happen is a total war of greater proportions than WWII. As part of that war effort the boomers will release the nation from their claims upon it. And suffer their premature deaths in poverty. After that war the debt will be made good as subjects or offset against reparations, depending upon the outcome.

      Short of that, we are in deep wee wee. Phil, name all the republics or global hegemons that have endured over 400 years. And the UK cannot be said to have become a republic, if they ever have, before we did.

      The only way out short of war is for the claimholders to take a cramdown. To avoid a reduction in entitlements would be the first time the debt holders said, “We’ll take it all in the shorts and let the equity holder out whole.” No, the boomers are up wee wee creek without a paddle, one way or the other.

    15. tyouth Says:

      “Bottom line remains — the US political system will not sustain high taxes or a “substantial contraction of their standard of living.” Period. There will always be a political party that will offer an alternative.”

      Jim, after I read that all I could think was “war” of some sort (I don’t suppose one could rule out extreme domestic politcal upheavals of some sort – near war or war-light perhaps). Then Mrs. Davis expressed what I was thinking in the next comment. Did you have some other “alternative”s in mind?

    16. Brett_McS Says:

      This via Powerline is quite interesting, refers to another article outlining a shell game being (possibly) played by the Fed (who knows?).

    17. canada business Says:

      u see, business here- which we are talking about, and business there-up-quite different things-very different

    18. Jim Bennett Says:

      I don’t see a big war on the WWII scale on the horizon. Two words — nuclear weapons. Once nuclear weapons are used again (sometime in the next decade, possibly) people are going to be much more circumspect about hostile actions against nuclear powers. People have become complacent lately. I’ve just spent eight months studying scenarios for wars using Hiroshima-sized air-delivered bombs (basically, US-USSR wars circa 1951-53) and it’s a dangerous place to be – -small enough to consider using, big enough to do nasty damage. There are maybe three or four places on the planet where such a war might break out in the next decade. Deterrence ought to prevent that. Ought to. Deterrence requires rational actors with good judgment and good information on both sides, who don’t have an apocalyptic death wish. Let’s cross our fingers.

      I do think that there will be some cuts in benefits, by the way. But the Obama strategy — fold Medicare into Teddycare (effectively) and then ration — won’t work. It is true that the Jacksonians have been roused. I foresee another giant cheese in the White House. The two ways most likely to happen will be raising the age of eligibility more radically than has been done to date, and changing the formula for inflation adjustment. This would come in tandem with some cramdown for bondholders — refinancing into very-long-term bonds is the most likely.

      Th most rational strategy is aggressive productivity enhancement, either through deregulation or aggressive R&D, hopefully both. Kling mentions this, but he should have discussed particularly aggressive R&D on medical issues related to high-cost aging conditions. That’s the real wild card in the deck and we should be playing it.

      We can avoid apocalyptic scenarios if we can defeat the irrational strategies on the table and play from our strengths for a change. The next few years will tell a lot.

      And, by the way, what matters is that the hegemon is a constitutional state with effective representation, not formally a “republic”. Britain became that more than any other contemporary state after 1688, substantially after 1832, and even more so after 1888. So the world has had a commercial hegemon pretty much since 1700, and it’s been using the same toolkit and rulebook since then, applied first from London, and more recently from New York and Washington. So from the viewpoint of the rest of the world, it’s been the same hegemon.

    19. Jonathan Says:

      -A gradual redefinition of the terms of Medicare and Social Security might be the path of least political resistance.

      -The central problem is that, while we can grow our way out of debt, our leaders are hostile to pro-growth govt policies and are actively promoting anti-growth policies (including by borrowing so much to fund boondoggles and outright corruption as to make it difficult for businesses to raise capital for productive purposes).

      -Under previous administrations deficits were politically useful because they encouraged restraint in govt spending. That was then. It seems clear that the current administration and Congress are determined to ram through as much govt spending as they can before they are stopped, in the hope that political ratchet effects will prevent the new spending programs from being canceled and will thereby insure a large and permanent increase in the size of the federal govt. It may be that the only way for the voters to block their leaders’ plans will be by turning over a substantial number of House and Senate seats in 2010. (In a perfect world we might replace the entire Congress.)

    20. Jim Bennett Says:

      “-The central problem is that, while we can grow our way out of debt, our leaders are hostile to pro-growth govt policies and are actively promoting anti-growth policies (including by borrowing so much to fund boondoggles and outright corruption as to make it difficult for businesses to raise capital for productive purposes).”

      Yes. This is the real issue. The last thing the Republicans (or whatever the anti-big-government party is going to be) need to be doing is to be the people who come in and clean up the messes left by the statists, by administering the political pain. That’s why Ross Douthat was so off-base in his comments on Medicare. Our job is to focus attention back onto the real solution — we should accept no reform measures in entitlements unless they are accompanied by progress in growing the economy. And sure as hell no tax raises.

    21. tomw Says:

      Jim Glass:
      Krugman versus Krugman grudge match!

      Guess why the difference?

      Lack of integrity. [or character if you prefer]


    22. TMLutas Says:

      Who was it who said that once Americans exhausted all the other options, we always did the right thing? We’re going to take a great deal of time to get there but we are going to do the right thing. We have the means to do it and the price of going off the hyperinflation cliff is simply too high.

    23. Jonathan Says:

      Jim Bennett:
      Our job is to focus attention back onto the real solution — we should accept no reform measures in entitlements unless they are accompanied by progress in growing the economy. And sure as hell no tax raises.

      The Pete Peterson Republicans are again coming out of the woodwork to promote entitlement reform (usually in the least imaginative way, as benefit cuts without fundamental restructuring or privatization) and tax increases, all as “debt reduction”. These people were wrong the first time around, when they peddled tax increases and spending cuts as the alternative to spending cuts and growth incentives, and they are still wrong. The Democrats under Clinton, after 1994, co-opted their rhetoric brilliantly, to rationalize keeping tax rates high (“deficit reduction”, “pay down the national debt”). What was missing was someone to make an effective Reaganite counterargument about how, rather than taxing capital away from our most productive people so that the govt could pay down 4% debt, we should cut tax rates to leave capital in the hands of people who would use it to gain returns orders of magnitude higher than 4%. Then everyone would become wealthier and paying off the govt debt would be no problem. But instead the wrong arguments are made over and over by people who either don’t understand investment and productivity or are socialist control freaks who don’t care about investment and productivity.

      We need to reduce govt spending and regulation, reduce tax rates and reduce political uncertainty. If we can do these things to a significant degree we will have nothing to worry about.