Jeffrey Rogers Hummel lays out a pretty solid case for saying that the US government will let down international borrowers, and fairly soon. This is not a new or original argument, but he does so with great aplomb. Definitely worth a read.
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The coming debt blowup by the US governmentAugust 20th, 2009 |
 26 comments to The coming debt blowup by the US government |
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Hummel may be being needlessly technical: if Congress is willing to issue more debt than taxpayers are willing to pay for (and so far, Congress has been infinitely willing), then at some point repudiation is inevitable. The real question is “at what point?” and lately the natives have been getting restless.
As I’ve said before, a frank call to repudiate the debt may be the only thing that can keep Congress from borrowing us into the poorhouse.
Sovereign default by the USA or UK is the last best hope we have for a brighter future and I have never been more optimistic that it is a realistic possibility within my lifetime 🙂
Not only is Hummel “needlessly technical”, by putting that entended (and somewhat erroneous) discussion of “seigniorage” at the beginning of the article he weakens his case. Bank reserves are either cash in the vaults (which is not government debt) or cash on deposit with the Fed (which is already “government debt”, in a sense). In neither case does permitting the Fed to pay interest on those mandated reserves increase debt. It does slightly increase the total amount of interest payable by the government, but since the rate is 10 basis points less than the current Fed Funds rate, which today works out to a payment rate of 8 basis points (that’s 8 one-hundredths of one percent), it’s a nominal amount. We have far bigger problems than that.
Hummel’s far more interesting point (which is not original with him) is pointing out the apparent structural ceiling on the amount of total revenues the US population is willing to pay to its federal government. Since WW2 that has hovered right around 20% of GDP. That’s over a period when marginal personal interest rates have varied between a high of 90% and a low of 31%, corporate tax rates have fluctuated greatly (even including periods of a “windfall profits tax”), capital gains have been alternatively punished or rewarded, minimum and alternative minimum taxes have come and gone, and we have seen a bewildering array of deductions, credits, changes in depreciation schedules, etc., etc. What that says is that it doesn’t matter* what the tax rates are, the government gets only 20% come hell or high water. It is spending which is the problem, and that’s not going to be controlled until we suffer an economic collapse.
So I think Hummel’s conclusion is correct: US debt repudiation is inevitable, because until a large percentage of Congress has been strung up from lampposts they won’t cut back on Medicaid and other such programs. We will screw the Chinese (and all other foreign holders of our debt) before we will inflict pain on our own citizens, but doing so will provide only temporary relief. Once we have defaulted the debt window will slam shut, and the government will be forced to live within its means. And then there will be rioting in the streets.
* In a macro sense; of course it matters to the individuals being taxed.
Anecdotal., I’m afraid. But.
Go to any where in Europe that used to have its’ own currency and if you were from the UK you enjoyed a cheap holiday. I know, I know: this is not up to the usual standards of Samizdatae but think for a momont (ce n’est-pas Le Frog mais peut-etre c’est right), 2 years ago I could have subscribed to a European website for £37 pounds and now it will cost me 54 Euro/pounds.
One thing I have not read on your or other sites is that the pound is being slowly devalued.
I look forward to yous(Scotch Plural Second Person)all catching up.
STB.
While I do agree that sovereign default by the US will likely come, I think Hummel has fallen in the trap of choosing “one of the following” among inflation, dollar collapse, and debt repudiation. The incentives that make politicians tick suggest that we will have “all of the above”.
The US government has already demonstrated abundantly that the value of the dollar is not its priority; the standard line by Treasury secretaries “a strong dollar is in the interest of the US” became a joke long ago.
Inflation of Zimbabwean proportions will not have time to develop. Too many wealthy and politically connected Americans are too invested in dollar denominated financial assets. When inflation begins to hit and surpass the 70’s levels, politicians’ will begin to lose their jobs before the citizenry with torches and pitchforks get to them.
That’s when talk of default will become loud, and enter the mainstream. The value of dollar bonds will tank (even further than a weak dollar and rising inflation will have pushed them), and government borrowing will become prohibitively expensive long before an actual default. The social upheaval will precede the default, unless the default is precipitated by some cataclysm like a world war.
I am not hyperventilating in the grip of a bad LSD trip talking about a world war, although I hope I am this deluded. A depression in the US will mean a global depression – look at the world economy right now, and the US consumers have not stopped consuming, they just slowed down a bit. Yet every primarily exporting nation (China, South Korea, Japan, EU (Italy, Germany, France)) took a hit to GDP unseen in decades. Extrapolate that to when the US consumers, even if they wanted to spend, would have only useless green paper to do it with. And economic hardship brings wars… the anger of the masses must be directed outwards, and politicians will oblige.
There will be, of course, intermediate steps in the process. For example (see here), the US will stall for a while by issuing “inflation-protected” debt. In a rational world, that should not work, but for a while it will, until the crashing dollar cancels out the inflation hedge embedded in TIPS.
This post probably became too disjointed, but the brief recap is: default, Zimbabwean-scale inflation, or $1000/yuan are the death of the US political class in equal measure, and since default is a binary event, while inflation and exchange rates are continuous variables, the latter two will be the ones that will be let slide enough that the damage will make the default unnecessary, or if indeed declared, expected and relatively inconsequential.
I do hope someone can give me a scenario which I am missing.
Plamus, the optimistic scenario is that present and near-future talk of defaulting scares potential lenders away, and the debt load that makes defaulting necessary never develops because the US government can’t find anyone willing to lend to it.
So, of course, it begins to print money overtime….
I agree with you, Plamus, that “all of the above” is a likely scenario. Where I disagree is with the idea that social upheaval will precede the default.
The US government’s cost of borrowing is not going to gradually creep up to intolerable levels as the market senses trouble brewing and starts demanding a “default premium”. Everyone “knows” that Treasurys are “riskless”; what central banker (and they are the primary buyers of our bonds) would dare say (or is even capable of thinking) otherwise? That would require an overt adverse action by the rating agencies, and do you really believe that either Moody’s or S&P is going to downgrade Treasurys? Which one of them would have the courage to go first? They can barely bring themselves to downgrade insolvent municipalities, and you expect them to state publicly that the emperor has no clothes? They’re already reeling from the criticism they’ve received over their role in the “subprime crisis” that precipitated the current recession; downgrading Treasurys even to “AA” would bring down the government. They’d be accused of treason; they’ll go down with the ship first.
Sovereign defaults always seem to catch the professional investor class napping; witness the Russian default in 1998, or the various South American ones in the 60’s. Central bankers (who frankly don’t seem too bright) are unwilling or unable to believe that any government would repudiate its debt. When the default happens, it will have been preceded by soothing words from the Treasury Secretary, and then will occur without warning, probably over a weekend. It is only then that the debt window will slam shut, and further borrowing become impossible. That’s when we’ll see the social upheaval. Time to lay in a supply of rope and pitchforks.
Laird, your scenario is certainly plausible. You are correct that central banks are important players in the dynamic. Where I can see this pattern of blindly buying US debt breaking down is the point where printing local currency in order to keep it low, and local exports competitive, jacks up local inflation to the point where local populace becomes restless. Many of them are already looking in quiet horror at the pile of US bonds they have – hence the recent moronic talk about replacing the dollar with a global currency. Like you, I do not hold central bankers in much higher respect than Paris Hilton, but more to the point, I try to remember that central bank independence is a carefully maintained myth. When governments feel under pressure by unhappy, unemployed poor and unhappy middle classes whose wealth is melting away, free trade is one of the first to go out the window, and with it the urgent need to maintain weak currency. I expect this to happen in China, for example, before it does in the US, thus short-circuiting the debt binge before the explicit default.
I am not so sure about the importance of the credit agencies – they seem to be caught napping by sovereign defaults (or any other defaults) as often as big investors, and their downgrades (or even threat of, as in placing a security on watch negative) usually arrive so late as to accomplish nothing but demonstrate a firm grasp of the blindingly obvious. They are already dancing around the issue you point out by hedging their bets and saying that some animals are more equal than others. This was in effect a downgrade for the US (and UK, and Spanish, and Irish) debt back in January – “the USA is AAA, but not as AAA as a slew of others”. No one noticed. Grade inflation is a fact of life not only in education.
I am also a bit leery of looking at historical defaults for insights into the Big Kahuna. Defaults by Latam countries are a known unknown, mostly priced in at inception, and mostly hurt a few rich folks around the world. The Russian default actually enriched Russia’s nouveau riches, allowing them to snap even more companies at rock-bottom prices, and the general populace was already poor, so had nothing to lose. The world bond markets got scared for a few months, then shrugged and continued business as usual. A US default will dwarf the Lehman default by several orders of magnitude, the real game-changer. Overnight, there will be virtually no capitalized banks in the world left over. This alone will make the US government postpone a formal default until it is virtually meaningless – “We owe you what, $1trln in interest? Here it is, just wired it. Go buy yourself a box of Kleenex with it and weep.”
I wonder if Gordon Brown is thinking ‘All our economy has to do is last one breath longer than the US economy’.
You could certainly be right, Plamus: US currency debasement could become so severe as to render a formal default* anticlimactic. Time will tell. Still, my thought is that the bright lights at the Treasury** are going to say to themselvs “Hey, when other nations have defaulted on their debt the markets fretted for a while but then started lending again, so no long-term harm done” and decide to do so before hyperinflation kicks in. They won’t appreciate the fact, as you have pointed out, the a US default would be a game-changer.
Incidentally, I mentioned the 1998 Russian default not to talk about its effects, but merely to point out that, as far as I can tell, no one saw it coming. A US default would be the same, because the market is willfully blind with regard to sovereign debt, especially from major countries.
I wonder how many Treasurys Paris Hilton is holding in her portfolio?
* It is interesting to speculate on the form a US default would take, i.e., whether it would be a simple skipping of an interest payment or a full-blown repudiation of debt. My guess is that it would be the former followed quickly by the latter. Your thoughts?
** Where did Geithner get a reputation for intelligence, anyway? I mean, he’s not a world-class moron like Harry Reid, but he’s not some financial genius either. Frankly, I think I’d rather see Larry Summers in that job.
Aargh! Smited! You’ll just have to wait for my latest pearls of wisdom.
Hm, good question about the form of the default. I am not an expert on constitutional law, but I surmise that the decision to wire the next interest payment is cleared at the Treasury level, while a formal repudiation of debt may require an act of Congress. If that is so, a lot will depend on who is in control of the White House and the two chambers of Congress, what level of cooperation there is among them, what the level of public support for either of the two moves is, etc. I can see an uncooperative Congress trying to score political “survival” points by refusing, at least temporarily, to play ball – “See, they did it!”, but there are too many unknowns for anything but a lucky guess.
As for Geithner… I do not recall where I had seen this (may have been here on Samizdata), but it’s worth reading. The guy is a weasly, talentless bureaucrat who excels at riding coattails. I have no respect for him professionally.
Good article; thanks for sharing it.
A bit O/T, but this song about Ben Bernanke always makes me laugh. Maybe someone can make one about Geithner?
Both the Federal Reserve Board and the Bank of England are already buying government debt (with money they create out of nothing) and have been doing so for some time.
This is “monetarizing” (spelling alert) the debt – the very thing they swore (so passionately) that they were not going to do.
It is default in all but name – and, I repeat, it is already happening and has been going on for some time.
“But it is only short term – they plan to bring things back into balance”.
B.S.
Neither government has any real plans to bring government spending under control (indeed the American government is planning yet more spending – and such “economists” as Krugman and Stiglitz are demanding yet more still).
“Taxes”
Increasing tax rates on the wealthy will bring in next to nothing – and will actually REDUCE revenue over the next few years.
As for the “crackdown on tax evasion” – this is about POWER not getting revenue.
Look at the deal with Switzerland – it is about saying “we can get your name if we really want it – so you had better play ball with us politically, say a nice donation to some ACORN type group”.
That is politics today – and is one reason why so many of the super rich donate so much money to the left (not that it will save their skins of course).
The current financial situation in the US is not sustainable. The major entitlement programs already in operation, such as social security and medicare/medicaid, will go bust sometime over the next few decades.
Any new programs, such as Obamacare, or other major entitlements as yet only proposed, but not enacted, will only hasten and make more severe the collapse.
The last several administrations have operated under the assumption that the wealth of the country was some sort of magical spring which could never go dry, but would always refill itself to satisfy any requirements the various levels of government might make of it.
Various states within the country are now experiencing the consequences of this kind of thinking, as the businesses which create jobs and wealth either close up or leave their high tax/poor services environments for more open spaces, either foreign or domestic.
If the current political viewpoint acsendent in the country remains the general approach, one of the major effects our various allies and friends around the world will notice soon is that the US is drawing down its military forces, and will no longer be able to be relied upon for major efforts in situations of mutual assistence and military aid.
Many around the world have been asking for exactly that, especially in Europe. You are going to get your wish over the next several years.
At some point in the near future, when threatened by agression or terrorism by any of the ususal suspects, the response of the US will be “Good luck and godspeed.”
You asked for it, you got it.
I don’t disagree with any of veryretired’s specific points, but from the last part of his post I infer that he thinks that for the US to “draw down” the worldwide deployment of its military forces would be a bad thing. If my reading of that is correct, then I do disagree with him there.
Many of us have argued for a long time that the US government shouldn’t be spending our tax dollars being “the world’s policeman”, let alone in trying to force our brand of governance on the rest of the world. NATO outlived whatever utility it may once have had when the Berlin Wall fell and the Soviet Union collapsed; we should withdraw from it and remove all of our troops in Europe. Same with SEATO (if it even still exists and which, as far as I can see, never had any utility). Japan can defend itself, as can South Korea. Bring all those troops home, and muster them out of the military; you* can fight your own fights. And also abolish the purile joke which the UN has become. Please.
In fact, the US is the largest market in the world, and the dollor is (at least for now) the world’s de facto reserve currency. Our collapse would be terrible for us but a total disaster for you. If anything, you should be defending us.
* I don’t know veryretired’s nationality, so this isn’t directed to him personally; when I use “you” here it is intended to mean everyone outside the US.
Laird, my own very idiosyncratic take on NATO is that, by co-opting Europe’s militaries, it kept the European powers from indulging in their usual “Twenty years of sophisticated diplomacy and a mutual lunge for the throat” foreign policies. A European war would surely have invited Soviet intervention ‘to stabilize the region’, whereas a straight war of conquest was never very likely.
By now, of course, Europe is sufficiently detesticate that NATO is no longer needed.
I think I agree, PFP, but I don’t know what “detesticate” means. Perhaps you meant to write “domesticated”? Or is it something deeper than that?
Laird, not deeper, just, um, lower…
Ah, now I take your meaning!
Ah, a new word for an old condition—either way it makes me shiver.
I’m not sure what Laird is reading into my comment, so I will try to clarify without overly abusing the courtesy of our hosts with another too-lengthy post.
Nato has been meaningless for quite some time, and the idea that the US would risk itself for the safety of Germany or France any longer is delusional. Their relentless anti-Americanism and slanderous backstabbing at every opportunity makes the prospect even more repugnant.
Between their own demographics, and the longing gazes aimed their way by the new Russian aristocracy, there’s not much future to save anyway. Moslem dhimmi’s or Russian vassals, either is better than they deserve.
It’s a shame about the eastern European states that have demonstrated some true desire for a strong relationship with the US, but geography is what it is, and the relatively strong isolationism found in Laird’s comment is widespread in the US now.
Defense of one’s own is a proper function of the state, and I am loath to join those who call for the US to disarm itself in a hostile world, regardless of their oh-so-proper libertarian anti-militarism.
I believe the US still has strong allies, and significant interests in the pacific and Asian regions, not only in trade, but as regards the continuing aggressiveness of islamic jihadists.
China and India are natural allies in this latter regard, and further interaction may improve their current statism towards a more open system, but only if the US can provide an example of less, not more, state intervention. That certainly will not occur under the current regime.
While I would love to see the long overdue redeployment of troops from Korea, in the current circumstances it would appear as one more instance of appeasement, and, therefore, must be delayed a while yet.
As much as it appears a burden to continue to guarantee the security of Japan, it is very much in the interests of the US to prevent any aggressive actions either by or toward Japan.
Disarmed, it would prove an overly tempting apple on a low branch hanging near the Chinese, and re-armed, it would immediately antagonize, if not actually threaten, the several countries nearby which have frequently been the object of Japan’s overly ardent desires.
The best world would have pacifistic and disarmed cultures in both Germany and Japan, but one out of two may be the best we can do at this point.
There are no perfect choices in this, as in many other areas of international relations. Better to be so strong that none dare attack, than weak and inviting repeated predation.
I have not mentioned many aspects of these questions, in Europe, Asia and the Western Hemisphere, that would be covered if I was writing a thesis or a book. I had hoped to keep this comment from becoming either.
Thank you for that explanation, PFP. I think you and are are largely in agreement (I am no anarchist). With respect to Korea, however, I don’t understand just whom you think we would be “appeasing” by a withdrawal of our troups. Certainly not China. North Korea? Perhaps, but so what? South Korea is more than capable of defending itself these days.
Japan is, too; its military forces may be called “police” but they are nonetheless very potent. Japan has long outgrown its military expansionist tendencies. It is a westernized, capitalist nation now, and we are as far from its WW2 atrocities as we are from Germany’s. Three generations is long enough for everyone to have gotten over it.
I agree with your point that there should be natural affinities between the US and both India and China, but those are commercial in nature. Reciprocal trade is a better guarantee of our mutual security than is military posturing, especially the sort conducted through proxies. So I’m still for bringing home all those troops, although I understand that it needn’t happen overnight. We can announce our intentions and gradually reduce our asian troop strength over a period of time, perhaps five years. That would give the region time to adjust to the new dynamic. (And I never said that we couldn’t keep a few nuclear subs cruising around in secret, just in case.)
And in any event, the troops in Europe should all be home by this Christmas.
US debt default is long-range, the more immediate issue will be when people ’round the world start not accepting dollars—the dollar loses its privileged status as the world’s reserve currency. Already straws in the wind, and more, from China, Russia, and others. When it happens, it’ll happen quite suddenly, not because of conspiracy but because as soon as it is known that a major player (govt or corporation) has lost confidence, everyone will head for the exits. Much like a bank run.
This will happen by surprise, tho after the fact it will seem predictable (like Northern Rock or Bear Stearns or Lehman). It’ll develop over the course of a few days, couple of weeks at most, and then we enter the brave new world. The US won’t be able to keep running $700B trade deficits, which will threaten to knock the props from under China as well as an instant 5% reduction in the US economy, and the rest of the world will scramble to figure out how to deal with existing dollar-denominated contracts and to find an alternative.
US debt default is long-range, the more immediate issue will be when people ’round the world start not accepting dollars—the dollar loses its privileged status as the world’s reserve currency. Already straws in the wind, and more, from China, Russia, and others. When it happens, it’ll happen quite suddenly, not because of conspiracy but because as soon as it is known that a major player (govt or corporation) has lost confidence, everyone will head for the exits. Much like a bank run.
This will happen by surprise, tho after the fact it will seem predictable (like Northern Rock or Bear Stearns or Lehman). It’ll develop over the course of a few days, couple of weeks at most, and then we enter the brave new world. The US won’t be able to keep running $700B trade deficits, which will threaten to knock the props from under China as well as an instant 5% reduction in the US economy, and the rest of the world will scramble to figure out how to deal with existing dollar-denominated contracts and to find an alternative.
Actually, I’m quite proud of “detesticate.” Not every new word in English should come into being through typos in the MSM.
Getting rid of the entire United States military (some 4% of G.D.P.) will not save the fiinances of the United States even in the short term. Between them Bushbrain (accidentally) and Comrade Barack Obama (deliberately) have seen to that. Although it would hand over Europe to Putin and Asia to the People’s Republic of China – not good.
But then the Pentagon is not even bothering to buy F22s (because they are not useful against terrorists in Afghanistan) so it is going to be little help against (say) China in a few years anyway.
As for default – as I have already said…..
It is already happening – if you “monetarize the debt” (i.e. create money, out of thin air, to buy up government debt with) that is a de facto default.
And both the British and American governments (via the Central Banks) are doing this.