America’s Fiscal End Game: Debt Repudiation?

I’ve always envisioned the fiscal end game of the federal government as similar to the fate of, say, Circuit City, where creditors simply stopped lending to it because they no longer believed they would get repaid. The federal government cannot “go out of business,” however, so national leaders would have to soldier on, slashing spending to match the level of incoming revenue, regardless of the social or economic cost.

But the federal government does have options that Circuit City never had. Among those options: inflating the currency and/or repudiating the national debt. Economists are beginning to seriously explore these end-game scenarios.

One example is “Why Default on U.S. Treasuries Is Likely,” by Jeffrey Rogers Hummel, an economics professor at San Jose State University, writing in the Library of Economics and Liberty. Writes Hummel: “I believe … that the United States will be driven to an outright default on Treasury securities, openly reneging on the interest due on its formal debt and probably repudiating part of the principal.”

Hummel doubts that the government can inflate its way out of its dilemma: “Today’s investors are far savvier and less likely to get caught off guard by anything less than hyperinflation.” Unfortunately, he doesn’t fully explain the point. My argument is that financial capital is so hyper-mobile that investors will respond to any strong whiff of inflation by shifting capital to other nations that offer better risk-reward ratios. Any benefit of inflation to the federal government would be short lived. I suspect that Hummel would agree.

Regardless, as the U.S. approaches the financial end game some 15, 20 or 25 years from now, our central bankers undoubtedly will try the inflation strategy out of pure desperation. Thus, we can predict that the final meltdown will be accompanied by inflation, capital flight, a plunging dollar and skyrocketing interest rates as investors demand compensation for higher risk. However, we can be equally certain that an inflation gambit will buy only a few months or years of respite.

One other solution would be to raise federal taxes from the 20%-of-income level that has prevailed since World War II to something approaching European levels. Hummel is skeptical that will happen. Public resistance to higher taxes is so intense that politicians will follow the path of least resistance — borrowing — until investors foreclose that option. I tend to agree.

Of course, debt repudiation is a stop-gap solution, too. Repudiating principle or interest payments on our national debt might bring down the cost of carrying that debt, but it also means that no one will lend anymore money. In sum, no matter what flailing acts of desperation the federal government is driven to, the end result eventually will be the same: A drastic curtailment of the size of the federal government with all the disruption and pain that implies.

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8 responses to “America’s Fiscal End Game: Debt Repudiation?

  1. "Among those options: inflating the currency and/or repudiating the national debt."

    Tell me. Is there any national government anywhere that has NOT cone one or the other?

    This isn't a fiscal crisis, it is the natural order of how governments do business: they print money.

    But even if our money is wampum, we wil still do business and good businesses will make money.

    What happens to employees, is another matter.

    RH

  2. speaking of accountability, lest we forget:

    " For his first annual budget next week, President Obama has banned four accounting gimmicks that President George W. Bush used to make deficit projections look smaller. The price of more honest bookkeeping: A budget that is $2.7 trillion deeper in the red over the next decade than it would otherwise appear, according to administration officials."

    http://www.nytimes.com/2009/02/20/us/politics/20budget.html

    Now, I'm NOT making this about Bush nor Obama but I AM pointing out that almost 3 Trillion of the current projected deficit was there all along – but not accounted for.

    so when you add that in right now.. as it should be – it leaves the impression …a wrong impression that it just now popped up as part of the deficit when ..it was there all along… and "we" ignored it.

  3. Maybe it's time to bring back the "Readjusters." They had a good ride for a few years in Virginia in the late 19th century.

    And I do like more transparency in government. I'd also like to see some imposed on WMATA and MWAA.

    TMT

  4. Here's a plausible worst case scenario.

    Just replace Argentina with USA:

    " The Argentine government met severe challenges trying to refinance the debt. Some creditors denounced the default as sheer robbery. Vulture funds who had acquired debt bonds during the crisis, at very low prices, asked to be repaid immediately. For four years, Argentina was effectively shut out of the international financial markets.
    Argentina finally got a deal by which 77% of the defaulted bonds were exchanged by others, of a much lower nominal value and at longer terms. The exchange was not accepted by the rest of the private debt holders, who continue to challenge the government to repay them a greater percentage of the money which they originally loaned. The holdouts have formed groups such as American Task Force Argentina to lobby the Argentine government, in addition to seeking redress by attempting to seize Argentine foreign reserves."

    http://en.wikipedia.org/wiki/Developing_countries'_debt

  5. Jim,
    The guy you cite is from a Libertarian group– the Liberty Fund Inc. I might suggest you try to broaden your stable of economists to get more interesting conflicts. If you write based only on Libertarian groups, you'll be about as thought provoking as the op ed in the R Times-Dispatch.Ugh!
    Peter

  6. But Peter, that's why I like having *you* contribute to the Rebellion. I couldn't stomach quoting Paul Krugman, but I know that you could!

  7. Jim,
    There's more to life than the over-exposed Paul Krugman.
    Peter Galuszka

  8. what a mess! I see no good way for this to end… and I can't see it taking as long as you suggest but other than that I agree absolutely. Why does it have to come to this?

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