Blog Post: Can a country default on its debts? Can the US?
Posted: Mon Feb 02, 2009 4:26 pm
John, I take your main point in this post to be: the U.S. cannot and will not inflate to pay off its debts; instead it will be forced to default on them.
After ridiculing people who think differently, you get down to explaining why you think this is so:
"The dollar is the world's reserve currency, and many, many trillions of dollars are held by people, businesses and governments around the world. This effectively means that it's politically impossible to inflate the currency to reduce the debt. "
You argue that the U.S. couldn't inflate the dollar supply because all those people holding dollars would be angered. What about all the people holding the Treasuries that would be defaulted on? You don't think there'd be some focused anger there? Political power is influenced by small committed groups or individuals with the resources to lobby and affect the politicians. The holders of Treasury debt are some of the most powerful institutions and individuals in the world. Do you think the political power of the masses, most of whom do not understand inflation anyway, is going to be enough to offset the political power of these Treasury-holding powerbrokers? I don't.
You argue that if we were going to inflate away the debt, why haven't we done it already? Well of course there are negative repercussions to inflating away the debt and there would be no point in doing it lightly or before being forced to because no one would buy anymore debt. So far the market has happily soaked up all the new Treasury debt being offered - so much so that rates are at historic lows. There's no need so far to engage in "quantitative easing", i.e., printing money, because so far there are takers for the new Treasury debt.
But when the amount of borrowing that needs to be done starts to exceed what the market wants to soak up, rates will start to rise - and then the Fed will start buying the excess Treasuries with printed money. I cannot foresee a situation where the Fed would sit by as new Treasuries were offered, and not bought up, and do nothing so that the debt has to be defaulted upon. And that is what would have to happen - the government would have to need to borrow more money than the market would want to buy, and the Fed would have to refuse to step in. Interest rates would skyrocket to the moon, business activity would crater as all available funds went to feed the high-interest-paying government borrowing, the total debt would start to grow exponentially to the point where the interest payments would be greater than what is taken in in tax revenues in a year, and the economy would collapse.
That will not happen. And besides the political power of the bond-holders, the reason it won't happen is because the U.S. is in the enviable position of owing debt to the rest of the world denominated in U.S. dollars, the supply of which it controls. It's different for a country that owes money denominated in someone else's currency - then default really is the only option unless someone with a lot of that currency (the U.S., the IMF) comes along to bail them out. Printing is not an option if the debt is in some other currency. But in our case we can print our way out of debt.
And printing is a much more politically pallatable option than default. Printing can be done gradually, relatively quietly. No single great printing event need alert people to trouble. A default however, is earth-shaking. It immediately throws the confidence in the country out the window.
According to your reasoning, no country would ever inflate in this situation. Because every country has holders of its currency who would be hurt by the inflation, so according to your reasoning, it should be politically impossible for any country to ever inflate. Yet they do, all the time.
A year or two ago we exchanged some emails where I predicted that because there is no real sense of fiscal restraint or respect for real capitalism and the free market's price signals left in our government, the government's response to the approaching fiscal crisis would be to bail out and nationalize companies and industries left and right. You ridiculed that idea, saying the government would never nationalize. Well that's just what's happened on a trillion dollar scale. And they're not done yet.
Already, in the last couple of Fed announcements, they've said they will consider buying long-term Treasuries - i.e. "quantitative easing", i.e. printing - if necessary to keep rates low. That is what will happen. When the government has to borrow the trillions of dollars they need this year, the Fed will step in to print in order to keep the rates down. They will do it in the hope that later on they can withdraw that printed money again before it causes inflation. But the exponential growth of the debt of the government will prevent it from ever being paid back and thus allowing the Fed to withdraw the printed money again. The printed money will be spent by the government on the massive pork programs Obama and the Democrats are planning, dispersed around the economy, and result in growing inflation especially as the supplies of goods for sale decreases as businesses go bankrupt.
----------------
On an unrelated note, may I offer a suggestion for the organization of your forum: create a new category for discussion of your blog posts, with one forum topic for each blog post you make so that we have somewhere specific to post our comments about your blog post. Otherwise it has to go into some other existing category and gets lost.
Best Regards,
Mark
After ridiculing people who think differently, you get down to explaining why you think this is so:
"The dollar is the world's reserve currency, and many, many trillions of dollars are held by people, businesses and governments around the world. This effectively means that it's politically impossible to inflate the currency to reduce the debt. "
You argue that the U.S. couldn't inflate the dollar supply because all those people holding dollars would be angered. What about all the people holding the Treasuries that would be defaulted on? You don't think there'd be some focused anger there? Political power is influenced by small committed groups or individuals with the resources to lobby and affect the politicians. The holders of Treasury debt are some of the most powerful institutions and individuals in the world. Do you think the political power of the masses, most of whom do not understand inflation anyway, is going to be enough to offset the political power of these Treasury-holding powerbrokers? I don't.
You argue that if we were going to inflate away the debt, why haven't we done it already? Well of course there are negative repercussions to inflating away the debt and there would be no point in doing it lightly or before being forced to because no one would buy anymore debt. So far the market has happily soaked up all the new Treasury debt being offered - so much so that rates are at historic lows. There's no need so far to engage in "quantitative easing", i.e., printing money, because so far there are takers for the new Treasury debt.
But when the amount of borrowing that needs to be done starts to exceed what the market wants to soak up, rates will start to rise - and then the Fed will start buying the excess Treasuries with printed money. I cannot foresee a situation where the Fed would sit by as new Treasuries were offered, and not bought up, and do nothing so that the debt has to be defaulted upon. And that is what would have to happen - the government would have to need to borrow more money than the market would want to buy, and the Fed would have to refuse to step in. Interest rates would skyrocket to the moon, business activity would crater as all available funds went to feed the high-interest-paying government borrowing, the total debt would start to grow exponentially to the point where the interest payments would be greater than what is taken in in tax revenues in a year, and the economy would collapse.
That will not happen. And besides the political power of the bond-holders, the reason it won't happen is because the U.S. is in the enviable position of owing debt to the rest of the world denominated in U.S. dollars, the supply of which it controls. It's different for a country that owes money denominated in someone else's currency - then default really is the only option unless someone with a lot of that currency (the U.S., the IMF) comes along to bail them out. Printing is not an option if the debt is in some other currency. But in our case we can print our way out of debt.
And printing is a much more politically pallatable option than default. Printing can be done gradually, relatively quietly. No single great printing event need alert people to trouble. A default however, is earth-shaking. It immediately throws the confidence in the country out the window.
According to your reasoning, no country would ever inflate in this situation. Because every country has holders of its currency who would be hurt by the inflation, so according to your reasoning, it should be politically impossible for any country to ever inflate. Yet they do, all the time.
A year or two ago we exchanged some emails where I predicted that because there is no real sense of fiscal restraint or respect for real capitalism and the free market's price signals left in our government, the government's response to the approaching fiscal crisis would be to bail out and nationalize companies and industries left and right. You ridiculed that idea, saying the government would never nationalize. Well that's just what's happened on a trillion dollar scale. And they're not done yet.
Already, in the last couple of Fed announcements, they've said they will consider buying long-term Treasuries - i.e. "quantitative easing", i.e. printing - if necessary to keep rates low. That is what will happen. When the government has to borrow the trillions of dollars they need this year, the Fed will step in to print in order to keep the rates down. They will do it in the hope that later on they can withdraw that printed money again before it causes inflation. But the exponential growth of the debt of the government will prevent it from ever being paid back and thus allowing the Fed to withdraw the printed money again. The printed money will be spent by the government on the massive pork programs Obama and the Democrats are planning, dispersed around the economy, and result in growing inflation especially as the supplies of goods for sale decreases as businesses go bankrupt.
----------------
On an unrelated note, may I offer a suggestion for the organization of your forum: create a new category for discussion of your blog posts, with one forum topic for each blog post you make so that we have somewhere specific to post our comments about your blog post. Otherwise it has to go into some other existing category and gets lost.
Best Regards,
Mark