Home > Economics - General > The Ultimate Nightmare: American Default

The Ultimate Nightmare: American Default

October 4th, 2013

That’s the self-explanatory headline on my latest piece in The National Interest. I guess “ultimate” is a little hyperbolic, given the perils of nuclear war and climate catastrophe, but even a short-lived default on US debt could bring the global financial system to its knees.

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  1. Ken_L
    October 4th, 2013 at 11:51 | #1

    Another GFC might be a price worth paying if it helps transform the global financial system to one with a sounder foundation. Having the rest of the world hostage to political stability in Washington is no way to run a planet. Just like in any organisation, stakeholders in the USA will resort to all kinds of stratagems to conserve their power and influence at the expense of everybody else, with scant regard for the rest of the world.

    America is in decline; it can no longer be relied on to play the role it has in global affairs since 1945. Opinions will differ on whether that is a good or bad development but it appears inevitable and there will necessarily be some unpleasantness as the rest of us adjust to a new dynamic reality. The longer the shocks are postponed, perhaps the worse they will be.

  2. JamesH
    October 4th, 2013 at 12:26 | #2

    How about this as a hypothesis: Rather than give way on Obamacare, or expose himself to legal action by 14th amendment invocation or coin minting, Obama allows default because the pain falls on Wall Street, who backed the tea party et al last time around, rather than the Democrats. He now owes Wall Street nothing, he doesn’t need to campaign again, and punishing the Street would be extremely politically useful.

    New York Democrats can then say to Wall Street “This is what happens when you don’t pay your dues to us. Don’t ever defect again.” and lock in the finance industry’s contributions for as long as this event is remembered. Republicans have both their public credibility and their fund-raising base destroyed as both the population and the capitalist class blame them. Barring almost-unprecented screwups by the Democrats in combination with a complete repudiation of the Tea Party, the Republicans will not win the White House for a generation.

    Of course default would hurt the general population, especially those getting social security, substantially – but not getting healthcare and, more generally, the continued existence of the Republicans hurts the general population more in the medium to long term.

  3. may
    October 4th, 2013 at 13:23 | #3

    he he,definitely OT

    http://www.theguardian.com/politics/2013/oct/tory-lynton-crosby-linked-tax-haven

    that mark textor? our very own?

  4. Troy Prideaux
    October 4th, 2013 at 13:43 | #4

    @JamesH
    Truly hope you’re right! Anything but a repeat of last time:
    http://billmoyers.com/segment/bill-moyers-essay-the-crony-capitalist-blowout/

  5. Ernestine Gross
    October 4th, 2013 at 14:25 | #5

    The USA has lived beyond its means for a very long time. No effort has been made to increase taxes on the super wealthy but instead legal currency units have been given by the bankers’ union, the FED, to the wrong people, the financial segment of the super wealthy, in exchange for their US$ demonimated private money, also known as junk debt securities of various forms.

    By implication of the USA having lived beyong its means, others somewhere in the world had to live below their means.

    It is not true that it would be the first time the USA would default on their financial obligtions on or around 17 October 2013. The USA defaulted in the early 1970s with respect to gold-convertibility of their greenbacks.

    I cannot see how a ‘market related economy’ can survive with the financial system of the USA. But I can see how their financial system together with their blind ignorance toward the importance of limits to feasible wealth inequalities runs their economy into a state of collapse. I’ d like to be proven wrong.

  6. Will
    October 4th, 2013 at 15:05 | #6

    Through luck more than anything else the US dollar became the reserve currency of the world. The intrinsic demand allowed the US to experience far more favourable terms of trade than otherwise and also led to a high demand for US government debt (both State and Federal). Give a few years, there will be three economies larger than that of the US: EU, China and India. Going forward there are several likely outcomes. The US might continue deluding itself that it is the jewel in the Earth’s crown while the world moves on around it; cede that it is not exceptional and admit to it’s lesser status as a trade partner rather than overseer; or it could bankrupt itself in a string of ill-advised massive military shows of force desperately struggling to retain the pecking order. To mangle the Chinese proverb, we shall soon witness interesting times.

  7. Jordan
    October 4th, 2013 at 16:22 | #7

    @Will

    Through luck more than anything else the US dollar became the reserve currency of the world.

    O no, Will,
    $US became reserve currency because after the WWII, US was giving $US away to all nations that wanted to influence. Either by giving it away or by paying for US troop stations.
    Once you have $US, what can you do with it? Can you buy products in Australia with $US? No you can not, first you have to exchange it for domestic currency before using it.

    Currencies do not cross borders except in our pockets.

    Once countries have $US, they can use it only to buy from US, or freeze it somewhere where it doesn’t bring them any tangible benefits.
    You can use $US only in US to buy their products.
    US was giving away its printed $US so world would buy from them. That is how $US became world reserve currency.
    This is what JM Keynes suggested after the WWII and it worked.
    He also argued for a bit better Bretton Woods conditions but he was overruled and BW had to be cancelled in 1971.

  8. Jordan
    October 4th, 2013 at 16:27 | #8

    @Ernestine Gross

    By implication of the USA having lived beyong its means, others somewhere in the world had to live below their means.

    This is the first time i see you argue that exports are the loss of exporters, giving it away to importers for some paper called money.
    Australia is living bellow its means by exporting its valuable resources for some numbers on the computor screen. I would say that is completely correct, that most of the economists do not see or people can not see because rich wants to privatize natural resources of a country and enjoy larger share of the benefits so they sell the propaganda to people trough elected representative. “We have to get budget surplus” is an ultimate con onto the people.

  9. BilB
    October 4th, 2013 at 16:44 | #9

    Australia is determined to head down the same path as the US. We are now over 10 years here where manufacturing is presumed to be dead in the water. Another 10 years on this track and there will be a full generation with out the knowledge of how to develop manufactured products and build businesses based on the plethora of processes that make up broad field manufacturing. With this loss also goes the ability to innovate and entrepreneur new products.

    This loss has been masked by job creation in the services and construction field along with the mining industry. All it takes is a slump in both mining and agriculture and the Australian economy will hit a slide that will be difficult to pull out of, particularly if complicated by climate change events. We do take our security for granted, and not totally without cause. The US have been skating close to the brink of broad poverty for many years with their minimum hour rate of $7.50 compared to our $15 per hour. But that just means that Australians are gear to need a higher income to stay afloat.

  10. Ernestine Gross
    October 4th, 2013 at 20:13 | #10

    @Jordan

    I am not saying exports are the loss of exporters (assuming you mean international trade data). I am saying under some conditions this is the case. (International trade theory establishes conditions for potential gains from trade but it does not provide conditions for the distribution of gains from trade. Furthermore, most of the international trade is carried out by corporations. It is profit motivated. The distribution of these profits isn’t as presumed in the Fisher Separation theorem.)

    I suppose I should have been more explicit when using the term ‘the USA’. I mean not only the government but also the citizens. As for corporations, Walmart and others prospered from imports and consumer debt, while unemployment grew as did the trade deficit. Taxes and subsidies or government generated employment are not used sufficiently to mitigate these effects. Worse than junk bonds were sold by the proverbial Wall Street bankers as ‘investment bond quality’ securities as per the USA’s rating agencies’ magic, to people all over the world. To ascertain who has to live below their means as a consequence of this system cannot be established from national accounting data alone.

  11. Jordan
    October 5th, 2013 at 00:37 | #11

    Only way that Americans in total can live of off another parts of the world is by getting products of those countries aka imports much higher then exports. other parts have higher employment thanks to that but giving their natural resources away instead of using them themselves. Resources like labor and materials.
    Yes, Americans live by manufacturing less then they use today, but considering times before 1971 they exported more then imported so it all evens out in long term.
    I am talking about real REAL values that products and services are while currency that was used to get real value have only nominal value. I am talking in terms of real values.

  12. Ernestine Gross
    October 5th, 2013 at 12:45 | #12

    “Only way that Americans in total can live of off another parts of the world is by getting products of those countries aka imports much higher then exports.”

    Really?

    Rate payers in some local government areas in Australia (in Norway and elsewhere) paid amounts that allowed councils to accumulate ‘funds’ for the purpose of non-trivial investments (physical capital included) in the future (time). The accumulation of ‘funds’ involves the purchase of financial securities (a deposit at a bank is one type of large number of different types). Councils purchased AAA-rated CDO, originating in the USA. The sale of the CDOs to these foreigners, resulted in increased accounting numbers, denominated in US$ in some balance sheets in the USA. These numbers were used to pay for housing, first the construction and then the ‘sale’ to individuals via a hierarchy of financial intermediaries and various types of debt securities linked to the proverbial Wall Street Bankers and their associates, the rating agencies. By ‘sale’ I mean transfer of ownership of a physical asset in exchange for a debt security (mortgages). This house of financially engineered cards (securities) collapsed; the Lehman event is explicitly associated with it. So far I haven’t even mentioned the secondary effects due to another house of financially engineered cards (swaps and insurance contracts written on this financially engineered house of cards). Note, there are no exports or imports of goods involved and the services (financial) are only part of the problem.

    Surely, one has to be wilfully blind to reality to not notice that there are wealth transfers involved which are not recorded in national trade statistics. The ‘funds’ of councils (and individuals via superannuation funds or directly) in foreign countries are gone (loss of real wealth, ie the physical assets or goods people wanted to buy in the future). And, in the USA ‘non-performing mortgages’ (ie default) resulted in empty houses with people who were too poor to take on the mortgages in the first place on the streets (or in caravans, tents, cars, on the couch of relatives or friends…….) The USA has recourse mortgages (ie the house is returned to the lender), other countries don’t. So, the too poor to buy people had a ‘home’ for a short while only; a very limited benefit. But they are not the only people in the USA. The bankers, the lawyers, the rating agencies, and the entire hierarchy of distribution of these financial mirages they benefitted.

    The notion of “Americans in total” is irrelevant, Jordan. I am surprised you missed my point about the persistent blindness to the importance of limitations on the inequality of wealth distribution within the USA and the associated failure to adequately increase taxes on the super wealthy and redistribution policies.

  13. Jordan
    October 5th, 2013 at 18:57 | #13

    @Ernestine Gross
    What you are saying is that AUS sold real goods to US and then the money you got was destroyed by investing into bad CDOs.
    YOu never planned to use that money to exchange it for stuff, did you? Only to echange assets with no maturity (money) with assets with maturity date (CDO) that would bring premiums.
    What would you use such premiums for? For getting more assets that brings premiums so that you can accumulate it evermore without ever using it for exchange for real tangible goods.
    Money has no value, except in exchanging it for real goods. I tought you knew that.

    Loosing value was allready when you exchanged real goods for such assets, real value that Australian themselves could have used it.
    Your Central bank did not know what to do with $US but to invest it with an option that it might use it some day.

  14. Ernestine Gross
    October 5th, 2013 at 20:47 | #14

    @Jordan

    No, I am not saying what you claim I say. I don’t agree with your narrative.

  15. James Wimberley
    October 7th, 2013 at 00:35 | #15

    The line being given by US Treasury officials to those few journalists interested in the mechanisms of financial administration rather than the Grand Guignol political threatre in the Capitol is that (a) Treasury has made no plans to meet the unthinkable and (b) the computers don´t allow prioritisation of payments anyway (source: Bruce Bartlett)..

    Assertion (a) reflects the famous tactic in the teenagers´ (mythical?) game of chicken of throwing the steering wheel out of the window, thus putting the onus on the adversary to flinch. It´s good game theory but incredible behaviour for cautious and competent professionals.
    Assertion (b) must be wrong. First, the Bureau of th e Public Debt has its own payment systems. It must be relatively easy to ensure that its calls on the central Treasury account to service Treasury bonds go through first. Second, as we are seeing now, Treasury do have a working system for prioritising in the ¨shutdown¨ scenario. The amount of the cuts in cash flow required in the two scenarios is about the same (about 40%).

    The difference lies in the psychological spooking of the markets by the default. But to Lockheed, say, it´s the same: they have invoices which are legal debts against the US Government, but that the Pentagon can´t pay until Congress acts sensibly.

  16. Fran Barlow
    October 11th, 2013 at 13:10 | #16

    An interesting discussion from nate Silver on the political impacts of the US government shutdown …

    http://www.grantland.com/fivethirtyeight/story/_/id/9802433/nate-silver-us-government-shutdown/

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