Default?

by Don Boudreaux on July 29, 2011

in Current Affairs, Debt and Deficits, Myths and Fallacies, Other People's Money, Politics

Here’s my two-cents on the calamity du jour (namely, the possible ‘failure’ to raise Uncle Sam’s debt ceiling).

In response, Roger Garrison sent to me the following e-mail (posted here in full with Roger’s kind permission):

I enjoyed your “Capping the Debt Hyperbole.”

You mention, though, that the government could “choose to default.” Well, if default means that you’re unable to pay, then “choosing to default” must mean that you “choose to be unable to pay.” Hey, that really does sound like government-speak. But I think a more accurate and more revealing term is “renege.”

Another point. Remember that the government’s authority to spend rests with Congress, while the debt limit is set by Congress.  So, on the one hand (the left one), the government would allow more spending, while on the other hand (the right one), it can’t exceed the debt limit.  Now, which hand do we think will win this little arm-wrestling match.

One more point. The debt limit was first set in 1917. During the 94 years since then, the limit has been raised (by the left hand) more than 100 times—more than once per year. Isn’t there a close kinship, here, between debt limits and New Year’s Resolutions? The main difference is that New Year’s Resolutions are broken only once per year.

Only when the subject of the conversation is government do most participants in that conversation treat seriously the notion that ensuring a debtors’ future solvency – and signalling to skeptical creditors that that debtor is indeed taking sensible steps to reduce its debt – requires that that debtor renege on its previous commitment to keep its borrowing from going above a certain level.

(And, btw, as Veronique de Rugy, and Richard Rahn, point out, Uncle Sam also owns lots of salable assets.)

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{ 34 comments }

Shawn Slayton July 29, 2011 at 9:43 am

A nation cannot fake a default. This is a contrived crises, and the debt markets will continue to see it as such.

Martin Brock July 29, 2011 at 10:42 am

The state may threaten me more forcefully and confiscate more of my wealth. A state with an effective monopoly of nuclear weapons in my neck of the woods hasn’t reached the limit of this capacity.

Since I don’t want the state to reach this limit, I want it to renege instead. I am pro-state-reneging. If you don’t want the state reneging on you, don’t buy entitlement to tax revenue from it. The state will eventually sell so much this entitlement that its subjects rebel, in one way or another.

Seth July 29, 2011 at 10:45 am

Isn’t the debt limit unnecessary government intervention in government? Is there a reason, other than political theater, for a debt limit? Shouldn’t we let the markets set the rates and limits?

Martin Brock July 29, 2011 at 12:13 pm

No. We shouldn’t let “markets” decide the price of slaves either. A slave market is not a libertarian market.

Seth July 29, 2011 at 1:53 pm

Are you’re saying that the market prices the value of the government’s power to force citizens to pay taxes, rather than pricing the current fiscal situation of government?

Good point.

Though, a debt limit set by the very folks who can raise it doesn’t seem like a great solution either. At best, it becomes what it is now, a political bargaining chip and the price of government debt is still based on its power of force rather than its fiscal condition.

Anotherphil July 30, 2011 at 1:46 am

At least in theory, restraining politicians from borrowing prevents them from pandering to present constituencies and shifting costs to “future generations”. Of course, until recently, it was a rubber stamp to get an increase, so de facto, there was no limit.

Then one Senator spoke out against the debt limit increase. That Senator was Barack Hussein Obama.

Kirby July 29, 2011 at 10:55 am

You want the government to stop giving money to their special interests? But… but… but…. then Mitt Romney would be elected and the world would come to an end!

vidyohs July 29, 2011 at 11:34 am

Egads, Don,
You seem to think the national budget, debt limits, and repayment schedules should be addressed with logic and a rational assessment of reality.

We know that ain’t gonna happen, ever.

Frank33328 July 29, 2011 at 12:23 pm

This entire debate seem to me to boil down to Republicans stating (to Demoncrats I guess) “if you promise to spend less than you have in the past, then we will allow you to spend more than you already have up to now….” Why isn’t the line in the sand more like “We refuse to raise the debt limit, now let’s negotiate on how we work within the revenues we actually have.”

JWH July 29, 2011 at 1:45 pm

Thanks once again for some clarity and logic. More than all the talking heads and political class have given me in the last 2 weeks. I know it takes time for you and Russ to address the issues of the day on a busy site like this but it does help knuckle draggers like me understand them.

vidyohs July 29, 2011 at 2:14 pm

This is why you are seeing a debate about default, a debate about debt, a debate about cutting spending, and a stubborn resistance from the looney left to do anything about it.
I give you muirgeo’s godchild, a solid democrat voter:

http://www.youtube.com/watch?v=J7XA2UUpXRk

There is your problem with this country, people enculturated from birth to believe they get a free ride on the backs of the productive.

And, if you think that muirgeo’s godchild is an aberration of nature, think again. There are a lot more just like him out there, and there are a lot of them with lighter skin colors as well.

LowcountryJoe July 29, 2011 at 4:54 pm

That is hilarious and sad all rolled into one.

muirgeo July 30, 2011 at 2:50 am

Good point vidyohs…. I think we need to default on your government pension and throw you off of any VA benefits… you frinking worm of a person. Keep your gobmint hands off my Medicare right??

MinArcMan (….with a government pension), yep you are one hell of a deep thinker.

vidyohs July 30, 2011 at 8:41 am

:-) The truth about what your kind, your religion, spawns just hurts like hell when it is put out there for people to see, doesn’t it my little teacup chihuahua intellect?

I bet when you saw that clip, your heart started singing “He ain’t heavy, he’s my brother……”

vidyohs July 30, 2011 at 8:48 am

:-( Yes my little muirhuahua, we can go to the Socialist Church and delve into the socialist scripture and what we find is a desert in which there are no morals, no character, and no standards.

Your church has produced not only the two characters in that last clip, but it produces learned judges like this one:

http://www.theblaze.com/stories/u-k-judge-tells-teacher-sex-offender-busted-with-child-pornography-i-dont-criticize-you-for-being-attracted-to-children/

Joe Cushing July 29, 2011 at 2:17 pm

I’m glad that you put the word “failure” in quotes. I never like that word applied to congress. Congress never fails to act. It decides not to. You could say that deciding not to act causes some other failure but congress never fails to pass a bill.

Henri Hein July 29, 2011 at 2:19 pm

I was just thinking this morning that the debt ceiling debate is the most awesome thing that has happened on Capitol Hill the whole time I have lived in the country (almost 20 years now). I love seeing a consequence to all that spending, even if only cursory and ephemeral.

I also think Obama is showing his incompetence as a leader. He should have seen this coming six months ago and already at that time have started to wind down non-essential operations of the Federal government. The fact that the Aug 2 deadline has not moved at all this whole time says a lot.

Randy July 29, 2011 at 2:21 pm

To “default” is to fail to keep a promise. The US political organization has made many promises. It seems to me, given that borrowing 40 cents of every dollar spent cannot continue indefinitely, that the US political organization must, sooner rather than later, default on some or many – that is, it must break some or many of its promises. So the question is not whether there will be a default, but who will be defaulted on. The Democrats want to default on taxpayers. The soft-core Republicans want to default on future recipients of entitlements. The hard-core Tea Party Republicans want to default on the political organization – all of it! They are showing a surprising and much welcome attention to principle, and they are seriously starting to impress me.

vidyohs July 29, 2011 at 5:01 pm

“The soft-core Republicans want to default on future recipients of entitlements. The hard-core Tea Party Republicans want to default on the political organization – all of it!

I think you’re stretching the definition of the word default there. I am skeptical that even soft-core republicans sincerely believe in entitlements and promised them. I would say acquiesced to them. As for the Tea Party in default, did they promise support to any political organization but their own?

The corporate USA may go into default, but I remain stubborn in denying that I have any part in that. It was no promise of mine, as a matter of fact I spoke against it and I act against it.

Randy July 30, 2011 at 9:10 am

Vidyohs, I believe that you have no part of it. But for many decades now the Republicans have spoken out against these programs while trading their defacto support for them in order to receive rewards in return for their own political favorites.

D. F. Linton July 29, 2011 at 2:32 pm

veryone is underplaying the fact that both the Social Security (SS) and Medicare (MC) trust funds hold a pile of restricted federal bonds that can be sold to the Treasury on demand with the funds coming from a corresponding public sale of debt without violating the debt limit.

I don’t have 2011 projections at hand, but at the end of 2010, SS assets were $2,609 billion and MC assets were $344 billion. Total federal spending in 2010 was $3,456 billion and tax receipts were $2,162 billion for a deficit of $1,294 billion (37.4% of spending). Of the spending, SS and MC were $713 and 523 billion respectively for a total of $1,235 billion (or 35.75% of spending).

If post 8/2 all spending for SS and MC were done by redemptions, the cash flow deficit would only be 58.6 billion annually or 1.7%, trivial even by DC standards.

By my calculations, SS could be funded in this way for 1,336 days and MC for 240 days before exhausting the trust fund assets.

The 2011 situation can’t be that different.

Imminent crisis? Not so much.

txslr July 29, 2011 at 4:17 pm

Thank you! This is an important point that no one seems to understand.

RLH July 30, 2011 at 6:59 pm

And aren’t some of the incoming cash streams payroll taxes that are “earmarked” for SS and MC? Spending that cash flow on anything else seems “wrong”.

LAD July 29, 2011 at 2:56 pm

If a private loan agreement provided that the borrower couldn’t exceed a certain debt limit, and if the lender waived that covenant more than a 100 times, I can understand the borrower being upset when the lender finally decided to enforce the limit. On the other hand, the borrower shouldn’t have made so many commitments on the assumption that the waivers would continue.

Ocaine July 29, 2011 at 3:21 pm

Thanks for that article. I’ve shared it with everyone. Really puts it into terms which, in my mind I understood, but just couldn’t put into words.. and I didn’t have the figures.

LowcountryJoe July 29, 2011 at 3:52 pm

Don,

I just listened to you on the Cato Daily Podcast. I know that causing inflation is terrible, as you stated there. But under these circumstances — because you know that no one is really going to cut spending — it [increasing the money supply to pay for government] is probably going to happen. And the effects might do some interesting things.

First, those who are living off Uncle Sugar’s fixed income checks [sugar that they get too early in life, in my opinion] will get the hidden tax of inflation while today’s income earners, those who are going to be shafted by Social Security’s promises later on down the road, will face less of inflation’s burden.

Secondly, it will press those who have their assets in cash to do something different with it.

Ideally, spending cuts would be made and many things that the federal government does now could be left up to individual states to provide, if still desired by residents of those states. But we do not live in an ideal society because too many damned people want government services while pretending that they’re not going to have to pay for them.

GP Hanner July 29, 2011 at 6:29 pm

“(And, btw, as Veronique de Rugy, and Richard Rahn, point out, Uncle Sam also owns lots of salable assets.)”

That’s what the UK is going through right now. Anybody wanna buy a slightly used nuclear aircraft carrier? How ’bout some nice range land in Wyoming or Nevada? Need a few thousand acres of timber land? We got some in South Dakota or Oregon or Washington.

axiomata July 29, 2011 at 8:55 pm

I don’t think default necessarily means that you cannot pay, just that you don’t. So technically you could choose to default.

Anotherphil July 30, 2011 at 1:41 am

While there’s a huge grey area when repayment is difficult, but possible, as some point it becomes mathematically impossible. Long before you approach impossibility, creditors “call the loan” and look for you to forward collateral. What that means when other countries own your debt is often increasing distrust, leading to bellicosity and conflict.

We are engaging in a grand macroeconomic experiment of “chicken” and have been for decades.

Anotherphil July 30, 2011 at 1:35 am

What’s frightening and fascinating is the absolute lack of understanding about what the “debt limit” is and is not. The debt limit is a statutory contrivance, nothing more. Anybody who has a credit card knows asking for a new limit only forestalls the day of reckoning.

The real risk of default is an economic risk, not a statutory risk. More debt might allow refinancing instruments as they come due, but each additional dollar increases the real risk.

At certain point, long before default or bankruptcy, credit junkies begin to psychologically separate themselves from their debts. Once there is a decision that repayment is futility or fantasy, the spendthrift ceases to care and if creditors are happy with “minimum monthly payments” then all bets are off. Nothing has a real cost, its just a monthly payment.

The interesting thing about Washington is that unlike a natural person, a government has a presumed indefinite life-there’s always tomorrow. They can also cheat their debtors with debased money. Since the Feds have been declaring that the “national debt” (or more accurately the political debt) will never be paid off for decades-our government is now a credit junkie. Today’s debt incurred to buy votes becomes part of a fungible mass, and the politician trades a current benefit for a future cost.

FDR and LBJ are rotting corpses, but their legacy lives on in the form of costs incurred by those of us who had no control over their acts and the costs of the 1936 & 1964 elections are an indistinguishable part of all sorts of postponed payments, some legitimate, most not.

But hey, we’ll always have “hope and change”.

vikingvista July 30, 2011 at 2:08 am

I know this guy named Sam. He has a pretty lucrative extortion racket where he brings in a good $200K/yr. Not lucrative enough, apparently, since he’s already made a $300K shopping list this year.

The weird thing is, he also owes $400K in principal payments just this year on his outstanding loans. I asked him if he was going to file for bankruptcy. He cavalierly replied, “No way”. Apparently he has this scheme where he will simply take out another $400K short term loan to pay off this year’s principal, plus yet another $100K loan to complete his shopping list. And he says he’s been doing this for years! In fact, he plans an even bigger shopping list next year, regardless of what his extortion income is.

Astounded, I of course asked him, “Who the heck is loaning you this money?” He says his brother Freddy runs a very profitable counterfeiting business. He says, the weird thing is, Freddy only needs to print off and loan me part of what I want. He says, that when his neighbors and local banks see how he is always flush with all the cash he needs to pay whatever interest he needs, they actually come knocking on his door ASKING if they too can loan him money.

Something didn’t seem quite right. I asked him if he didn’t think something would eventually come to a head. I mean, wouldn’t the money Freddy was counterfeiting be too common to be of value? You know what he told me? He said, “Maybe, but my dad and uncle lived high on the hog their entire lives using this scheme, and I’m sure I’ll be long dead before it all comes crashing down.”

DeeBee9 July 30, 2011 at 10:45 pm

But, isn’t the real point that while the house can choose not to spend so much money, it needs to do so in a bill and that bill needs to be passed in the senate and signed by the president. And, that can’t even be attempted until the the next round of spending bills come up. On the other hand, the debt-ceiling increase is an early opportunity to try to force the hands of Democrats in the senate and the president because without Republican agreement, the ceiling can’t be lifted.

kyle8 July 30, 2011 at 11:32 pm

I call for a new Homesteading act, There is a lot of good land I would like to purchase in the Rocky mountains and, or great plains areas.

Dan J July 30, 2011 at 11:45 pm

Can I get two parcels? One at about 7500-8500 elevation and another within 4 hours drive at about 3000 foot elevation? Each at about 40 acres or more?

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