Monday, July 21, 2008

Default Dollars

Unlike many members of my generation (X), I have absolute confidence that I’ll receive Social Security payments when I’m old. Thousands of dollars each month, in fact. Granted, with inflation that’ll only be enough to buy a jar of peanut butter and perhaps a loaf of stale bread, but the important thing is that when government accountants tally the actual number of US dollars I paid versus the number I’ll eventually receive, they’ll be able to tell me “See? You did get back all the money you paid into the system!”

If necessary, I’ll supplement my income by writing and selling freelance financial-advice articles with titles like “Save Money On Toilet Paper: Wipe Your Ass With Dollar Bills Instead.”

Yet my vision of the future sounds downright optimistic compared to The Economist, which contemplates the thought that America might do the unthinkable: default on its national debt.

THERE is a story about a science professor giving a public lecture on the solar system. An elderly lady interrupts to claim that, contrary to his assertions about gravity, the world travels through the universe on the back of a giant turtle. “But what supports the turtle?” retorts the professor. “You can’t trick me,” says the woman. “It’s turtles all the way down.”

The American financial system has started to look as logical as “turtles all the way down” this week. Only six months ago, politicians were counting on Fannie Mae and Freddie Mac, the country’s mortgage giants, to bolster the housing market by buying more mortgages. Now the rescuers themselves have needed rescuing.

- snip -

The GSEs [government-sponsored enterprises] are not the only liability for the government. IndyMac’s recent collapse is the latest call on the Federal Deposit Insurance Corporation (FDIC). The FDIC has some $53 billion of assets, so it is better funded than most deposit-insurance schemes. But if enough banks got into trouble, the government would be on the hook for any shortfall. The same is true of the Pension Benefit Guaranty Corporation, which insures private sector benefits, but is already $14 billion in deficit.

In the end, the turtle at the bottom of the pile is the American taxpayer. But that suggests that, if Americans are losing money on their houses, pensions or bank accounts, the right answer is to tax them to pay for it. Perhaps it is no surprise that traders in the credit-default swaps market have recently made bets on the unthinkable: that America may default on its debt.

From the perspective of the average American, what would defaulting on the national debt actually mean? Your insights here would be most appreciated; I haven’t the time to add any of my own, as I’m too busy preparing for my future by doing absorbency-comparison tests ‘twixt Washington and Charmin.


Blogger Caveman Lawyer said...

A good book to read on the subject is "Empire of Debt". Two ex-pats living in France wrote it several years ago and many of the predictions they made back then have already come to pass so the events they predict that haven't come up yet are probably on the money too.

It's a good primer on how our economy really works and what it's weaknesses are. It is pretty well balanced politically, they don't go out of their way to blame everything on Bush or Clinton. In fact they tend to level the blame pretty fairly over everyone who ought to be blamed. Unfortunately that includes the American people too.

I wont steal their thunder, or save you the twenty bucks to buy it. Besides, you have to read the book to understand the history of the debt so you can understand it's future.

5:44 AM  
Anonymous thoreau said...

You know, I don't know what it would mean. It would probably be really bad, though. I think it's the sort of thing that we could actually get through and adjust to...if we decided to. But some demagogue would probably come along and...I need to stop thinking about this.

8:00 AM  
Blogger Jennifer Abel said...

What are some of their predictions, CL? The only one I can make is, "They'll continue to pay out pensions, benefits and other promised money to in-country people, but the dollars they'll use to pay it with will be effectively worthless."

But otherwise, I have no idea how, say, my day-to-day life will differ if the country defaults on its debts.

8:42 AM  
Blogger WJW said...

Fear not. We'll just recruit Bono to get our debt forgiven!

10:22 AM  
Blogger NoStar said...

What is it we do with the money we borrow to increase our debt. When we default that will mean the Chinese, the Japanese, the Saudis, etc. will no longer loan us money to do those things.

Here is my short list of things we will have to curtail:

1. Global military adventurism
2. Welfare, Social Security
3. Pork Barrel domestic spending

12:28 PM  
Blogger Caveman Lawyer said...

Well, the likely outcome will be they will monetize the debt. It means printing enough money to pay everyone off.

Yes. That means printing a bajilion dollars. The inflation will be something that only third world countries have managed to pull off in the past. The dollar will be a joke and you'll be buying candy bars with 100 dollar bills if you're lucky and can find them in the stores.

We won't be importing anything and likely we'll be exporting everything that has real value. The price of scrap metals will go through the roof along with the price of everything that can be easily shipped overseas.

As the Brain Gremlin said in Gremlins II, "We're advising all our clients to invest in canned food and shotguns."

The sad thing is all this has happened before in other nations that tried this game, it shouldn't be a shock to anyone who is paying attention to something other than Brittney Spears or Lindsy Lohan...

1:13 PM  
Blogger Jennifer Abel said...

Perhaps the next generation of Americans will be the ones working low-paid factory jobs making cheap crap to be exported to the Chinese middle class.

1:19 PM  
Blogger NoStar said...

And with the Chinese buying up Citibank and other mortgage banks, when we get foreclosed on, then we will see how we have become a nation of serfs.

3:42 PM  
Blogger Caveman Lawyer said...

Well, can you blame the Chinese? They've been selling us cheep crap taking our dollars in good faith and then they see the value of the dollars they have been taking decline over time. So they want something of value for their inflated bucks. Why wouldn't they buy up the one thing Americans seem to make a lot of. Debt.

They are also going to buy up the politicians with those dollars. So expect any "bank holidays" to go in the favor of those who hold the notes on your debt instead of your favor. While the dollars in your paycheck will be less valuable your debt will likely be valued in some other currency that is more stable. Like the soon to be released gold backed Chinese currency. Why else do you think the Chinese have been buying up crap loads of gold every chance they get?

5:02 PM  
Anonymous A Moose said...

Q:"From the perspective of the average American, what would defaulting on the national debt actually mean?"


1:03 PM  
Blogger Caveman Lawyer said...

Maybe that's the change that Obama is promicing...

6:16 PM  
Blogger rhhardin said...

National debt doesn't work like family debt, because national wealth does not work like family wealth.

National money is a ticket in line to say what the national economy does next. Dollars say what the American economy does next.

The Fed adjusts the number of dollars in circulation so that there aren't too many tickets for what the American economy can do at once. If there are too many tickets, the Fed sells debt and soaks up and destroys some tickets. If there are too few tickets (the economy has some slack), the Fed buys back debt with newly printed tickets.

That form of intervention is minimally intrusive in the functioning of the economy, as to saying what the economy should be doing; it only says that it should do more or do less.

The Fed has ``leading indicators of inflation'' that it uses to tell whether there are too many tickets or too few. It waits a month, and then decides whether it ought to extinguish more money or create more money. If it decides to create more money, it targets for itself (!) a slightly lower interest rate, and starts buying back debt until the market responds by lowering the short term interest rate to the new target. Where the market puts the interest rate is how the Fed keeps track of what it's doing. Too high means buy back more debt; too low means sell more debt.

After a month they look again at the leading indicators, and decide whether to tweak the target interest rate up a bit or down a bit, and the process repeats, always looking out for only the slightest beginning of future inflation as the sweet spot.

As to defaulting on the debt, it makes no sense. It's not a burden at all. Investors use the income from government interest to buy government debt, so it never really reappears as money at all.

The country's wealth is the capacity of its economy, not the tickets that reserve a place in line in it.

Money looks like wealth to a family, but it is not wealth to a country.

All foreigners can do with dollars, incidentally, is spend them in the American economy or invest them in the American economy. It's no hazard if foreigners hold dollars.

Their willingness to hold assets in dollars depends not on the US debt but on the capacity of the US economy compared to the debt.

9:40 AM  
Anonymous A Moose said...

Investors use the income from government interest to buy government debt, so it never really reappears as money at all.

I disagree, there are many who use income from govt interest for other things.

The country's wealth is the capacity of its economy, not the tickets that reserve a place in line in it.

You run into a situation like CA. CA has very little discretionary spending, due to the number of hairbone mandatory spending driven by propositions. If the US has an increasing commitment to national debt interest payments, this same situation could occur.

That would make our options to either a) reduce or stop interest payments, thus causing people to devalue the debt, thus causing them to dump it, thus causing inflation due to increased costs of imports, or b) print more money, causing a similar effect. The effect of "default" is nothing more than increasing the effective interest rate, but the problem is the inflationary silliness like they had in South America years ago (which really only becomes a problem when you aren't indexed to something, which in turn negates inflation)

2:06 PM  
Blogger Caveman Lawyer said...

The country's wealth is the capacity of its economy, not the tickets that reserve a place in line in it.

What exactly does the US economy produce? We import almost everything. The only thing of consequence we export are dollars. If the thing we export is devalued doesn't that mean our country's wealth is devalued?

5:11 PM  

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