Thursday, August 27, 2009

Will the Fed.Gov default on the national debt?

Jeffrey Rogers Hummel thinks so:
Almost everyone is aware that federal government spending in the United States is scheduled to skyrocket, primarily because of Social Security, Medicare, and Medicaid. Recent "stimulus" packages have accelerated the process. Only the naively optimistic actually believe that politicians will fully resolve this looming fiscal crisis with some judicious combination of tax hikes and program cuts. Many predict that, instead, the government will inflate its way out of this future bind, using Federal Reserve monetary expansion to fill the shortfall between outlays and receipts. But I believe, in contrast, that it is far more likely 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.
I'm not so sure, although I agree with him that if a crisis comes, it will come quickly. Think collapse of the Soviet Union quickly - over in a year, and altogether too fast for politicians to grapple with.

Here's why I'm not so sure - summed up in a passage from David Landes' indespensible The Wealth And Poverty Of Nations:
The heart of the matter is Latin America's need to go on borrowing, if only to pay the interest on the older loans. A research student from Latin America once complained to me about this burden of old debt and the vexatious, small-minded foreign insistence on repayment. "You don't have to repay," I pointed out; "a sovereign nation can always repudiate." "Yes," he replied, "but then where shall we go to borrow more?" Exactly.
The problem is that the current model since Reagan has been "run smallish deficits (as a % of GDP) and let economic growth drive Fed.Gov revenue higher." If you remove the cost of the Iraq war (and arguably you shouldn't), then deficits have been a couple percent of GDP, even under Bush.

Obama aims to change that. His plans will simultaneously increase spending and reduce growth - reasonable people can argue over how much of each will occur (the slope of the lines), but it's simply not credible to argue the trajectories (are they headed north or south).

Add in the slow motion fiscal train wreck that is first Medicare and then Social Security, and the Fed.Gov will simply be out of maneuver room. If we need to borrow a Trillion dollars a year - 8% of GDP, default is simply not an option. The borrowing would be funding current expenditures, and the political class will not have the courage to jeopardize Grandma's monthly checks.

This is probably the single most compelling reason for the Fed.Gov to not be involved with healthcare (more than it is now), as the scope of the problem would put health benefits on the chopping block, by necessity.

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