By Kyle Russell
The current big debate in Washington revolves around one issue: raising the debt limit. The United States federal government has borrowed all the funds permissible by current law, and needs the permission of Congress to continue to borrow for the various programs that it funds. Failure to raise the debt ceiling has two potential outcomes, both catastrophic to the economy: in the first, the United States defaults on its loans, interest rates skyrocket, credit becomes even tighter (with bleak implications for the real estate industry locally), and unemployment jumps. In the second, the United States is unable to pay some combination of Social Security, Medicare, Medicaid, the military, and contractors, interest rates skyrocket, credit becomes even tighter, and unemployment jumps. Neither situation is pretty, which is why the debt ceiling must be raised.
But not at all costs.
Should the government balance the budget by drastically cutting spending? Not according to Laura Tyson, former Chair of the US President’s Council of Economic Advisers during the Clinton Administration:
There is a logical way out of this policy conundrum: pair temporary fiscal measures targeted at job creation during the next few years with a multiyear, multitrillion-dollar deficit reduction plan…. [I]magine for a moment that logic prevails. […] [I]ntroduce additional stimulus measures to offset the substantial fiscal drag – in excess of 2 per cent of GDP… invest more in infrastructure maintenance and replacement…. Each $1bn of infrastructure investment creates between 11,000 and 30,000 jobs. On the revenue side, the government should extend some of the targeted tax measures enacted at the end of last year… the payroll tax cut for employees and the capital investment expense deduction… cut payroll taxes for employers on all new hires…. This cut should be linked to the unemployment rate and should be maintained until it falls to the 5-6 per cent range….
A study by Jaime Guajardo, Daniel Leigh, and Andrea Pescatori found that deliberate fiscal contractions on the parts of governments has a detrimental effect on the economy: specifically, for every percent of GDP the government makes in cuts, GDP falls by 0.62 percent. With the current cuts being discussed ranging between two and four trillion dollars over the next decade, the potential impact to output (and therefore, jobs) could to be catastrophic.
So the claims that we can reduce our short-term deficit and boost our short-term employment at the same time are out. Even so, should we cut the short-term deficit to prevent a future disaster? According to Berkeley economist Brad DeLong, cutting when the economy is still so fragile may actually have the opposite effect from what was intended. Essentially, cutting now may increase the deficit in the long-term.
So the ideal thing for Congress to do would be stimulus tied in with reduced future spending. This would give the economy the kickstart it needs, and prevent a debt crisis in the years to come. The best part? The deficit, under current law, goes away in eight years:
So how does doing nothing actually return the budget to health? The answer is that doing nothing allows all kinds of fiscal changes that politicians generally abhor to take effect automatically. First, doing nothing means the Bush tax cuts would expire, as scheduled, at the end of next year. That would cause a moderately progressive tax hike, and one that hits most families, including the middle class. The top marginal rate would rise from 35 percent to 39.6 percent, and some tax benefits for investment income would disappear. Additionally, a patch to keep the alternative minimum tax from hitting 20 million or so families would end. Second, the Patient Protection and Affordable Care Act, Obama’s health care law, would proceed without getting repealed or defunded. The CBO believes that the plan would bend health care’s cost curve downward, wrestling the rate of health care inflation back toward the general rate of inflation. Third, doing nothing would mean that Medicare starts paying doctors low, low rates. Congress would not pass anymore of the regular “doc fixes” that keep reimbursements high. Nothing else happens. Almost magically, everything evens out.
As long as Congress can pay for any spending it proposes and doesn’t actively attempt to reduce taxes, the deficit is a non-issue in the years to come. Besides this, all the government has to do is avoid the advice of Congressmen like Ron Paul, who recently suggested the United States default on the loans held by the Federal Reserve. “We owe, like, $1.6 trillion because the Federal Reserve bought that debt, so we have to work hard to pay the interest to the Federal Reserve,” Paul said. “We don’t, I mean, they’re nobody; why do we have to pay them off?”
For a Congressmen famous for his hatred of inflation, this is what is known as a very bad idea. For those who remember Econ 1, traditional monetary policy consists of buying and selling Treasury bonds on the open market. If the Federal Reserve no longer had those assets, the next time inflation crept up, the Federal Reserve would be unable to sell those bonds, its normal method of putting the brake on the economy. On top of this, defaulting on these bonds amounts to simply printing money, the exact policy that Federal Reserve is often (inaccurately) attacked for doing.
Unfortunately, seemingly none of these ideals are being followed. The Republicans have found that they can get away with saying that they’re busy fighting off “wasteful’ stimulus and campaigning against higher taxes. The Democrats call themselves the adults in the room in that they’re “serious” about the deficit. Which strategy will work best in 2012? No one can say for certain at this point, though 2012 isn’t what matters most: the nation’s fiscal stability does. No matter who comes out on top, it’s seeming increasingly likely that we all lose.
Kyle Russell, a FlaglerLive contributor, graduated Flagler Palm Coast High School at the top of the Class of 2011. He’ll be studying computer science at Berkeley starting this fall. His last piece was on Google+.
Nelson says
Citing the likes of Paul Krugman (’cause he ran his own business, created jobs, and had to make bi-weekly payroll for his employees, right? Er.. NOT!) for econ advice is like asking a plumber to do neuro-surgery.
I think the Nobel committee lost ALL its credibility when they decided to award a WARCRIMINAL oBUSHma with the Nobel PEACE Prize, PRIOR to having done anything BUT continuing and expanding ALL of GWB’s UnConstitutional warcrimes, and police state at home.
‘Cause you know, PEACE means starting NEW wars in Libya, Somalia, and Yemen, right? Hell, since Kissinger got the same prize, I suppose it’s only fitting. Just wait until NUREMBERG Tribunal 2.0 bitches!
But the reason why I’m replying is to your following HILARIOUS comment:
“As long as Congress can pay for any spending it proposes and doesn’t actively attempt to reduce taxes, the deficit is a non-issue in the years to come.” – “YEARS to come??” THAT alone tells me you have no idea how dire an impending currency collapse can be, AS A RESULT of CONTINUED BORROWING. This ain’t the 1970’s or the 80’s buddy!
“Besides this, all the government has to do is avoid the advice of Congressmen like Ron Paul, who recently suggested the United States default on the loans held by the Federal Reserve:
“We owe, like, $1.6 trillion because the Federal Reserve bought that debt, so we have to work hard to pay the interest to the Federal Reserve,” Paul said. “We don’t, I mean, they’re nobody; why do we have to pay them off?
For a Congressmen famous for his hatred of inflation, this is what is known as “a very bad idea.” For those who remember Econ 1, traditional monetary policy consists of buying and selling Treasury bonds on the open market. If the Federal Reserve no longer had those assets, the next time inflation poked its head out, the Federal Reserve would be unable to sell those bonds, its normal method of putting the brake on the economy. On top of this, defaulting on these bonds amounts to simply “printing money,” the exact policy that Federal Reserve is often (inaccurately) attacked for doing.”
LOL. REALLY? Reneging on payment on a nonexistent debt=”printing money?” Tell me genius, which is more preferable, a FULL DOLLAR COLLAPSE via continuous govt default (as they don’t default the way you or I, they just ‘pay’ their ‘debt’ with cheaper ‘money’) via continuation of inflating currency supply, or a “default” on a note that FED.Reserve decided to create for itself?
It never ceases to amaze me how so few in this country understand rudimentary economics: IF you can tell me without having to WIKI (hell, let alone the FED.Reserve’s own publicly available whitepapers), how a single dollar is ‘printed,’ how the PRIVATE Federal Reserve LOANS our Treasury Dept OUR OWN ‘MONEY’ at 10% interest while enriching the likes of GoldmanSUX in the process as it uses market mechanism to sell gvt bonds, then you can begin to lecture us on what is a sound econ advice. Seriously, we’re gonna ‘pay off debt’ when each dollar ‘printed’ is essentially only worth 90% of its face value? It’s DESIGNED to be NEVER paid back! Tell me genius, HOW do you pay off something when you only have 90% of something??
Frankly it’s embarrassing to read an adult purporting any understanding of economics, when they confuse repeating ‘intellectual’ midgets like Krugman, as if YOU yourself came up with all the talking points you’re propagating. While very few are economists, like in any field of study, even to a layman ,it’s PLAINLY obvious to those who have actually studied the subject vs. those who love showing off by quoting others’ books/writings without internally comprehending what any of it means.
Frankly the entire FIAT monetary system is based on a Ponzi scheme; a Harvard economist was quoted recently in response to Dr.Paul’s suggested INTERIM remedy as an accounting gimmick. Um, excume you Mr.Harvard, the ENTIRE SYSTEM is an “accounting GIMMICK” of “printing” “money” out of thin air backed by nothing but “FAITH.”
Funny, considering how many atheist/agnostic liberals routinely ridicule those who believe in anything, yet you’re certifying that your ‘FAITH’ is religion of Govt Tax Farms.
As for Dr. Paul’s proposal of rescinding FED.Reserve’s $1.3-1.6 TRILL it “owes itself,” if you actually understand how the system works in reality, vs. what has been advertised via PROPAGANDA, Dr.Paul is laying bare WHERE those actual payments would go to: Wall St. FED.Reserve member banks.
In effect, he’s giving the middle finger to the Wall St.banksters who CAUSED this current financial crisis in the first place! And, rightfully so! He’s basically saying, ‘IF you’re gonna engineer the BIGGEST heist in world history, and LIE to the American Populace, and engineer a financial collapse based on your on speculatory malfeasance, YOU GET NOTHING!’ is basically what he is saying.
IF he had a bombastic personality he’d just say that, but being the calm country doctor that he is, he’s TELLING you in not so many words to: THINK DUMMY, begin to research on your own, convince yourself with REAL facts!
I’m constantly bemused by imbeciles who laugh at the specter of having to tell Dr. Paul to “stick to his day job” when it comes to discussing economics.
Okay children, time to exercise some REAL common sense. The Dr. Ron Paul is a medical doctor, an OB/GYN, a SURGEON. Now, considering Michelle Bachmann the former IRS monkey can become a lawyer, WHICH do you think would be easier? A lawyer to become a doctor, or a doctor to become a lawyer (for the sake of discussion, moral quandary of being a scummy lawyer aside, purely intellectually speaking)??
Now, ask yourself, if a person has an intellectual capacity to study and become a doctor, and the calmness and hand-eye coordination of a surgeon, do you not think the same acute intellect can be applied to studying and fully grasping economics, which, let’s face it, if you actually sat down Roubini or Krugman after a few glasses of wine, would readily admit that UNLIKE medicine, economics is NOT a science put more of a philosophy with mathematical models that more often than not, have been produced based on mathematical algorithms/model with no basis in reality, just ask the Black Swan author/economist Nassim Taleb.
Um, dude, like humans decisions… like… they’re the unquantifiable variable! Unless, you have a delusional God-Complex, that is. Hell, let’s face it. Except for the likes of Dr. Paul, those in govt are precisely attracted to it BECAUSE they’re control-freak lunatics suffering from delusions of God-Complex.
Yeah, so I’d rather defer to my own independent study of Austrian School of Economics, vs. the Keynesian Imperialist Mercantilist Colonial model nonsense. So excuse me, while I take the advice of a medical doctor/surgeon equally applying the same intellect to master Economics, COUNTER to the current batch of “intellectual” hustlers that have sold the rest of the world down their degenerate path and their “repeaters” in the blogosphere.
So ask yourself, how many economists do you know that can ALSO be surgeons?? Of the two, which professional would have EASIER time mastering the other? A surgeon studying economics? Or an economist becoming a surgeon? Better yet, of the two, WHICH do you think would master the other’s profession QUICKER?
IF you can’t even answer that, it only proves that in the REAL world of common sense, it’s MUCH more prudent to listen to the advice of a surgeon who studied the field of economics with equal vigor, MASTERED it, has been dishing out sound advices for over 30yrs, with publicly verifiable voting records, speeches, writings, books, and interviews to back up the fact that the man WALKS the Talk.
Seriously, ARE WE IN CURRENT MESS BECAUSE the country followed the advice of Dr. Paul, whom the rest of CONgress and the nation IGNORED for over FOUR decades? Or, are we in the current mess because imbeciles worship their kind, the likes of Keynesian HACKS like Krugman? LOOK AROUND YOU!
Hell, it’s well known to political and econ junkies that some moronic GOP AND Dem members on the House Financial Services Subcommittee CONFIDED to Dr. Paul in the past that they are CLUELESS of the fact that the Dollar is BACKED by nothing!
But, if there is a single constant in the universe, is that those in govt FAIL UPWARDS; the same ignoramuses sit on a govt committee that sets economic agenda for ALL Americans, and as the Dollar as the de facto world reserve currency, the rest of the globe as well.
Frankly, the same arrogance is seen in MSM/Establishment/RulingClass propaganda Repeaters!
Moi says
If we don’t grab this by the tail ultimately we are looking down the road to have our US dollar devalued so much that we are going to wake up one day to find that the green back will only be worth 50-60%. So if we think we have it hard right now, wait till we start paying 50-60% more for every thing but our take home pay remains the same.
William says
I’d like to remind everyone of a conveniently forgotten quote:
“Deficits don’t matter.” – Dick (war criminal) Cheney
This whole Kabuki theater ignores one simple fact. We don’t have a deficit problem, we have a revenue problem.
The US economy is 70% consumer driven. When consumers don’t have disposable income, they don’t create demand by way of their purchases. When businesses don’t have customers, they don’t hire employees. In such a situation, government does not collect revenue from the consumer or the employer or the employee.
During the great depression, FDR’s stimulus plan put people to work. Taxes were collected. Purchases were made, in turn creating demand, which created jobs, which created revenue. The nation began to pull out of depression with unemployment falling. Then, in 1937, FDR got the deficit bug and cut spending. The nation went into a double-dip, saved only by WWII.
Raygun instituted the “Laffer Curve”, now denounced by such “liberal” heavyweights as David Stockmann and Alan Greenspan, tripling the national debt and causing a two-year recession which, at the time, was considered the worst economic downturn since the great depression. Along comes Chimpy McCokespoon and again doubles the national debt to the deafening sound of silence. Nobody noticed, and nobody cared that job growth during dumbya’s 8 long, illegal years in the oval office was 0.5%.
History has shown, absent private-sector investment, stimulus programs work. History has also shown that tax cuts don’t create jobs, they are merely a vehicle for the upward flow of wealth, as evidenced by today’s record income inequality. I read a piece in USA Today on this issue. In FY 2010, CEO compensation rose 23%, to a median of $10.8 million. At the same time, the average worker’s income rose 0.5%.
If we are unable to learn from history, we are doomed to repeat it.
Where’s your outrage?
Nelson says
On second thought, Kyle, considering your age, perhaps I was being a bit too harsh with factual criticism.
Nevertheless, for all the points I’ve cited in the previous thread, I think proves my point: the self-evidently hilarious nature of your post, for anyone who have ever studied economics, or actually run a business, it goes to show how woefully fraudulent our govt-run public indoctrination centers have always been.
Kyle, you’re precisely the reason why people need to continue to tell you, though cliche’d maybe, but nevertheless true: REALITY is not what they teach you in HighSchool.
But, alas, since you’re heading to Berkeley, you can reconcile having arguably the most ‘liberal’ public institution, of the American ‘higher learning’ centers, HIRING, TENURING a WARCRIMINAL and one of the biggest neoCON war/torture apologists, one John Yoo, to continue to teach, laughably, Constitutional Law classes there.
But then again, rationalization and denial are just part and parcel of the Sheeple still stuck under the peacock colored hypnosis/delusion of the false L vs.R paradigm, as you’ve unfortunately proven above.
IF one had any common sense, the appropriate reaction to John Yoo at the liberal Berkeley should be one of horrors and theatrical public demonstrations/protests that UC Berkeley is practically synonymous with, but like the fraudulent Leftist AntiWar protesters during the GWB regime, they were only against a GOP war: just watch the oBUSHmaBots bask in the Kool-Aid drowning pool of Govt lies; seriously, would Dems/Liberals/Progressives accept “humanitarian aid” causus belli/EXCUSE to murder/bomb/occupy another nation filled with ‘brown people’… say like Libya, IF Dubya decided to unilaterally, again, to murder innocent sovereign citizens of another nation?? Um, NO.
But… but… but… oBUSHma WAS a ‘Constitutional Scholar!’ Yeah, as if a douchebag’s self-proclaimed platitudes have any bearing on reality.
Kyle, you’re too young to fall prey to it this early. It’s obvious from the way you write, you’re enamored with your own level of political grasp, but really sit down and dissect it. Is it REALLY your own opinion, or that of the State, or of popular and ‘safe’ authors, economists, and snakeoil salesmen like Roubini, Bernanke, Summers, or Krugman? Don’t you already know when you’re rationalizing BS to yourself?
The best thing for you to do is save your money, research on your own, BEFORE you become jaded with burnt out teachers at Berkeley too busy chasing their own research grants to give a frakk about your education. Besides if you were really smart, the likes of Harvard already offer full-ride scholarships. Hell if you’re self-motivated, you can raid any number of free online courses like the ones that MIT and Harvard offer, along with hundreds of other schools that offer the same for FREE, or a fraction of the cost.
Kyle, as one American to another, before you waste away the most intellectually impressionable stage of your life, explore the REAL world, first. Travel, say hello to your local commissars and oppressively invasive regiment of the TSA; perhaps then you’ll find out what govt really is, when it decides it can touch you, track you, without your consent, let alone meeting the only lawfully accepted legal criteria: probable cause. Or in the extreme, as growing number of “Rodney King beating” type YouTube video uploads become ubiquitous, if you’re a cop, even literally getting away with MURDER.
As Washington warned: “Govt IS force.”
We’re deep, DEEP in PoliceState tyranny. Oddly enough, if one were to judge the reality of the world on a PURELY FACTUAL basis, one may as well conclude that the ‘terrorists’ have won: seriously, did OBL pass the Patriot Act, establish DHS-TSA, NSL, 100mile-border “Constitution Free Zones,” or any number of UnConstitutionalities? And, we’re bankrupting ourselves in the proces.
We’re doing it too ourselves. We’re turning a once “FREE COUNTRY” into a rampant PoliceState with a PANDEMIC of copthuggery. The Frogs are WILLFULLY slowly boiling themseves to death, in cheers!
Be part of history. Teach yourself REAL facts and our American Constitutional Heritage. Recognize to see the world for what it really is: tell it like it is.
Problem with empires in decline? Initially the govt propagandists KNOW they’re lying to sell you something, but after generations of it, like an abstract painting that began with a photographic representation of a still-life, its later iterations bear no semblance to the original still-life that it began with, likewise, the propagandists begin believing in their own PR, propaganda and LIES.
Decide NOW that you’ll CHOOSE to lead an AUTHENTIC life, and will not veer off the path of REALITY. Arm yourself with the American Heritage of Constitutional primacy of MAXIMUM individual liberty, and MINIMUM delegated Govt ‘powers.’ Freedom, understanding that free society based on NON-FIAT, sound money, free markets, property rights, and MAXIMUM individual freedoms is what secured a creative and ambitious society that America has been, but is now on a quick death spiral in its last days of a Republic that’s become hijacked by Banksters who have fast turned it into an empire.
America today is but a mere remnant of her glory days; it’s precisely because generations of spoiled brats, particularly the BabyBoomer generations, have squandered all the wealth and freedom, not to mention OUR GOOD NAME/image across the gloge built upon generations of good deeds, in spite of ebb and flow of occasional imperial tendencies, built by our forefathers and mothers.
Will you continue the self-delusions, believing in a known intentional lie, that became a self-deluded ‘truth-ism?’ Or will you be part of the growing number of generation of youth that is finally beginning to wake up out of the slumber and CHOOSE to RE-Learn what the American REPUBLIC is all about and embark on a path to RESTORE knowing what it means to be a Free and Independent sovereign human being?
Hope you choose the latter. Consider it at your leisure, Kyle.
Good Luck.
Outsider says
Very well said, Nelson. While my mind seems capable of only shortening ideas to the Cliff notes version, we are in agreement as to what happens when a so-called “intellectual” with no real-world experience is actually given some power. I believe some people think they’re so smart that if they can dream up an idea, justify it in their own mind and in academia, maybe even earn an “A’ on it in a prestigious institution of higher learning, then it will readily translate into reality. Sound familiar? The problem is, when reality strikes and one (he) is forced to deal with it, there is no plan B. One response to this utter failure of liberal idealism might be to hop onto the largest, taxpayer funded private jet and take yet another vacation to Hawaii.
Jack Cowardin says
“Economists and politicians always speak with logic and theories. Somebody has to come and offset them with the facts.”
“It does seem our country could be run much better by someone…if we could only think who.”
Will Rogers
Kyle Russell says
I’ve never been quite so insulted in my life.
For someone who makes a seemingly huge deal about “facts,” you sure get plenty wrong. For instance, did you know that the organization that gives the Nobel Prize in Economics is completely separate from the original Nobel organization? It’s quite apparent that you didn’t. Strike one.
Hicks (in 1937) told us that in a financial crisis, investors will make a ‘flight to safety,’ during which there will be an intense jump in the demand for safe assets (U.S. bonds) which will lower both their other investments and their consumption of goods. This, of course, will force the economy into recession until the supply of safe assets catches up with demand. If there were a dollar crisis coming, interest rates would have gone up form historic lows sometime in the last, oh, say four years? Strike two.
The Federal Reserve temporarily bought that debt with created money, with the intent to sell it at a later time to fight inflation when it was necessary. When it eventually sold it, that “new money” would be effectively taken out of the system. Destroy those bonds, the Federal Reserve can’t destroy that money. Where do you get a 10% interest from? Even the 30-year bond is below 4.5%. Strike 3.
The funny thing about athiests and agnostics? We generally like evidence to back up our claims. Strike four.
I actually agree with you about economics models, many of them are just plain wrong. But many of them are right, so your point is moot. Also, doctors, like Austrian economists (well, all 3 of them) don’t need to know much math. Funny that. Sure, we can’t predict exactly what one person will do, but we can know in the aggregate how people will react to changes in prices. We know what percentage of their income people will save, and we know tax rates. So it’s entirely common sense to see how things like the Keynesian multiplier works. Strike five.
I really don’t even know what to say to your comment on economists versus doctors. Doctors can be brilliant people. Economists can be brilliant people. Being one does not automatically make one better than the other. In a college setting, the economist would have to take plenty of science to catch up with the doctor, but the doctor would need plenty of math to catch up with the economist. Strike six.
I don’t know why you think I have so much faith in our government. My entire article was about how Congress isn’t doing the right thing, and have a quote where Obama says the wrong thing. But you do realize we haven’t done Keynes in this country since the the Federal Reserve pulled us out of recession in the early 1980s, right? It’s been voodoo all the way since then. Strike seven.
You think I learned any of this in public high school? Our teachers don’t even think at my level. Strike eight.
Funny how the law school is completely separated from the computer science and economics departments. Strike nine.
I believe what I believe because I weigh the facts and look at the evidence. I’ve read Hayek, Rothbard, and even your precious Paul. I disagree with what they say because I think it’s wrong. Don’t make assumptions about people. Strike ten.
Now here comes the fun stuff. Did you *really* just tell me not to go to Berkeley, and that if I was smart I’d get a full-ride to Harvard? You know what’s funny? I *chose* to not apply to Harvard. I was the valedictorian at FPC, I’ve won awards at the international level, high SAT, passed AP test independently, etc. Don’t you dare attack the institution I choose to attend. Take online courses? Yeah, that’ll get me a job at Apple or “GoldmanSUX” or the New York Times or *wherever* I decide to work when I graduate. Strike eleven.
Have fun with your 19th century ideology.
Pierre Tristam says
I was going to give Nelson my two bytes’ worth but Kyle beat me to it as usual, being more nimble and perfectly able to sweep off cluttered thinking on his own. A couple of points though: had Kyle’s identification at the foot of his column said nothing of his recent affiliation with FPC, no one would have had any idea that he he is between high school and college, and it would have saved us a great deal of silly condescension, age having generally nothing to do with anything–except, in this case, revealing an older mind’s crabbiness. At this juncture I’ll take the younger mind’s pragmatic optimism over cynicism on parade any day. It also seems to me that for all the valid points scattered here and there in those two Nelsonological floods, born-again Bazarovs are as dull as ideological rants. I look forward to more reasoned, and readable, arguments. And please, leave the caps to Fox.
Liana G says
Interesting reading all around!
Mr Russell I admire your temerity, but jadedness comes from experience of which I too am guilty of :)
You did not mention Simon Johnson but I am inclined to believe that you also share his views
Defaulting to Big Government: Simon Johnson
WASHINGTON, DC – Leading United States congressmen are determined to provoke a showdown with the Obama administration over the federal government’s debt ceiling. Ordinarily, you might expect House Republicans to blink at this stage of the negotiations, but there is a hardline minority that actually appears to think that defaulting on government debt would not be a bad thing.
These representatives – with whom I’ve interacted at three congressional hearings recently – are convinced that the US federal government is too big relative to the economy, and that drastic measures are needed to bring it under control.
Depending on your assessment of “Tea Party” strength on Capitol Hill, at least a partial debt default does not seem as implausible as it did in the past – and recent warnings from ratings agencies reflect this heightened risk.
But the consequences of any default would, ironically, actually increase the size of government relative to the US economy – the very outcome that Republican intransigents claim to be trying to avoid.
The reason is simple: a government default would destroy the credit system as we know it. The fundamental benchmark interest rates in modern financial markets are the so-called “risk-free” rates on government bonds. Removing this pillar of the system – or creating a high degree of risk around US Treasuries – would disrupt many private contracts and all kinds of transactions.
In addition, many people and firms hold their “rainy day money” in the form of US Treasuries. The money-market funds that are perceived to be the safest, for example, are those that hold only US government debt. If the US government defaults, however, all of them will “break the buck,” meaning that they will be unable to maintain the principal value of the money that has been placed with them.
The result would be capital flight – but to where? Many banks would have a similar problem: a collapse in US Treasury prices (the counterpart of higher interest rates, as bond prices and interest rates move in opposite directions) would destroy their balance sheets.
There is no company in the US that would be unaffected by a government default – and no bank or other financial institution that could provide a secure haven for savings. There would be a massive run into cash, on an order not seen since the Great Depression, with long lines of people at ATMs and teller windows withdrawing as much as possible.
Private credit, moreover, would disappear from the US economic system, confronting the Federal Reserve with an unpleasant choice. Either it could step in and provide an enormous amount of credit directly to households and firms (much like Gosbank, the Soviet Union’s central bank), or it could stand by idly while GDP falls 20-30% – the magnitude of decline that we have seen in modern economies when credit suddenly dries up.
With the private sector in free fall, consumption and investment would decline sharply. America’s ability to export would also be undermined, because foreign markets would likely be affected, and because, in any case, if export firms cannot get credit, they most likely cannot produce.
The Republicans are right about one thing: a default would cause government spending to contract in real terms. But which would fall more, government spending or the size of the private sector? The answer is almost certainly the private sector, given its dependence on credit to purchase inputs. Indeed, take the contraction that followed the near-collapse of the financial system in 2008 and multiply it by ten.
The government, on the other hand, has access to the Fed, and could therefore get its hands on cash to pay wages. With the debt ceiling unchanged, this would require some legal sleight of hand. But the alternative would clearly be a collapse of US national security – soldiers and border guards have to be paid, the transportation system must operate, and so on.
Issuing money in this situation would almost certainly be inflationary, but the Fed might conclude otherwise, because the US has never been in this situation before, credit is now imploding, and the desperate credit-expansion measures implemented in 2008 proved not to be as bad as the critics feared.
So this is what a US debt default would look like: the private sector would collapse, unemployment would quickly surpass 20%, and, while the government would shrink, it would remain the employer of last resort.
The House and Senate Republicans who do not want to raise the debt ceiling are playing with fire. They are advocating a policy that would have dire effects, and that would accomplish the opposite of what they claim to want, because a default would immediately make the government more, not less, important.
The only law that Congress cannot repeal is the law of unintended consequences.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of 13 Bankers.
http://www.project-syndicate.org/commentary/johnson22/English
Outsider says
Now I’m really curious as to whether you believe doing nothing will actually occur without consequences. Will there be no consequences to de facto across the board tax increases? You call a 4.6% increase in the top marginal rate modest? That’s a 13% tax hike in my book. One of the reasons we have a lack of hiring is because of the uncertainty of future tax rates; business owners know if the rates go up they won’t be able to maintain jobs for those they may hire. If they know for sure their taxes will go up 13%, then they certainly won’t hire. More likely, they’ll just go open another factory in China. Are we really supposed to believe that Obamacare is going to lower health care costs without affecting quality? I don’t believe for one moment that doctors are going to react favorably to “low medicare reimbursements?” Are they just going to say, “God, I love working for nothing so much, I think I’ll open another practice?” More likely, many experienced doctors are going to leave medicine to go play golf full time, creating yet another crisis. There will be millions of patients, including many of the newly insured freeloaders looking for healthcare and many fewer doctors to provide it; sounds like a recipe for rationing to me. I have to admit though, the idea of our government doing nothing sounds pretty appealing……
Kyle Russell says
If it’s the kind of business with the capability to build a factory in China, it’s probably a corporation. Corporate taxes =/= income taxes. I also think that “Obamacare” is better than the alternatives, especially the Paul Ryan plan.
Outsider says
Not sure I read your implication correctly, but I don’t agree that just because a businessman is unable to move to another country it’s right to soak him for more taxes. Regardless, as I contended earlier, the problems we face are largely the result of uncertainty and fear of the current administration’s shoot from the hip approach to formulating policy. Democratic businessman Steve Wynn summed it up nicely, calling Obama the “greatest wet blanket to business and progress and job creation in my lifetime.”
http://www.cnbc.com/id/43808793
The biggest problem with our economy, and the resulting lack of revenue to the government is the American psyche. They don’t trust the government. The fed has already shot their load of fiscal policy, keeping interest rates low and pumping cash into the system, with little result. The solution is not more financial hocus pocus from the federal reserve; the solution is to get the current “leader” to understand that when businesses do well, the American people do well. Since he seems to be a slow learner, I believe it is time for real change and some real leadership.
Kyle Russell says
According to the National Federation of Independent Businesses, the single biggest problem is poor sales, not taxes or regulations: http://www.cepr.net/index.php/blogs/cepr-blog/structural-unemployment-the-data-just-doesnt-match-up
Outsider says
I agree. People are fearful for the future, and as such are not spending as freely as they might otherwise. Businesses, such as those run by Mr. Wynn have money to spend but don’t have faith in the current administration and have no idea what the future holds. And, of course, the unemployed don’t have money to spend to boost sales. It’s all a vicious cycle, which I believe is caused by this current administration’s ineptness and socialist aims. On a side note, I am interested in your opinion as to the Flagler County School board’s recent decision to stop naming salutorian and valedictorian at the high schools.
Kyle Russell says
I agree that it’s because of the administration’s ineptness. Obama has failed to stay “on message” at nearly every turn. I disagree that it’s due to socialist aims, but rather his want to be the “great compromiser.”
As per your question about valedictorian, let’s just say I was rather disappointed with that decision.
D Smith says
I was ready to respond to Nelson’s diatribe with its uncalled for attacks and its liberal (or is that word not allowable?) use of caps. (Note: excessive use of caps, just as shouting, is the fallback of the person who really has no basis for his arguments.) However, I went on to read Kyle’s effective and well-reasoned rebuttal, and realized that I could not improve on that. Well written, Kyle!
Ms. C says
Kyle, I am very proud of you, and as always your argument is well presented.