Stop Whining, and Learn To Love a Default
A Wall Street Journal headline from Wednesday in many ways told the ridiculous tale of a very minor federal government shutdown, and the subsequent cave by a scared-of-its-own-rhetoric Republican party. "Uncertainty Chips Away at Prestige" was the headline, and the article alleged reduced prestige for the U.S. globally in light of a budget fight taking place domestically.
It all sounds very bad until we remember that the headline was mostly aimed at our political clout. In the politics profession, one's prestige is a function of how much he or she can fleece the taxpayers for highway systems, airports, space programs, and yes, healthcare on demand that's ‘generously' provided by the government. No doubt in the ‘spending the money of others' sense, U.S. political class prestige vis-à-vis its serial plunderers globally is well down in light of the just ended budget fight, but then isn't that the point?
Quite unlike the rest of the world where political power is the rule, the U.S. was founded by very wise men who first granted the federal political class a government, then proceeded to severely limit that same government's power and prestige. In that case, a budget impasse driven by frustrated Americans surely is a blow to the political class's international prestige among politicians. With good reason. The ability to dole out big sums of other people's money serves as the proverbial scoreboard in politics. But then we're not like the others, and that's a good thing.
The Republicans gave in on their budget fight, they essentially did so for nothing in return to read the media accounts, and a common explanation for why is that the polls were moving against them. In short, politics drove their decision to hand President Obama a victory, but by virtue of Obama winning, this wasn't very good politics. Either way, the Republicans talk a big game about limiting their time in very alien Washington, D.C., but then given a chance to risk their plush jobs in Congress on their professed belief in limited government, they quickly retreated.
To the above, the popular answer is that for the Republicans to truly shrink government they must control it through elections. That all sounds nice, but as evidenced by a prescription drug benefit, Sarbanes-Oxley, along with nosebleed spending increases when they controlled Congress in the early part of the 2000s, the notion that Republicans would reveal government-shrinking prudence once in power isn't terribly compelling. Better it would be if the GOP had continued to keep the federal government shut down, thus revealing an ability to control at least parts of federal spending. This would have to be better than the post-shutdown headlines we're seeing now describing how the Republicans lost to President Obama.
The response to such a strategy beyond the supposed political hazards is that the Republicans would have been foolish to risk a federal default. Comical here is that if there's one thing that brings liberals (New York Times editorial page), conservatives (Wall Street Journal editorial page), bombthrowers for the right (AEI's Jim Pethokoukis), and bombthrowers for the left (Paul Krugman) together, it's that a federal default would be a "disaster" (Bret Stephens - Wall Street Journal), and that such an occurrence would be quickly followed by a recession. Really?
Considering the possibility of ‘default' whereby the feds would cease paying bills, it's already been well covered by the commentariat that this wasn't going to happen. Indeed, it's shooting fish in the barrel to point out that a self-interested political class would never knowingly do that which would be inimical to its own interests. Political types in D.C. love to borrow cheaply, this is true no matter party affiliation, so there was no way a default was ever going to happen. They'd sooner cut programs altogether, as they should, than potentially imperil their ability to borrow. To be blunt, the Republicans should have held firm. If it meant losing their jobs in 2014 that's not our problem, plus if any party is more incompetent than Republicans when they have control, it may be the Democrats (see 2009). Assuming a loss of seats, the Democrats would quickly give them back, not to mention that Obamacare fails in its present form no matter what.
But for fun, let's assume that small thinkers like President Obama and Treasury Secretary Lew had actually called the GOP's bluff and stopped paying bills. Would such an occurrence really have resulted in the economic calamity that has so successfully united both sides of the political aisle? It's very doubtful.
For evidence we need only reference the book (This Time Is Different) by Carmen Reinhart and Kenneth Rogoff that ‘everyone' seems to cite despite nearly everyone having not actually read it. Had they, they would not be as fearful of ‘default." As the two economists put it, "most defaults end up being partial, not complete." Indeed, they found that in most cases, "partial repayment is significant and not a token." Ok, so assuming we default it's a fair bet that soon enough thanks to regime change, national pride, or more economic growth thanks to reduced government spending rooted in the shutdown, bill payment resumes.
To such a scenario the ‘disaster' crowd would surely say that trust in the U.S. Treasury would be ‘shaken' for a ‘sure bet' having defaulted, that this would have long-term interest rate and national security implications, the dollar would be in a freefall, etc. etc. Funny about the dollar is that these same doomsayers have for the most part never paid much mind to the dollar's decline since 2001 under both Parties, both in terms of gold and in exchange rate value.
But if we're to believe their sudden interest in the greenback, they'd do well to know that by that line of thinking the sure thing that is the United States has already defaulted at least once. Specifically, Reinhart and Rogoff mention the abrogation of the gold clause in 1933, which meant that debt paid to American creditors (from 1928 to 1946 the U.S. had no external debt) was repaid in paper currency rather than gold.
If 1933 can be counted as a default episode, and Reinhart/Rogoff count it as just that, then it's easy to argue that the U.S. has been giving investors haircuts ever since, especially beginning in 1971. During that time the value of the dollar in terms of gold has collapsed from the $35 Bretton Woods fix, all the way to recent lows beyond $1,300/ounce. Notable here is that the dollar didn't collapse in the ‘30s after the default, as evidenced by the Fed's quietude during that same decade interest rates didn't skyrocket, and then judging by our ability to run up the largest deficits in U.S. history (per GDP) to fight World War II, default in no serious way imperiled our ability to borrow in order to fight the war.
So if it's agreed that we've defaulted before without serious consequence, it's worth it to ask if it's actually a good thing for our economy that the U.S. federal government is viewed as a ‘sure thing.' Basic economic logic says no. To paraphrase George Gilder, economic growth and advancement is about the 'leap,' but if our federal minders can offer investors that which is at least nominally a safe haven, the latter must necessarily exist at the expense of the very economic experimentation that moves the economy forward. To put it plainly, safe government debt allows investors to be careful on the taxpayer dime, as opposed to being more intrepid absent the subsidy. Forever unknown is what we've lost over the decades for government consumption and waste attracting so much ‘careful' investment.
That's the case because despite what you read and hear from the Keynesians who mostly populate the economics profession and the commentariart, there's no such thing as idle money or credit, or saving at the expense of consumption and/or investment. Unless we as individuals consume all of our income, or hide it under a mattress, the money we save constitutes our shifting our consumptive ability to others; that or our savings are being borrowed by entrepreneurs and businesses with a need for growth capital. Looked at in terms of very safe Treasuries, assuming a lack of them or a very short supply of same, investment would have to go somewhere. Banks don't pay for deposits so that they can warehouse money, rather scarce Treasuries or less reliable Treasuries thanks to the alleged horrors of default would mean more bank deposits and more lending to that which actually constitutes real economic activity.
Not asked enough is why the federal government (meaning U.S. taxpayers) must provide a safe haven, or for that matter an interest rate benchmark to the private sector. Implicit in such illogic is that before massive Treasury issuance that the markets were blind to actual interest rates and that the economy limped along sans the benevolent hand of Treasury. In truth, and this belief is promoted by billionaires like Peter Thiel, economic progress was far greater over 100 years ago than it is today in relative terms. There are no doubt many authors of this decline in economic experimentation (it says here the floating dollar since '71 robbed the economy of a lot of investment, not to mention human capital that migrated to Wall Street to trade the chaos) in modern times, but one hard to ignore factor has been all the government spending made at least somewhat possible by the safe haven that is U.S. debt. Not explained then is why it would be so bad if the debt were deemed not so safe.
Looking at default in yet another way, California, Illinois and New Jersey are regularly fingered by deficit scolds as likely default candidates for their own debt. Ok, so if all three default, can anyone say with a straight face that Apple Inc., Caterpillar and Johnson & Johnson will suddenly face debt finance problems for being located in states known for their budgetary incontinence? Assuming a national default that as history reveals will be very minor, is it remotely true that the resulting decline in Treasuries will make borrowing very expensive for cash rich companies like Microsoft? Will global brand Coca-Cola suddenly face financing difficulties alongside Miley Cyrus and LeBron James?
Assuming yes to all of the above, basic market logic tells us that high prices always and everywhere beget low prices if left alone. If it's really true as left and right, Republican and Democrat want us to believe, that a federal default would lead to ‘disaster' and high, recessionary interest rates, then it's also true that soon enough those rates would come down as those with credit on offer would enter the credit space to enjoy high rates of interest. The natural reply to this scenario is that a minor correction in Treasuries would so spook the markets such that credit altogether would be erased, but if readers can stop laughing as they consider the absurdity of such an assertion, they might remember that for as long as they've been alive, deficit hand wringers have been roaming the earth, always predicting doom for Treasuries thanks to federal deficits. What this means is that there's massive short interest in Treasuries such that those who've been preaching doom for decades would finally reach their payday. Flush with cash, they'd have to do something with it. Of course even if it's true that a minor haircut for Treasury holders would lead to mass bank failure and higher rates, can't we at least ask Republicans to state the obvious; that it's not the federal government's job to keep rates low, nor does it exist to prop up banks.
Can't we also demand that Republicans, the Party most associated with small government rhetoric, acknowledge that higher interest rates on Treasuries would be good, not bad for the economy. Can' t we similarly demand that a Party most associated (however incorrectly in both instances) with free market rhetoric be explicit about how bad it is for capitalism, and the banking system more broadly, that federal machinations, including the safe haven that is Treasury debt, continue.
As the article referenced at the beginning of this piece noted, the presumed bulletproof nature of Treasuries "gives the U.S. huge advantages, including the ability to borrow at rates lower than almost any other country." So true, but seemingly never asked by a bipartisan collection of elite thinkers so eager to dismiss those who cheer on shutdowns and default, is what would be so bad for the economy about investors losing faith in Treasury bonds such that our federal government could no longer "borrow at rates lower than almost any country." This question is particularly directed to right wing thinkers so contemptuous of those who don't fear shutdowns or defaults; as in isn't government spending generally government waste? If so, wouldn't it be good if there were less of it? Would reduced investor trust in Treasury debt maybe force a reduction?
After that, readers must consider who's offering up these dire warnings of doom in relation to a default that was never going to happen to begin with. Almost to a man and woman this same bipartisan collection said economic collapse was ours back in 2008 if we didn't bail out the banks. Simple logic says the economy's recovery was blunted precisely because we saved the failures (Citigroup for the 5th time in 22 years), so haven't the skeptics at least earned the right to question the predictions of the anointed? Better yet, isn't it time for those same skeptics to not only ignore the "smoke in the theater caucus" with regard to banks and Treasuries, but to go an entirely contrarian route? Plainly put, not only should we not fear default, we should learn to love it.
Federal default means the federal government will have less money to waste. If so, let's get moving on defaulting.