Feb 20th 2012, 16:05 by Buttonwood
WHILE Greece continues to inch its way towards a deal with its EU partners, the creditors of a much-larger debtor, the US government, appear to be untroubled. Ten-year Treasury bonds still yield just 2%. But the issue of how the US addresses its long-term fiscal problems is, as yet, unresolved. A series of papers from the Mercatus Centre at George Mason University in Washington DC, called "Tipping Point Scenarios and Crash Dynamics" attempts to address the issue. The academics seem to agree that the long-term position is unsustainable "“ that not all of the promises made by the government will be met. But in terms of the actual outcome, you pays your money and takes your choice.
Peter Wallison takes the (fairly widespread) view that a government with debt denominated in its own currency and with access to the printing press will not default on its debt. But he can still envisage a crisis in which repeated failure by politicians to tackle the debt burden means that investors eventually conclude that the debt will be inflated away. This will lead to a weaker dollar, higher prices for commodities and other real assets and a wage-price spiral. Foreign creditors may only be willing to lend to the US in renminbi, rather than dollars. Such a crisis will finally push Washington into putting its finances in order.
Garett Jones thinks that neither outright default nor inflation is likely, in paper because the markets would see such an outcome coming and push interest rates up to prohibitive levels. Furthermore, Americans will be able to see the messy state of Europe and will resolve to avoid the same outcome. Thus a massive deficit-cutting deal will be achieved although Mr Jones thinks this is more likely under the Democrats than the Republicans, because of the latter's anti-tax philosophy.
Bondholders, concerned about principal, not principle, will see the GOP as the key political barrier to repayment.
In contrast, Arnold Kling argues that neither Democrats nor Republicans will be willing to compromise because of the effect on their electoral prospects. However, a negotiated default would bring in the IMF to broker a deal, which would inevitably involve both tax rises and spending cuts.
The external guidelines would give both (parties) political cover to vote for compromises that would otherwise anger their bases.
Perhaps the most provocative paper comes from Jeffrey Rogers Hummel who reasons that default is virtually inevitable because a)federal tax revenue will never consistently rise much above 20% of GDP, b)politicians have little incentive to come up with the requisite expenditure cuts in time and c)monetary expansion and its accompanying inflation will no more be able to close the fiscal gap than would an excise tax on chewing gum. Most controversially, he argues that
The long-term consequences (of default), both economic and political, could be beneficial, and the more complete the repudiation, the greater the benefits.
Why does he take this view? Once allows for the Treasuries owned by the Fed, the trust funds and foreigners, total default could cost the US private sector about $4 trillion. In contrast, the fall in the stockmarket from 2007 to 2008 cost around $10 trillion. In compensation, however, the US taxpayer would no longer have to service the debt; their future liabilities would be lower.
If Ricardian equivalence holds even approximately, then the decline in the value of Treasuries should be mostly offset by an eventual rise in the total value of both privately issued assets, such as shares of stock and corporate bonds, and expected future wage income.
I am not so sure about this. If the US government defaults, most US borrowers will surely face higher borrowing costs especially as the banks are relying on an explicit and implicit guarantee from the government on their liabilities. Mr Hummel refers to the relatively short-lived effects of widespread defaults in the 1840s (after a canal-building boom). While I am all in favour of learning from history, the financial system was rather less sophisticated (and less leveraged) at that point.
But Mr Hummel doesn't stop there. The 1840s defaults were followed by greater fiscal discipline at the state level. Default would also be a good thing, he argues since government would be forced to renege on its social security and Medicare promises.
Reliance upon these government promises constitutes a particularly egregious form of fiscal illusion"¦.The best way to alleviate future suffering is to repeatedly and emphatically warn the American people that these programs will go under. The more accurately people anticipate this inevitable outcome, the better prepared they will be.
So there are your choices. Default on the debt in real terms via inflation, default in nominal terms or break the promises made to future benefit recipients. Not an appealing menu but an indication of the likely political battles over the next 10-20 years.
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Could we get a mixture?
Real wages fell 1% from Jan '11 - Jan '12. --- I need to update my "Holders of US Debt" data.
As of June 30th, 2011 foreigner held 31.4% of the total US debt. They'll take a hit of the dollar falls (if they want their money back).
Medicare/Medicaid: Fix it.
Social Security: I'll take my chances and end up with ~72% of my benefits rather than allow the politicans give me 50%.
Gotta pay for those tax cuts (Bush and Obama) and low capital gains rate. Remember, "long-term" according to Congress is 1 year and 1 day.
Regards
In a comment DJNHL compares 2012 USA to 1789 France, stating the real problem is the very rich manipulating the system to pay less tax than is due (read his most recommended comment). In France the system broke down and the very rich lost their heads in a populist revolution, yet in the USA ....
On Bill Maher last Friday, Bill was discussing the billionaires backing Gingrich and Santorum (and of course ROmney himself). Elliot Spitzer actually defended this travesty because of the constitutional right to fredom of speech. Nobody on the panel challenged Mr. Spitzer that it's not the content of the billionaire's speech but the volume they can bring to bear on the political process. They can and do shout at 120 decibels when all everyone else can muster is a whisper. With Superpacs and the Citizens United ruling, billionaires can completely usurp the democratic process to their own ends. Apres moi le delguge!
It is not an issue of whether the American government "will" default, or even "when" it will default, the question is "how" it will default.
Americans have a looming obligated deficit of $63.6 trillion"”which is more four times our total production (USA Gross Domestic Product-GDP; $14.58 trillion) is the largest single debt in world's history. The two largest federal spending obligations are Social Security and Medicare with Medicare being the 5 times larger then Social Security. As of 2009, the obligation for Social Security alone is $7.6 trillion while Medicare is $38.1 trillion.
We euphemistically refer to Social Security and Medicare, as a "pay-as-you-go" system. This means that money that we pay today goes to support the benefits of today's retirees. Any surplus is spent by Congress which provides treasury special issue bonds"”bonds only in name since they cannot be sold or exchanged. The 2009 Social Security Trustees Report states that: "Neither the redemption of trust fund bonds, nor interest paid on those bonds, provides any new net income to the Treasury, which must finance redemptions and interest payments through some combination of increased taxation, reductions in other government spending, or additional borrowing from the public." This means that these are not funds or bonds that could be sold, since to pay this money back the government will have to raise, borrow, print additional monies to honor them.
Unlike other countries that invested some or most of their surplus, the U.S. government spends all of it. For the past 40 years Congress has not had the ability stay within budget (apart from 1999 and 2000), it is unlikely that it is capable of balancing the budget and reduce spending enough to pay back four times our GDP to the Social Security Fund (including Title XVIII Medicare.) More telling is that there is no budget plan by Congress to ever do so.
The sad part of this story is that we have known this for at least three decades with the 1982 Greenspan Commission. With a major payroll tax hike to generate Social Security surpluses for the next 30 years, the strategy was to build up a large reserve in the trust fund that could be drawn when the boomers become retirees. The Budget Enforcement Act"”Section 13301"”made it illegal for Congress to use Social Security funds by excluding Social Security from all budgets including the congressional budget. However the intent of the law is ignored.
Medicare by far is the largest federal obligation, and despite consuming nearly 20 percent of our GDP (by 2016), twice that of Switzerland, Germany and France we still have 46.6 million Americans uninsured. In addition, for those Americans lucky enough to have insurance, these dollars do not translate to better health. The United States continues to slide further behind other countries in health status. In 1997, the U.S. ranked 15th in mortality. Since then, Finland, Portugal, the United Kingdom and Ireland have reduced their mortality rates from diseases that can be cured more rapidly than the United States. Similarly disappointing are results of child well-being, in which the U.S. ranked second to last when compared to 21 similar countries.
It is not an issue of whether the American government will default, it has to: or even when it will default, it will happen when the next round Congress does not pass a law allowing it to borrow more to pay off its debts; the question is how it will default.
Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," embraces whatever concerns the integrity of the public obligations such as Social Security (P. 294 U. S. 354.) And it is also a perceived political deal breaker, a third rail. Social Security can easily be modified to address perceived obligation simply by adopting the Medicare formula of taxing all income without any ceiling. And that will likely happen.
Medicare is the real issue. Administering Medicare is six times more expensive than health care systems in Europe, while nearly a third of all Medicare dollars are spent on moribund (dying) patients in the last two years of life. The solution needs to address both these issues. The government will need to harness Medicare (and title XIX Medicaid) through a comprehensive health care system. First will come the default on services, and the slip sliding of our health. The "how" is health of older adults which will continue to deteriorate until there is enough political will to adopt a more equitable and efficient system of health care delivery. Single payer, managed care, with rights and dignity of dying.
Mario D Garrett is a writer and Professor of Gerontology at San Diego State University and you can read his blog on aging http://iage-marius.blogspot.com/
If one looks at history the answer is obvious: Inflation. Before I went to Vietnam, a megabuck @ 6% was enough to retire and take your whole family. It still was after I expended a megabuck of ordnance per month there. Now not so much. Sure nominal interest rates will sky rocket, but real interest rates will become negative. Using the CPI, there will be no official inflation for food, clothing or housing because of down trading of steak to hamburger to dog food. Haute couture to Walmart to Salvation Army. McManisons to Suburbs to trailers to tents. Johnson, Nixon, Ford, Carter, Reagan inflation has a long and noble bipartisan history.
I guess that means buy everything you can now on borrowed money while it is still relatively cheap.
I think that would be a safe bet.
Americans continue to ensure their financial future is mortally jepordised by their own stubborn, intransigence & calculated denial of the dire economic consequences facing the nation. By not addressing the exorbitant & cumulative national debt & soaring budget deficits, year after dismal year, the country is sinking deeper & deeper into debt payment default & bankruptcy.
Their wiley political representatives - especially the Repugs - only perpetuate & encourage these fallacies & self-induced ignorance of the willing electorate, to safeguard their political positions. Commonsense dictates that without substantial tax hikes & deep spending cuts/austerity measures, the nation will be unable to tackle its mounting debt & only seal its crumbling & self-destructing future, that much quicker.
However, nobody seems to want to look beyond their arrogant noses or face the harsh realities looming over their grim & foreboding horizons. Living in catatonic denial, with their heads burried in the sand, seems to be the national pastime & predominant trait. But juvenile pride, imbecelic hubris & infantile denial, won't make the national debt disappear. The Day of Reckoning is just arround the corner & the the nation needs to wake up from it's self-induced stupor & shake a leg - PRONTO!
As the saying goes: "None are so blind as (s)he who will not see"
Yeah but the problem is not just an American one. The entire world is built on borrowed money. Germany and Japan are both reliant on America's willingness to spend in order to keep their own heads above water, and every time that Baynard or Ryan say that they are going to cut this or that from the budget Walstreet screams that it will cause a downturn in the market and might kick off the next recession.
You are correct in your assertion that if Congress showed a willingness to compromise and raise taxes that this would have a psychological effect to shore up the markets and it would enable us to keep selling out bonds. In Illinois once the State government passed a state income tax hike the bond markets opened up the doors once again to the state because the bond markets and credit insurance markets felt that Illinois was willing to take measures to increase revenue, but this was nothing more than a psychological power play. In a year or two from these tax hikes that Illinois has undertaken it has turned out that the state is actually losing revenue because fortune 500 companies are fleeing like the plague has come to town. They are going to Texas and Alabama and Georgia were they aren't being taxed to death.
So there is a backlash to every policy, and every time you either want to cut spending from a budget or increase taxes there are unexpected and unforeseen consequences. Basically cutting from a budget means that someone or some lobby's going to lose out. This is politics.
So it is not necesarily a case of living in catatonic denial, or having heads buried in the sand. It is more of a case of misaligned interests.
The bottom line is that we are now paying for bad policies put into place 15, 20, 40 even 55 years ago. Policies like "A War on Drugs" that has cost us 3 trillion dollars and has done nothing to curb drug use. Also wars in Panama, Somalia, Bosnia, Iraq, ten years of air raids from Saudi Arabia and Kuwait, having troops deployed to Korea and Japan for the past 55 years, etc. These campaigns probably cost on the order another 6-10 trillion dollars of unnecessary spending. This fancy for military operations throughout the world is what has cost us and is what will ultimately bankrupt us.
To clarify one comment. The USA is not a democracy. The USA is a constitutional republic. Unfortunately, mob rule has taken over the executive, legislative, and judicial branches resulting in people voting tor spending like they were teenagers with their first credit card.
Also, I would point out that by any moral person's definition, when you promise to repay a loan with interest but instead repay a loan with a currency that you debased yourself, that is essentially default.
When the bondholders loose faith, there will be a nonlinear exponential stampede to exit the dollar. Then the US will be in big trouble.
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