Mail-Bag Day

A couple of weeks ago, I had the pleasure (based on the fellowship, not the subject matter) of speaking at the annual Economic Summit of the Dallas Regional Chamber about the budget problem.  There were so many written questions submitted for the discussion period at the end of the session that the moderator could feed in only a few.  Briefly this week, I would like to try to answer one question that did not come up during that discussion.  In a later entry or entries, I will try to do some more.

This first question is one that I have heard occasionally, but which has never been addressed actually to me.  It goes something like this:  What would be worse, a federal government default, or running up this enormous debt to pass on to future generations?

My answer, which I perceive from the question would come off as contrarian, would be “default.”  It probably will require some explanation.

(To clarify terminology at the outset:  The written question used the term “default,” as I suspect did I in the oral presentation.  There are strong differences of opinion about the precise meaning of that term.  Some believe that only the failure to pay principal or interest on a debt would qualify as “default;” others would say that it means simply failing to pay all of your bills in full and on time.  Trying to respect these differences in the following discussion, let me confess that I fall into the latter camp.)

Basically, I believe that default today would impose on our posterity all of the potential ill effects of a long-term buildup of debt, but they would occur right now, and they would be essentially irrevocable.

Let’s stack up those ill effects.  If the size of our public debt reaches a tipping point, and the markets conclude that the nation lacks either the will or the means to service that debt, interest rates will rise, increasing the debt-service cost that must be financed through higher taxes or lower spending on other public purposes.  (And although you might cut public spending down to nub of your own preferences, if then debt remains excessive, you must give up whatever public purposes you yourself would rank highest to service that debt.)  Lack of respect for our debt would mean that the dollar would fall, making our nation poorer in terms of the goods and services from overseas that we could afford, and driving up U.S. inflation.  The lost conviction around the world that our paper was inviolable would take decades to regain, if it ever could.  If in addition to the holding of dollar-denominated paper as reserves other countries began to shift away from the dollar as a yardstick – such as for the pricing of oil – the institutional underpinning of the financial respect for our nation would be further eroded, and the cost to future Americans would become still larger and harder ever to recover.

For comparison, if the United States were to default or fail to pay its bills, interest rates would rise and the value of the dollar would fall – just the same as in the instance of a long-term buildup of debt.  Other nations would want to move away from using the dollar for pricing.  The difference is that in the instance of default, the markets would move at that moment, and the die would be cast.  In contrast, if we make a try at deficit reduction without default on the table as a threat, and we fail, we can always take another run at the problem next year, or the year after that.

Another question is the inevitable context of a potentially default-driven attempt at changing the budget.  I have never heard or seen default used as an even-handed threat at both sides to compromise on a balanced and comprehensive deficit-reduction program.  Default is always a weapon used by one side to force the other side to capitulate – a “my-way-or-the-highway” tactic.  Opinions differ strongly here again, but some would argue that an enduring budget-and-debt solution would have buy-in from both parties and would spread the pain and sacrifice approximately evenly across the population.  Such a compromise would be much less likely than a one-sided approach to be repealed at the next shift of the political winds in an election.

In short, the goal of fiscal responsibility is a stable environment without severe shocks.  Default, however defined, would be the ultimate financial shock; in fact, the nation never has been there, and so it would be a step into the unknown.  We need to turn the budget ship around to avoid the kinds of consequences that would result from default, and we need to keep trying in a straightforward way without default as a threat – no matter how many attempts it may take.

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