Wednesday, October 16, 2013

Felix Salmon: The Default Has Already Begun

The big question in Washington this week is whether, in the words of the NYT, we’re going to see “a legislative failure and an economic catastrophe that could ripple through financial markets, foreign capitals, corporate boardrooms, state budget offices and the bank accounts of everyday investors”. In this conception — and I have subscribed to it just as much as anybody else — the sequester is bad, the shutdown is worse, and the default associated with hitting the debt ceiling is so catastrophic as to be unthinkable.

This frame is a useful one, not least for the politicians in Washington, who seem to have become inured to the suffering caused by the shutdown, and downright blasé about the negative consequences of the sequester. Both of them could last more or less indefinitely were it not for the debt ceiling, which is helpfully providing a hard-and-fast deadline: Congress is going to have to come up with a deal before the ceiling is reached, because the alternative is, well, the zombie apocalypse.

There’s more than a little truth here: I’m a firm believer, for instance, that the president both can and should prioritize debt repayments in the event that the debt ceiling is reached. If we’re going to be so stupid as to hit the ceiling, then prioritizing debt service is the least-worst outcome. But at the same time, the situation is less binary than it looks, not least because the US government is already in default on its obligations.

The best way to look at this, I think, is that there’s a spectrum of default severities. At one end, you have the outright repudiation of sovereign debt, a la Ecuador in 2008; at the other end, you have the sequester, which involves telling a large number of government employees that the resources which were promised them will not, in fact, arrive. Both of them involve the government going back on its promises, but some promises are far more binding, and far more important, than others.

Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. Indeed, by Treasury’s own definition, it’s reasonable to say that we have already defaulted: surely, by any sensible conception, the salaries of government employees constitute “legal obligations of the US“.
Read the rest here.


The Anti-Gnostic said...

Moralistic talk about "broken promises" is misplaced. Current taxpayers have no duty to keep obligations enacted by past legislatures. Would we consider a father's pledge of his child's future labor to be binding? This is all government debt is.

If government is so large it can no longer be funded out of current tax receipts, then it is too large.

Chris Jones said...

Current taxpayers have no duty to keep obligations enacted by past legislatures.

I think this is completely wrong. Unless you are willing to say that it is never right or necessary for the government to borrow money, then the "full faith and credit" of the government is something to be prized and defended. Bondholders need to know that they can rely on their loans being repaid. Thus, current taxpayers must be obliged to honor the debts incurred by the state in the past.

Generally absolving the taxpayers of that obligation is a moral hazard of the highest degree.

If government is so large it can no longer be funded out of current tax receipts, then it is too large.

I agree with this as a general principle. Of course the government's debt should never have been allowed to grow to its current state. But that is a prudential judgment which, however sound, does not alter the principle that the government must honor its debts if it is to be able to borrow in those situations where borrowing is, in fact, justified and necessary.

Chris Jones said...
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The Anti-Gnostic said...

Bondholders are supposed to price the risk of default with interest. When they don't, we get the distortions we see all around us. How "right" is that?

Good credit of government is simply a matter of expediency. There is not a single moral principle at stake, because there is no moral principle by which current debtors can bind future payors, no more than I can sign for a loan now to be repaid by your future grandchildren.

Government debt is frankly theft unless you can limit it to an obligation paid solely by current taxpayers.

James the Thickheaded said...

THe problem isn't that the government can't afford it's debt. The problem is that the government has no intention of paying it off at face value. Whether I default by giving you 75 cents on the dollar, or give you a dollar that's only worth 75% of the value it had when you lent it to me... is merely a technical difference. Both are defaults. Incidentally, taxing people today for Social Security and Medicare benefits that the Government has not intention or capability of paying... is similarly a default. The problem today in my eyes, China's and most of the rest of the financial world is that the US is a spendthrift nation. Government thinks if it keeps buying its girlfriends (the public) sweeter toys, we'll like it and agree to pay higher taxes. Sadly, the girlfriends continue to live well as the best revenge and intend to go on doing so no matter what... most especially, they have no illusions about becoming domesticated and are insulted to think their boyfriend thinks they can be bought. These things never end well. Democrats think the won and Republicans lost. Truth is we all lost a small bit now, but in the end, we'll lose more.

Question is whether it can be turned around. Dunno.

James the Thickheaded said...

I should add that if the Government proceeds to curtail the intended spending for Social Security and the like, that too is a breach of promise and the high priced girlfriends will move along. And just so no one gets their nose out of joint, could as well substitute gigalo or pool boy for girlfriends. Same principle