Breaching Debt Ceiling Will "Not Be a Catastrophe," Says Nobel Prize-Winning Economist, and May Have an Upside

Vernon SmithChapman UniversityPoliticians and establishment figures warn that, with the goverment spending far more than it takes in in the form of tax revenues, the leviathan on the Potomac will not only be unable to pay its bills if the debt ceiling isn't raised—further partially shutting down an already slightly closed for business establishment—but that it could default on payments on its existing debt and cause an international financial crisis. President Obama claims "every economist out there is saying" that "millions of Americans—not just federal workers—everybody faces real economic hardship" if the debt ceiling isn't raised.

Well...Maybe not every economist out there.

Vernon L. Smith, professor of economics at Chapman University's Argyros School of Business, and 2002 co-winner of the Nobel Prize in Economics (he's also a Trustee Emeritus of the Reason Foundation, which published Reason), takes the prospect of a frozen debt ceiling, and even a debt default, in stride.

Reason asked Dr. Smith his take is on the consequences of breaching the debt ceiling. Will it be a catastrophe or not? He responded:

No, it will not be a catastrophe. The U.S. is one of the few countries in the world and in history that has NOT defaulted on its debt; consequently we suffer the consequences of the curse of a reserve currency. The great housing-mortgage market bubble, 1997-2006, was fueled by a massive inflow of foreign investment funds. This is the other side of our deficit on trade account which looks like a sweet deal in which foreigners send us more goods and services value than we send them. But it has negative consequences and cannot be sustained indefinitely.

By Smith's take, making the United States less attractive as a destination for foreign investment might spare us future bubbles, and so have an upside.

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  • Fist of Etiquette||

    Breaching Debt Ceiling Will "Not Be a Catastrophe," Says Nobel Prize-Winning Economist...

    Paul Krugman said that?

  • DH||

    Of course, that's part of the "Bizarro World Paul Krugman See and Say". He also says, "Government stimulus spending is bad" and "Government should stay out of the Free Market". Available now at local retailers.

  • Almanian!||

    You can tell the Bizzaro Krugnuts because it DOESN'T have a mustache and beard.

  • A Secret Band of Robbers||

    Theory: In the primary timeline, Tom Friedman is an insightful and responsible journalist who improves the world by persuading his opponents with reasonable arguments. We have the evil version.

  • Live Free or Diet||

    An hour or so in the Agony Booth should fix that. And Spock with a beard, of course.

  • Tman||

    The one positive outcome of the shutdown is it revealed the centrist RINOS to be just as useless as blue dog democrats. In fact, I'm not sure there really is a difference. And of course the beltway commentariat supports the "moderate way out" in this showdown because it reinforces their belief that they are the ones in charge.

    You have to admire the folks like Cruz and Lee who are finally standing up for something worth fighting about and are not giving in, despite the threats that "we are taking the country over the edge with this shutdown/debt ceiling" garbage.

  • BigT||

    And of course the beltway commentariat supports the "moderate way out" in this showdown because it reinforces their belief that they are the ones in charge

    I think the moderate way out is simply the folks being too stupid to understand the arguments, and so just cutting the baby in half.

  • carol||

    Amen. It is nice to know that there are at least a couple of politicians out there who have a set. What gets me is all the people screaming about default. Whether the debt ceiling is raised or not we are not going to default. We have enough income each month to service our debts and to sugest otherwise is just cheap political theater.

  • BigT||

    I think the Administration could *choose* to default by not paying on some bonds. But they would not be forced by lack of cash to default.

    Just like they didn't have to fence off the WW2 memorial, but they did it to spite the people.

  • Diogenes||

    Panties in a bunch, are they?

  • UCrawford||

    It wouldn't at all shock me if O'Bummer chose to go that route.

    It's such a cliched phrase, but he really is the worst President in U.S. history. Not just in scope of bad ideas, not just in bad policy choices, not in inept foreign policy...but across the board.

    Dumber than Bush. The man is dumber than Bush.

  • Tony||

    It's astounding how quickly the talking points get routed.

    Can you guarantee it wouldn't result in a recession as most people are predicting? If not, why on earth would you possibly advocate taking the risk?

  • carol||

    Because it is less risky and more responsible than piling debt on top of debt.

  • Tony||

    In the immediate term that is a ludicrous claim. A recession would only result in more debt.

  • LynchPin1477||

    I'm not advocating breaching the debt ceiling, but kicking it down the road has been the MO for years. At some point you have to face reality, and its better to do it when you aren't in real, honest to God crisis mode.

  • Tony||

    Deficit cut in half during Obama's term. The only way to significantly start paying down debt is to increase revenues significantly. That means not cutting government spending that would result in reduced economic demand (though there's plenty that can be cut) and it means raising taxes. That's just the way it is, and if you don't accept that then you don't really care about debt.

  • LynchPin1477||

    Cutting the deficit in half only means the debt isn't growing as fast, but it's still growing. And it is projected to continue to grow, a lot. Based on some quick Googling, it looks like federal revenues would have to increase by 8% of GDP to cover expenditures today. Historically, those types of tax rates have never been sustainable.

    That means not cutting government spending that would result in reduced economic demand

    The government isn't the only thing that can create economic demand. The government does plenty of things that reduce demand and growth.

  • carol||

    That's bullshit. Rip off the damn bandaid and quit being such a wuss. Is it going to hurt? Yes. Is it better in the long run? Yes, yes, yes!

  • DetachedObserver||

    And what do you propose will happen once the bandaid is ripped off? A Congress that can't reach any sort of compromise and political discourse that is so so combative is not the recipe for crafting any sort of longterm solution. I agree that all this deficit spending is unsustainable and this mountain of debt will surely crush us, but I don't think that the way this has played out in Washington is a sign of good things to come.

  • Ballz||

    deficit cut due to sequester.
    everything else you say is horse shit.
    government spending is economically neutral or negative. raising taxes reduces economic demand.

  • Ballz||

    here's an idea; stop sending $1 billion+ each year to Egypt (camel jockies). while we're at it cut funding for Israel, Afganistan, IMF, ............
    ...oh, fuck it

  • DJK||

    Typically disingenuous response from Tony. There are two ways to significantly pay down the debt - spend less or raise more. As has been pointed out to you plenty of times, taxes are not the same thing as revenue. And it is historically unheard of for revenues to be much higher than they are right now. Go ahead and raise the income tax rate to 90% and watch as people move their activities underground and take other actions to avoid having to pay such high rates. Good luck with that one.

  • DJK||

    This is historical fact. I suppose you could get around it by saying that tax collections need to be enforced more vigorously. The threat of imprisonment or death is pretty much the only thing you have.

  • Live Free or Diet||

    Deficit cut in half during Obama's term.

    Obama cut the what in who?!
    From http://www.treasurydirect.gov/.....histo5.htm

    09/30/2012 16,066,241,407,385.89 Deficit: 1,275,901,078,828.74
    09/30/2011 14,790,340,328,557.15 Deficit: 1,228,717,297,665.36
    09/30/2010 13,561,623,030,891.79 Deficit: 1,651,794,027,380.04
    09/30/2009 11,909,829,003,511.75 Deficit: 1,885,104,106,599.26
    09/30/2008 10,024,724,896,912.49 Deficit: 1,017,071,524,650.01

  • Wizard4169||

    Are you on the same crack Barack "We don't have a spending problem" Obama is on? The only way you can possibly say the deficit has been cut AT ALL (much less in half) is to take Dubya's wildly bloated "porkulus" budget seriously. Obama promised to cut the deficit in half (That's not debt, just deficit. He didn't promise to quit running up debt, just not to dig the hole quite as deep and fast.), yet it took him years (and massive resistance from Reps) just to bring the deficit down.

    Government spending (especially when financed with artificially cheap debt)only distorts the economy, it doesn't "stimulate" it.

  • James Taggart||

    Do you know of any examples where countries have solved their debt problems by raising taxes?
    (answer is: no you don't)

  • Brian||

    Can you guarantee it wouldn't result in a recession as most people are predicting? If not, why on earth would you possibly advocate taking the risk?

    Because I'm not a coward who goes running under the skirts or moronic politicians just so I can feel safe and OK? Even if that means not stealing from the future? Is that a valid answer? Please let me know if that's insensitive to your delicate situation.

  • Tony||

    How will a global recession help the US service its debt? A recession means even less revenues coming in.

  • Brian||

    Short-term employment isn't the primary variable in the objective function that I optimize.

    Especially with a government that funds so much bullshit that hurts people. They can cut some of that before they whine about short-term employment and short-term aggregate demand.

    In other words: I'll feel guilty and worried about policies that may cause short-term unemployment, when you guys feel guilty and worry about policies that kill hundreds of thousands of people and throw the innocent in prison.

  • Tony||

    Which guys? Criminal justice reform is like #2 on my list of priorities. I don't know which hundreds of thousands you're referring to, but gun violence is like #3 or 4.

  • Brian||

    If they'd legalize drugs, that would take care of 90%+ of your gun violence.

    But we can't talk about things that would reduce government spending during... a budget/debt ceiling negotiation.

    Which is how you know this system is completely fucked and will never address any of your concerns, unless they address the government's concerns.

  • Ballz||

    fuck you

  • Ballz||

    tony

  • Tony||

    I admire their rapid, directionless destruction of the Republican party.

  • Juice||

    Soon we'll be a one-party state. Hurrah.

  • Biden's Scroteplugs||

    Destruct sequence 1, code 1-1 A

  • BuSab Agent||

    Destruct sequence 2, code 1-1 A-2B

  • JW||

    Destruct sequence 3, code 1B, 2B, 3

  • Marc F Cheney||

    *stage whisper* Destruct

  • BuSab Agent||

    Destruct sequence completed and engaged. Awaiting final code for one-minute countdown

  • Scarecrow Repair||

    *****

    Damn it got censored.

  • Rich||

    making the United States less attractive as a destination for foreign investment

    Hey, just tax 'em *more*.

  • Rich||

    cannot be sustained indefinitely

    Yet another phrase that should go away.

  • JW||

    No, it will not be a catastrophe.

    Define "catastrophe."

    How does that square with our current debt and another 100 trillion on the way? We'll never run out of other people's money to spend?

  • Rich||

    Pretty sure he means it will not be a catastrophe for *him*.

  • JW||

    I'm sure you have to to take his answer in context of the question, but I'm left scratching my head in that is he alluding to the notion that you can never have too much debt? There's no downside to a complete and total lack of fiscal discipline and adult supervision on the part of our masters?

  • ||

    Of course, Obama doesn't have to default on the interest payments. But he's just petulant enough to try and teach the country a lesson about electing Republicans by doing so.

  • Rich||

    If the government is still shut down come 17 October, how could he *not* default?

  • Killazontherun||

    Debt is structured, and the money is still coming in to pay the interest. Even shrike gets that.

  • ||

    Because they are still collecting taxes, and will continue to collect taxes. If nothing else was funded, $2.5TT a year would pay off that $16.7TT debt in about 7 years. (I have no idea what our interest rate is, so it's probably a little longer than that.)

  • Rich||

    I retract my question, since upon reflection I realized that whoever "writes the checks" must be an *essential* civil servant.

  • ||

    We're all essential now.

  • BigT||

    But he's just petulant enough to try and teach the country a lesson about electing Republicans by doing so.

    Default? I didn't want to default! The devil made me do it!

  • Almanian!||

    ERMAHGERD! SERKWERSTER SHERTDERN DERFERLDTMAGERDERN!!!

  • Restoras||

    Everyone is looking at me funny because I am laughing out loud at this...

  • fish_remote||

    Where I work they just call that a.... "There he goes again" moment!

  • Paul.||

    Of course it won't be "catastrophic". There's not going to be a *bam* moment where everything goes sideways. You're just going to have a slow rot of value in your savings/wealth. At some point the currency might collaps (50 years, 75 years?) and then they'll do a currency re-issue, rinse repeat.

  • SweatingGin||

    I'm thinking more like 50 months, 75 months, but then again, I've been wrong lots of times before.

  • Killazontherun||

    Think Greece. Even Greeks aren't dying in the street but I sure as hell would not want to be one. I want to be in the alternative history America where the regulatory state didn't rob over $200,000 worth of wealth from each American family (doubt it, look up the net worth in low regulation states, factor in America having a headstart on every one of them), and the devalued dollar didn't make insuring and financing what use to be out of the pocket goods and services essential.

  • Joao||

    Sounds like today, just w/o hyperinflation

  • Lastseer||

    And having your parents laid off before Christmas is good for children, because they won't have high future expectations of toys for future holidays.

  • ||

    It's more like the credit card companies telling your parents they have maxed everything out and can't put those Christmas presents on the card.

  • Lastseer||

    Actually it's more the parents saying they won't borrow any more money from their parents to make the payments on the credit cards. Still failing to see the mentioned upside for the children.

  • Brian||

    Actually it's more the parents saying they won't borrow any more money from their parents to make the payments on the credit cards.

    No, it's as if they stopped spending with credit cards. What they do with the income stream, whether making payments on debt, or something else, is a different question.

    Still failing to see the mentioned upside for the children.

    You're analogy is incorrect in that, with the government, unlike a family, children inherit debt against their will. In other words, it's taxation without representation.

  • ||

    Well of course. Vernon Smith is just another tentacle of teh kochtopus.

  • General Butt Naked||

    I never realized that Gary Busey was an economist.

  • Paul.||

    Who knew a head injury could do 50 iq points of improvement?

  • Knarf Yenrab (prev. An0nB0t)||

    I would pay to see Busey & D. Friedman engaged in mortal debate.

  • Pro Libertate||

    Got in before me. Same observation.

    Call him Dr. Joshua.

  • Restoras||

    What say you, Professor Horwitz? I know you are out there somewhere reading all this...

  • Joao||

    Please, please foreign countries, please stop lending us money. As if we're ever going to come up with the money to pay you back.

    Er, um, well maybe we'll keep the presses running just a little while longer. If we pay em in fiats, it won't hurt us, just them ...suckers.

  • Death Rock and Skull||

    He's not Krugman so he doesn't count as an economist.

  • Tony||

    Obligations to pay Social Security benefits are no less legally required than obligations to pay interest on debt. "Prioritizing," even if it were remotely plausible, would result in breaking the law. In such a scenario, the president's only choices would each consist of breaking the law. Thus the only calculation to make is which action does the least amount of harm--and that would be directing Treasury to ignore the debt ceiling.

  • mgd||

    Debt service is constitutionally mandated. I'd say that trumps something with which, constitutionally speaking, the feds should not be involved.

  • Tony||

    So repeal SS through the legislative process. Jesus Christ what a bunch of authoritarians.

  • Butler||

    SS and Medicare are not debts. They are government benefits. If they were debts (i.e. guaranteed obligations), then the government would need to book the expected future payouts as expenses each year, raising our deficit several fold each year.

    Declining to pay for benefits via defunding is legitimate. Why else would the constitution provide for a budgeting process (that starts in the house, btw)? If we were simply obligated to pay for every law ever passed, we wouldn't need to budget annually. We'd just carry on until the underlying law was changed.

  • LynchPin1477||

    I suppose it could be argued that the framers envisioned the laws that would pertain the essential roles of protecting life and property and facilitating diplomatic relations (you know, the stuff actually in the Constitution) and not mandating that people be given money. A budgeting process makes sense when you the law says "raise a navy" and lawmakers decide how many sailors to hire, ships to build, etc. When you mandate a payment system with fixed procedures for determining the amount, you could of bind yourself.

  • Juice||

    If the interest on the debt costs about $400B/yr and total SS payouts are about $800B/yr that's still much less than $2.5T/yr.

  • Tony||

    It's not just SS but Medicare, etc. Congress is legally obligated to pay these bills until they pass a law repealing benefits. Thus, not paying some of these bills means default.

    Not to mention it would almost certainly cause a 2008-level economic crisis, and not to mention there would be a lot of poor and old people suddenly without any money or healthcare.

    None of that is worth the prospect of a phantom debt crisis when these consequences can easily be avoided. And it's just sick irony that you'd be creating a crisis to solve one that doesn't exist.

  • Brian||

    Just because you're wetting your pants over it doesn't mean everyone else has to.

  • Tony||

    I take it you don't participate in the stock market?

    If it's not appropriate to wet one's pants over a totally avoidable global economic calamity caused by a small faction with narrow partisan interests, what does one wet one's pants over? A 1% increase in marginal tax rates, perhaps?

  • Brian||

    You do realize that they're going to do whatever they're going to do irregardless of what you think or say, right?

    If you want to live in fear based on the actions of your political masters, feel free to wet your pants at will. And, then cheer when they save you from each other.

    Either way, seems kinda pathetic.

  • Tony||

    (I'm not actually wetting my pants.)

  • Brian||

    Then, act like it.

  • Tony||

    Do you treat the national debt with the same level of equanimity you're asking me to treat a default?

  • Brian||

    Do you think that question doesn't apply to you?

  • Lenoxus||

    So Brian, do you think the two things are basically equal causes of concern?

    Or perhaps that the rising debt is clearly worse than anything a default and/or crunch would do?

    I myself see it as pretty obvious that a sudden breach of the ceiling would be worse than, well, raising the ceiling, even though raising the ceiling can be seen as "raising the debt", in an odd way.

    One response I could imagine to this is to say that if we raise it now, we'll just keep raising it forever -- and keep passing the limit forever. In other words, actually writing a balanced budget in the first place is utterly politically infeasible, so a comparatively minor crisis is preferable.

    But I find that hard to swallow. In any case, it seems politically likeliest that they'll raise it anyway, so the argument is kinda moot.

  • ||

    Don't mind tony, he doesn't understand what words mean. Like "default".

  • The Heresiarch||

    Fleming v. Nestor disagrees with you.

  • Juice||

    The U.S. is one of the few countries in the world and in history that has NOT defaulted on its debt...

    But that's not true.

    http://www.forbes.com/sites/be.....ed-before/

    The United States defaulted on some Treasury bills in 1979 (ht: Jason Zweig). And it paid a steep price for stiffing bondholders.
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  • Diogenes||

    Smith is a Professor of Economics and Law,George Mason Universityfunded by aKoch Family Foundationsgrant, Mercatus Center Fellow and adjunct scholar,Cato Institute, funded by the Koch Foundation.

    Mercatus atGMUis a non-profitAmericanmarket-orientedresearch, education, and outreachthink tank, founded by Koch Executive VP Richard Fink.

    "This is truly a proud and exciting moment for GMU," said Pres. Merten. "The awarding of this internationally prestigious prize is a stellar example of how private support significantly impacts the recruitment of outstanding scholars." Smith is a faculty member in the Dept of Economics in the College of Arts and Sciences, a School of Law faculty member and research fellow at Mercatus. A $3 million grant from theKoch Charitable Foundationhelped bring Smith and his team of six distinguished economists and their Interdisciplinary Center for Economic Science from the University of Arizona to GMU. "We at the Foundation were excited to facilitate this scholarly partnership," said Richard H. Fink, Foundation president, executive V,P. of Koch Industries, Inc., a university Board of Visitors member and former university foundation trustee. Charles G. Koch, chairman and CEO of Koch Industries said, "The Foundation's gift was an excellent investment." The Foundation has provided major support to the university for over 20 years, including $3 million in 1997, which launched Mercatus and a $10 million multiyear grant in 1998.

  • Long Range Boredom||

    Back from masturbating in the marketplace I see.

  • Jerry Baustian||

    It's possible that he's right but I do not think much of his argument. The better way to promote balance in the current account and capital account is not to diminish the attractiveness of the US dollar, but to reduce the quantity of Treasury debt being sold to the rest of the world. If they can't buy all the dollar-denominated bonds they want, maybe they'll be inclined to buy more of our goods and services.

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  • ax123man||

    First of all, there is no way for this, or any economist, to know if breaching the debt ceiling will, or will not cause a catastrophe. Can this economist read the minds of millions of treasury debt holders or other investors? No, he can't. No one can. This is the same kind of arrogance and flawed thinking that brought the federal reserve into being in the first place.

    Second, the United States has defaulted on its debt before. Roosevelt did this covertly by simply saying "the paper you are holding is now worth 1/35 of an ounce of gold instead of 1/20 of an ounce", this was effectively a default. Of course these days this sort of blatant theft isn't necessary because the fed will simply devalue the dollar slowly but surely. Whether this actually works, who knows. I don't believe it will, not long term. It never has historically.

  • juliajuli314||

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