Monetary Policy

Nobody's Default But Ours


Old-school libertarian historian Jeffrey Rogers Hummel over at History News Network has some thoughts on the unthinkable in the wake of the Fannie Mae and Freddie Mac takeovers: is defaulting on U.S. Treasury obligations in our future? And would that be a bad thing?

He thinks yes, and no, for a variety of reasons. He sallies forth with some hardcore libertarian moral arguments. ("Treasury securities represent a stream of future tax revenues, and investors have no more just claim to those returns than to any investment in a criminal enterprise.")

But he also has come economic speculations that lead him to believe a partial U.S. government debt repudiation would not be the "end of the world" that Tyler Cowen, with whom he's grappling throughout the piece, thinks it would be. (Cowen's opinion is shared by most of the world, of course.) Says Hummel:

Repudiating government debt eliminates future tax liabilities. To the extent that people correctly anticipate those liabilities, the value of private assets (including human capital) should rise over the long run by the same amount that the value of government securities falls. Thus, people will gain or lose depending how closely their wealth is associated with the State. If on the other hand, people underestimate their future tax liabilities, they suffer from a fiscal or "bond illusion" in which Treasury securities make them feel wealthier than they actually are. Debt repudiation will bring their expectations into closer alignment with reality, which should increase saving.

Hummel even thinks the political repercussions of such repudiation might be relatively sunny, considering the history of past state-level repudiations. (Most of his value judgements here rather require you to be a libertarian to see them as sunny, of course.)

A government default is certainly a balanced-budget amendment with real teeth. Moreover, government defaults in the past, when not obviated by bailouts from other governments, seem to have had positive political consequences. Compare the widespread defaults of American state governments in the 1830s, with their cascading benefits–reluctance of states to set up government-owned railroads the way they had government-owned canals, balanced-budget constitutional amendments at the state level which even today impose lingering constraints, a general state retrenchment in a period of increasing laissez faire, among others–with the baleful consequences of the failure to repudiate the Revolutionary War debt, the most notorious of which was replacement of the Articles of the Confederation with the U.S. Constitution…..

The greatest potential political benefit of a future government default would be the end of the democratic welfare state…

It's an election year, and strangely no one is yet leaping on a "repudiate the debt" platform. But with the looming social insurance catastrophe, that's a possibility that those living today may well face. Starting to think about how much of an "end of the world" it might be seems both bracing and necessary.

NEXT: Instant City: Just Add Water

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  1. (Most of his value judgement here rather require you to be a libertarian to see them as sunny, of course.)

    A fundamental problem with libertarianism: If people can’t understand the foundation of a point of view, they will not be able to understand its potential. Someone who gives a crap might want to work on that … Rand failed.

  2. The State backstops and bailouts private financial entities. The State and it’s Central bank are trashing the (risk free?) dollars and bonds which aren’t keeping up with (price) inflation as it is. If they repudiate the debt I’m collecting my losses out of them one way or another and it ain’t gonna be pretty for either of us.

    If they repudiate their authority and dissolve the State , I’ll call it even.

  3. I was listening to the market news over lunch. The whole financial is squawking like a chicken just before it gets it’s head cut off, over the Fred and Fann takeover.

    This should be Bob Barr’s moment. If only he would seize it. Both major party candidates have endorsed a “More Heroin” financial policy.

    Actually I don’t even know if Barr backs sound money. But as the LP candidate, he should, and now is the time to be ringing that bell.

  4. I get the long-term sunniness. But if Fannie and Freddy are completely backed by the state, and as a result they completely monopolize the home loan market (kind of like now), wouldn’t the entire housing market collapse if they just decided to stop funding loans? That sounds less sunny.

    But hot damn, I could afford to buy a house with my ice cream cart income!

  5. It must be crazy day today.

    Yes, what a brilliant idea. Default on our bonds. Plunge three hundred million newly-minted Chinese middle-class people back into poverty.

    Angry, and with a ready made enemy to point at.

    Fucking astounding.

  6. Someone who gives a crap might want to work on that … Rand failed.

    Rand only failed to the extent that 95% (or am I being too generous?)of the populace is unable to produce a cogent thought unmuddied by mindless emotionalism.

  7. Let China and OPEC fight over it – the loser is the one whose U.S. debts are repudiated.

  8. A golden opportunity for a Led Zepplin pun in the headline wasted. WASTED. This place has really gone downhill.

  9. Elemenope: It must be crazy day today.

    You mean every day isn’t crazy day?

  10. Starting to think about how much of an “end of the world” it might be seems both bracing and necessary

    Vic: We coulda used her three more times!

    Blood: Ah, war is hell.

  11. I feel a litle better about the proposal after reading the link. I’m on board as long as “the other guy” gets fucked.

  12. The (false) idea behind the entire financial system is that there is a single risk-free investment — US treasuries. It’s one thing to default when you’re a subnational government in a second-tier economic power before there’s a global financial system. This would be several degrees of magnitude worse. A default will eventually happen (or the Fed will be dissolved and the govt will print money like it’s confetti, as in 1920s Germany, or the gov’t will resort to totalitarian means to re-establish fiscal stability). But let’s not kid ourselves into thinking that a default on the national debt would be a manageable decline. In short, it would make the Great Depression look like a damn tea party, which would likely strike a death knell for the cause of liberty (not that it takes much these days). People right now can’t accurately price a single, relatively small class of investments — mortgage-backed securities — and look what’s happened as a result of that. Imagine if no one can price any financial instrument in the entire world. Suddenly, the problem jumps into focus. And the debt rating of treasuries may be downgraded in the not too distant future.

  13. Repudiation or default is not necessary. Most US debt obligations are in the form of fixed rate noted and bonds… All the government needs to do is run a real rate of inflation at 7% more than the interest rate on the debt — something in the neighborhood of 5% — and the debt is halved in 10 years in real terms.

    In other words, a little replay of the 1970’s and we’re back to the races — assuming, of course that we don’t just keep on borrowing throughout….

  14. First little Pig —

    It almost sounded plausible, until you added that last sentence.

  15. Pietzsche Ietzsche —

    Not everyone who can read and have cogent thoughts thinks that Rand is the shit, you know.

    But I agree that many reject her writings (and others) because of an extralogical compulsion, rather than any rational counterargument.

  16. Elemenope:

    Not everyone who can read and have cogent thoughts thinks that Rand is the shit, you know.

    And you could include me among them, but you have to admit that she at least made one of the better arguments for rationalism in some time.

  17. And regardless of SOME of her radical ideas, anyone that committed to laissez faire capitalism can’t be all bad.

  18. Rand only appeals to 8th grade boys who have no friends. Everyone knows that the government taxes us to help us by building roads, provide basic education, healthcare a safety net and a solid national defense.To deny the basic fact that the government and income taxes are needed to save humanity from absolute anarchy is undeniable.

  19. Overlord, you forgot the funds necessary to raise little Moonbeam’s child because she was too much of a sissy to take it up the dirt road like a good little cosmotarian.

  20. No going concern (and we hopefully agree that the United States is a going concern) ever really has to repay its debt. It merely needs to refinance it upon maturity.

    So the only way that Treasury securities could ever default would be if the U.S. Government could not issue new debt at any interest rate, no matter how high. That’s implausible on its face, and also ignores the alternative last-ditch maneuver of simply monetizing debt as it comes due — which would result in extreme inflation of course, but not in flat-out default.

  21. CO- (nice moniker by the by) Rand did not deny the need of a government, she was not an anarchist, just a more limited one. Solid national defense was certainly something Rand was in favor off (just not the draft).

  22. CRD, perhaps you weren’t aware that the Overlord’s tongue is so far in his cheek he can taste last weeks cabernet.

    Bad running dog, bad!! *lightly pops on nose*

  23. The obvious solution is to make my brother President and give him temporary full control over the monetary system. He can not only hold off creditors with the best of them, he can tap new sources of credit.

    I can just see him on CNBC addressing all US debt-holders, “Look, I hate to tell you all this, but you know that money we borrowed? At the time we borrowed it, we totally were going to pay it back. But things have been pretty tough lately, so we’re gonna have to flake on this one. Sorry. Hey, we’ll make sure to get you some of it back if things look up later.”

  24. Unfortunately, there’s this little line from the Constitution:

    Section 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any state shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

  25. As if the US government has paid ANY fuckin’ attention to the letter, much less the spirit, of the constitution for some time now…

  26. Eryk,

    The obvious solution is to have an insurrection, successful just long enough to default all obligations, and then have a miraculous countercoup, establishing the Third American Republic.

    See? So easy.

  27. And, in breaking news, the question is asked:

    Will Bush and the GOP Nationalize the Auto Industry?

  28. “Let China and OPEC fight over it – the loser is the one whose U.S. debts are repudiated.”

    I remember someone, I forget who, saying Americans are getting TVs and cars and what have you from Asian countries. And what are the Asian countries getting in return? Little green paper rectangles. Which culture is the fool here?

  29. For better or worse, a treasury default isn’t going to happen. At least not without some other really bad stuff happening that nobody would wish for.

    Warren – the problem is not the bailout. The bailout is necessary. What should be cricitized is what came before, the actions and inactions of Congress that predictably led to the disaster.

    The message should be, throw the bums out.

  30. Nationalizing the auto industry…cool…does this mean GM…er…National Motors will start building these?,_DOD_Probotrans,_Expon%C3%A1t_Volha_M_21.jpg

  31. Repudiating national debt is inevitable, at least portions of it. Take Social Security for example. They won’t be calling it repudiation of course, they’ll call it “means testing”.

  32. Look to Argentina in 2001 to see what happens next if this option becomes reality. It will be painful, but have the desired effect of debt reduction. However, someone better make sure that subsequent governments and leaders do a better budgeting job. Debt default is a gun whose trigger a nation can only pull once…

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