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Would a default by the US government help America?

21 February 2010

Question for the Day

“Would a default on Treasuries accomplish what the Balanced Budget Amendment was supposed to achieve, by forcing the government to spend no more than it takes in?  With more collateral damage, of course. . . .”
— Glenn Reynolds (The Instapundit, Law Professor at U of Tennessee), source.

Contents

  1. The short answer
  2. Default comes in many forms
  3. Focus on the favorites:  inflation and devaluation
  4. Two examples of successful default
  5. Conclusion
  6. Other articles about this topic
  7. Reactions to Reynold’s question
  8. For more information on the FM website, and an Afterword

(1)  The short answer

A default on a loan occurs when the borrower does not make required payments on in some other way does not comply with the terms of a loan.  The hysterical answers to Reynolds are wrong, since default is a commonplace of history (sometimes successful, sometimes not).  It’s a perfectly legitimate question, the type a skilled lawyer asks his client.  We will need to make difficult choices to get America back on track, and clear evaluation of all options is essential.  Here is the short answer, in pieces.

  1. Yes, the budget would be balanced since there would be no more borrowing until the US re-established its credit.  But default does not fix the underlying problems causing the borrowing, which is why so many people and nations become serial defaulters.  Philip II the Spain defaulted several times, despite Spain’s riches stolen from the western hemisphere.  Today we have Greece and Costa Rica.
  2. Nations seldom default solely due to large debts. since debts can usually be managed.  To rephrase Milton Friedman, default (and its handmaiden, hyperinflation) are everywhere and always a fiscal phenomenon.  Nations default when they are running massive deficits and can no longer borrow.
  3. The costs of default cannot be reliably forecast, but would probably range from massive to catastrophic.  Government bonds are the foundation assets for domestic financial institutions.  Such as banks, insurance companies, and pension plans.  A default solves one problem and creates a thousand more.  Which is why nations default only as a last resort. 
  4. Why default when the government can just print money (aka monetize the deficit)?  Inflation probably has fewer side-effects than default, and we have much experience with inflation.
  5. Default on treasuries would eliminate our debt, now $7.9 trillion (from past spending).  The government’s liabilities (debt plus promises to spend) are far larger, in excess of $70 trillion.  See here for details.
  6. Emerging nations have different economic dynamics than developed ones.  Situations differ even among developed nations.  The calculus of default differs greatly in Greece and the USA.  This considers only America.
  7. This is a brief sketch of a complex subject.  See the links at the end for more information.

While this answer’s Reynold’s precisely worded question, it does not answer broader question posed in the title.  I briefly discuss this in the conclusion, but a full analysis requires several thousand more words.  So it must await another day.

(2)  Default comes in many forms

Governments default on their debt so frequently that have developed a thousand ways to do so, beyond just refusing to pay.  Just like in the song…

A Thousand Ways to Say Goodbye, by Jubal Lee Young

Where did the passion go I lie and wonder
Whispering rain, spinning blades, listening to the sound of thunder
Lightning struck here once, will it ever strike twice?
This raging fire has turned into sculpted ice
It’s all over but the crying now…

Au revoir, hasta la vista
Sayonara, baby
There’s a thousand ways to say goodbye
Adios, arrivederci
Do svidanja , baby
There’s a thousand ways to say goodbye
Goodbye

Where did we go wrong? I’m so tired of trying
I remember a time when we were so high we were flying
It’s just a matter of time as to how long we’ll hold on to what is gone
There ain’t no need to fight, I don’t have to be right and baby you got the right to be wrong
It’s all over but the crying now…

Yeah we might have stopped then and we’d still be friends
But we held on til the bitter end
Now a thousand “I’m sorries” will never be enough
I guess that’s why they call it love

They’re called soft defaults.  Such as the following:

  1. Temporarily suspend or change the terms of payments (e.g., US and UK de facto suspended payments in gold during WWI)
  2. Renegotiating the terms (often combined with threats to take stronger action), extending the maturity at lower interest rates
  3. Changing the mode of repayment:  from gold to currency, or a foreign (hard) currency to ones own currency. 
  4. Inflation and devaluation (Siamese twins of default) — Pay back the full amount in nominal terms, but less in real terms.
  5. Shifting the debt onto special entities, who can later default with lesser consequences

Most nations have used one or more of these techniques. Most nations used option #3 during the 1930’s — after which their economies stabilized (see Bernanke’s speech about this).  The US did so on 3 June 1933 with the wonderfully titled congressional resolution “To assure uniform value to the coins and currencies of the United States” (text here).  America did so again in 1971, when President Nixon ended convertibility of the US dollar into gold by governments (see Wikipedia).  Inflation and devaluation are commonplace tools of economic management throughout history.

(3)  Focus on the favorites:  inflation and devaluation

With the perfection of fiat currencies in the 19th century (after the early trials with the American continental and the French assignat), inflation and devaluation became the favored methods of default.  They offer the illusion of a smooth, controlled, and even painless reduction in government’s debt. 

There are many studies discussing this, but this is perhaps the most interesting:   “Is Inflation Effective for Liquidating Short-Term Nominal Debt?“, Guillermo A. Calvo, IMF, 3 January 1989 (Hat tip to Zero Hedge).  From a major quasi-governmental institution, it comes close to recommending a soft-default by inflation (and devaluation) for hard-pressed governments.  Classified secret when written, to avoid alarming government creditors.  Abstract:

The possibility of reducing the real value of domestic non-indexed government debt through inflation is studied. A central result is that this kind of debt liquidation is possible even though prices are sticky and government bonds are short term. A policy implication is that short bond maturities are no safeguard against surprise devaluations intended to lower the burden of the debt. If devaluation incentives are present, it is further argued that nominal non-indexed bonds could give rise to situations where devaluations are a consequence of self-fulfilling expectations cycles.

Other experts say that however attractive in theory, in practice inflation does not reduce government debt.  See this clear explanation:  “The debt-inflation myth debunked“, blog of the Financial Times, 4 August 2009.

The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future.

In brief, unexpected inflation provides the magic sauce for profligate governments.  But the government’s creditors see the situation equally clearly and take protective action. 

  • Shorten maturities (which are less affected by inflation)
  • Shift investment preferences from government bonds to inflation-protected bonds (e.g., TIPS) and hard assets.
  • Move money into harder currencies, even physically out of the country.

Consider America’s situation in 2 years (to pick an arbitrary number, when we’re well into the recovery).  Everybody (including elderly widows in Smallville) will own just only hard assets, inflation protected securities, or short-term debt.  The average maturity of the Federal debt will be 2 weeks. Under these circumstances the government must avoid inflation at any cost, as the resulting increase in its interest cost would be lethal.  Japan is in a similar situation today.

Note that these actions by themselves push up interest rates, worsening the government’s financial position. 

(4)  Two examples of successful default

The Soviet Union, following the revolution.  German’s Third Reich.  The latter is most relevant.  For details see  “Currency vs. Banking in the German Debt Crisis of 1931“, Albrecht Ritschl and Samad Sarferaz, 8 August 2006.  Note that both were totalitarian states, which allowed the government to control inflation through wage and price controls.  And suppress protests.  Both were economic success stories, if horrific from a broader perspective.

(5)  Conclusion

There are no easy or certain solutions.  We have to work our problems carefully,  in the correct sequence, aware of trade-offs.   I believe a default — in any form — is not necessary at this time.  Nor will it be if we act quickly and wisely.  The costs of default would be large and avoidable if feasible.

The chief problem we face today is a weak economy, and the risk of a double-dip recession (historically quite common).  In the third year of this recession the reserves at all levels are drained — households, businesses, and governments.  We are weak, as was the world in a physical sense after WWI – vulnerable to the 1918  influenza.   Another downturn might be worse than the first.   Should the economy weaken from here, failure to promptly enact another stimulus program might have cataclysmic — even historic — consequences.

(6)  Other articles on this topic

Articles with vital lessons for us:

Other valuable articles on this subject:

  1. Even superpowers default:  “The Sustainable Debts of Philip II: A Reconstruction of Spain’s Fiscal Position“, 1560-1598″, Mauricio Drelichman and Hans-Joachim Voth, 6 November 2007
  2. One of the best studies about governments getting in over their heads and the inevitable consequences that follow:  “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises“, Carmen M. Reinhart and Kenneth S. Rogoff, April 2008
  3. Will America default?“, blog of The Economist, 12 February 2009
  4. Why Default on U.S. Treasuries is Likely“, Jeffrey Rogers Hummel (Assoc Prof Economics at San Jose State U), Library of Economics and Liberty, 3 August 2009

(7)  Reactions to Reynold’s question (to be updated with new developments)

Mostly hysterical.  Esp given that governments (including ours) have defaulted so often, in so many ways.

Reynold’s reply to Bartlett is either over-the-top exaggeration or batshit crazy (typical of extremists, he says this with no attempt to explain or support it — as if the USA being like Zimbabwe is self-evident):

“Bruce, I’m not trying to turn the United States into Zimbabwe. That would be the guy in the White House, whom you seem surprisingly anxious to defend.”

That is an odd thing to say, since Obama’s economic and foreign policies largely continue those of Bush Jr.  Anyone making that comparison needs to read this:  Where to go to learn about economics, and help you understand what’s happening to America and the world.   This fails on so many levels it needs a separate post:  Can Obama make America like Zimbabwe?

(8a)  For more information on the FM website

To read other articles about these things, see the FM reference page on the right side menu bar, including About the FM website page. Of esp relevance to this topic:

Posts about causes of the crisis:

  1. The post-WWII geopolitical regime is dying, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
  3. Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the 1982 – 2006 economic expansion; why the down cycle will be so severe.
  4. Geopolitical implications of the current economic downturn, 24 January 2008 – How will this recession end?  With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive.  No more trade deficit, and we can pay our debts.
  5. A picture of the post-WWII debt supercycle, 26 September 2008
  6. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  7. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  8. A certain casualty of the recession: the US Government’s solvency, 25 November 2008
  9. Government economic stimulus is financial heroin, 26 December 2009
  10. A look at our government’s debt – rising because we like to spend, 29 December 2009

(8b)  Afterword 

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 word max), civil and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

Also — you can now subscribe, receiving posts by email — see the box on the upper right

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20 Comments leave one →
  1. Mikyo permalink
    21 February 2010 2:09 am

    Blind as Hell, and not gonna take it anymore!

    If you see this man, please tilt him toward the nearest tearoom.

    Like

  2. 21 February 2010 2:31 am

    This is one of the most valuable posts you have written in a while. Thanks for reminding me why I read this site!
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    FM reply: Please pass the link on to friends or colleagues.

    Like

  3. Indian Investor permalink
    21 February 2010 4:15 am

    Fabius Maximus, the logic discussed by Bruce Bartlett in his point 1) completely ignores the external financing view of sovereign finances. The central benefit of a US Treasury default will be a massive employment boom. The main challenge after a US Treasury default will be to secure needed imports, and to control inflation. I’ve frequently made my anonymous comments on topics related to this idea. When I said that the US economy is mainly an import value added economy, you can get a more practical perspective on that by walking around in your neighbourhood Wal-Mart store. The shirts may have come from Bangladesh, the electronics from China, and mangoes from Peru. There’s precious little “US manufacturing” left as of today. Once the US Treasury defaults, foreign producers will no longer have the incentive to supply goods and services in exchange for dollars. This will lead to spiralling prices of imports, aka 1971. The sudden requirement to produce locally will create a massive employment boom. The only main difficulty will be to secure imports, specifically oil imports.
    The only alternative to US Treasury default is a decade or more of economic stagnation. Do you want to see the unemployment rate dropping further as a result of more people going out of the US workforce?
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    FM reply: If you would cite some numbers your theories might at least look plausable. Exports as a percent of GDP have risen for the past 55 years, up over 4x (see this graph). A large fraction of US imports are consumer goods (mostly discretionary). Which is why the US trade balance is highly sensitive to GDP (lower income means fewer imports). Combine the two, and the trade balance appears in its true form: a problem easily solved through some combination of …
    * lower value of the US dollar (meaning increased exports, fewer imports),
    * some time with global growth faster than US growth, and
    * development of alternative energy sources (e.g., conservation, natural gas from shale), reducing oil imports.

    The trade balance is a minor factor in the US government’s financial problems, which are largely cyclical. The current recession and the longer age-wave cycles. Both of which can be managed with will and wisdom. Both will pass away with time. The easy way, or the hard way.

    Like

  4. 21 February 2010 5:55 am

    Update

    Reynold’s reply to Bartlett is either over-the-top exaggeration or batshit crazy:

    “Bruce, I’m not trying to turn the United States into Zimbabwe. That would be the guy in the White House, whom you seem surprisingly anxious to defend.”

    Question for discussion:

    In the post I said it was typical of extremists that he says this with no attempt to explain or support — as if the USA being like Zimbabwe is self-evident. But is it correct to call someone (esp an educated and intelligent person) who says this an “extremist”? He’s clearly so immersed in conservative faux-economics that he does not realize the many levels of exaggeration embeded in this statement. Can anyone suggest a better description?

    Like

  5. Mikyo permalink
    21 February 2010 7:01 am

    Sedition {Wikipedia} is the stirring up of rebellion against the government in power. Treason is the violation of allegiance to one’s sovereign or state, giving aid to enemies, or levying war against one’s state. Sedition is encouraging one’s fellow citizens to rebel against their state, whereas treason is actually betraying one’s country by aiding and abetting another state. Sedition laws somewhat equate to terrorism and public order laws.

    Like

  6. Agoraphobic Plumber permalink
    21 February 2010 2:15 pm

    FM: “He’s clearly so immersed in conservative faux-economics that he does not realize the many levels of exaggeration embeded in this statement. Can anyone suggest a better description?

    He’s someone who disagrees with your take on things?
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    FM reply: No. Zimbabwe is the #2 worst failed state by the 2009 Fund for Peace-Foreign Policy Magazine list (Somalia is #1). Zimbabwe had the second largest hyperinflation on record (see the chart I’ve added to the post), taking place in a third world state that was never really a nation. It has almost nothing in common with the condition of the USA.
    * Small, aprox 12 million people. vs our 310 million.
    * Poor, GDP aprox $100/person vs. our $48 thousand/person
    * New, government recognized in 1980 vs. our 1788.
    As for the last, the USA is one of the oldest governments — and oldest democracies — in the world.

    Reynolds does not even attempt to make a rational comparison, so I see no need to treat such nonsense with respect. He might as well have compared us to Mars. In fact, wingnuts would probably repeat that gleefully: “Obama is making the US into Mars!”

    Perhaps you could explain in what way Obama is “trying to turn the US into Zimbabwe.” Saying “trying to” is really nuts, esp as most of his foreign and economic policies are similar to those of Bush Jr.

    Like

  7. senecal permalink
    21 February 2010 3:02 pm

    It used to be that “Wall Street”, or corporations like GM, were terrified of inflation, since it would undermine the value of fixed income securities and make predicting the future for manufacturing companies impossible. The threat of inflation was also used as a stick to beat back labor’s demands for higher wages.

    We don’t need a stick to beat back labor anymore, and Wall Street doesn’t seem to care about inflation, or rather thinks it can hedge its way around it, by shifting investments to other countries and currencies.

    So far, judging from politicians’ statements, default on the debt is not being considered as a real problem, but IS being used a pretext for reducing government spending on entitlements. If default were being considered as a serious problem, there would be other alternatives on the table for reducing the deficit — rescinding Bush era tax cuts, and cutting military expenditures, for example. But these are off-limits, apparently.

    It would seem that default would be catastrophic for all levels of society, including capital and ownership. It also appears that no one is taking any steps to counter the possibility of inflation — probably because they can’t, in present circumstances. We seem to be in the situation of the football team which is already down 24 to 6 at the half, but can’t afford to think about the probable final score.

    Naomi Klein’s book Disaster Capitalism gives a clue to what might be the large picture of the moment — capital has given up trying to find safe, traditional areas for investment, and is now making money out of misfortunes — natural catastrophes, wars, un-repayable loans (both to countries and individuals), currency manipulations. Inflation may be just another one of these misfortunes which capital is already planning to make money from.

    Like

  8. vimothy permalink
    21 February 2010 4:45 pm

    This is crazy talk. The US government prints the non-convertible dollars in the first place! It does not make any sense to think of a sovereign currency issuer as posing a credit risk in its own currency. The fact that inflation reduces the debt is (or should be) a side-effect not goal of monetary policy. All the national debt is is cumulative private sector saving. Reynolds is asking if the government should wipe out those savings. And for no good reason, since the government can always print more dollars.
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    FM reply: I disagree. It’s a relevant and important question. To understand the situation we must evaluate all alternatives, such as default vs. inflation. Each has advantages and disadvantages, which economic and financial experts can clearly explain. We’re toast if experts believe than can decreee questions out of bounds.

    Like

  9. vimothy permalink
    21 February 2010 5:57 pm

    You can ask whatever you like, but that doesn’t mean every question is good. The government does not need to default on its debt, and such a default would not be in anyone’s interest. The US is not on the gold standard any more. Reynolds just doesn’t understand the way the system works at all or what the national debt represents, which is why he asks such a foolish question (and not simply for the reasons I gave, but also because the answer is quite obviously, “no it will not help balance the @*$!ing budget”).
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    FM reply: All questions are good; there are no stupid or foolish questions. That Reynolds does not understand means that he should ask questions. I don’t understand your objection.

    Like

  10. GoldenHorde permalink
    21 February 2010 9:22 pm

    FM: “Why default when the government can just print money (aka monetize the deficit)? Inflation probably has fewer side-effects than default, and we have much experience with inflation.

    The fed has been quantitative easing aka monetizing the debt for about a year now, but not on the same scale as the Bank of England. Inflation in the UK went from 1.9% in Nov/2009 to 2.9% in Dec/2009 to 3.5% in Jan/2010.
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    FM reply: The current blip in UK inflation was probably not caused by the expansion of the money supply. As explained in the statutory letter from the Bank of England (BOE) Governor to the Chancellor, 16 February 2010:

    In the medium term, inflation is determined by the balance of money spending and the supply capacity in the economy. Money spending, in turn, is influenced by monetary policy, allowing the MPC to meet the inflation target. But in the short run other factors, which cannot immediately be offset by monetary policy, can cause measured inflation to move around. Over the past three years inflation has been much more volatile than in the preceding ten years, reflecting an increase in size and frequency of these short-run factors. Three such short-run factors have driven the current measured rate of inflation up.
    * First, the restoration of the standard rate of VAT {from 15%} to 17.5% is raising prices relative to a year ago.
    * Second, over the past year, oil prices have risen by around 70%. That is pushing up petrol-price inflation significantly, which, in turn, is raising overall CPI inflation.
    * Third, although the exchange rate has been broadly stable over the past year, the effects of the sharp depreciation of sterling in 2007 and 2008 are continuing to feed through to consumer prices.

    For more about this, see the February 2010 BOE Inflation Report, esp sections 4 (Costs and prices) and 5 (Prospects for inflation).

    Like

  11. senecal permalink
    22 February 2010 3:49 pm

    Reading Balzac last night I came across a reference to another Fabius Maximus, who lived in the 3d century BC, and was called “cunctator” or conciliator. Which is the real Fabius — general or conciliator?
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    FM reply: It’s the same person, the inspiration for this website. On the FM website’s “About” page:

    Fabius Maximus (280 – 203 BC) saved Rome from Hannibal by recognizing Rome’s weakness and therefore the need to conserve its strength. He turned from the easy path of macho “boldness” to the long, difficult task of rebuilding Rome’s power and greatness. His life holds profound lessons for 21st Century Americans.

    From Wikipedia:

    Quintus Fabius Maximus Verrucosus Cunctator (ca. 280 BC–203 BC), was a Roman politician and general, born in Rome around 280 BC and died in Rome in 203 BC. He was Roman Consul five times (233 BC, 228 BC, 215 BC, 214 BC and 209 BC) and was twice Dictator in 221 and again in 217 BC. He reached the office of Roman Censor in 230 BC. His agnomen Cunctator (akin to the English noun cunctation) means “delayer” in Latin, and refers to his tactics in deploying the troops during the Second Punic War.

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  12. John Ryskamp permalink
    22 February 2010 7:48 pm

    You are leaving out–partially–a key component of default: individually enforceable rights. As you point out, soft default under totalitarianism comes with a shrinking of individually enforceable rights. However, you do not consider the possibility of soft default under a regime of EXPANDING individually enforceable rights. And actually, that is what is going on in the U.S. right now. You are very ignorant of the law, so you don’t realize that America is changing from the West Coast Hotel v. Parrish “scrutiny” regime–in which there are very few individually enforceable rights and most facts are controlled by the political system–to the maintenance regime, the doctrine of which is that the law maintains important facts, and under which there are vastly expanded rights to liberty, housing, maintenance, education and medical care.

    This is the flip side of what you suggested: this is soft rights, as opposed to hard oppression. In the U.S., it is the rightfully terrified homeowners who are screaming for new rights, but since they are quite a police-state-minded crew, the move is being made surreptitiously and inconsistently. It is a process I studied in my book, The Eminent Domain Revolt (New York: Algora 2007).

    I will give you a perfect example of it, which you should definitely study: housing. Housing enjoys only minimum scrutiny under Lindsey v. Normet. However, the Federal Government has broken above this standard (the “above” refers to the scrutiny continuum: to intermediate scrutiny and up to strict scrutiny–the individually enforceable rights increase vastly at ANY level above minimum scrutiny). It can no longer be factually maintained, given various foreclosure abatement programs by the Federal Government, that housing enjoys only minimum scrutiny. De facto, or “softly,” Lindsey has been overturned. Also see, online, Huxtable v. Geithner, for an example of how the Fifth Amendment is being brought in to give de jure recognition to a higher level of scrutiny for housing.

    So really, what you have to ask is: how does debt, public or private, maintain important facts? How do bonds maintain important facts? Because the doctrine of the new maintenance regime is that the law maintains important facts. So ALL facts are subject to this “important facts” test. In past defaults, this was actually the standard, although it traded under a variety of names. However, recently the American legal community went back and revisited both West Coast Hotel and U.S. v. Carolene Products. Lo and behold! both cases ground policy on “maintenance”–EXPLICITLY. It is also used in the Ur-government discretion case: Berman v. Parker.

    So, naturally, how everyone is asking the law (the Supreme Court), What in FACT is maintenance, Supreme Court? You used the term, now we have noticed it, so now you have to explain it. This is the death of the 70-year-old West Coast Hotel scrutiny regime. So the question is not, should the U.S. default softly or hard, but rather, how does debt maintain important facts?

    For the importance test, see West Virginia v. Barnette. According to the Court in that case, an “important” fact is
    1. a fact of human experience
    2. which history demonstrates
    3. is unaffected by attempts to affect it.

    The fact in that case was an exercise of religion. And according to the Court, when a fact is found to be important, it is kicked out of the political system and power over it is turned over to the individual. Nevertheless, exercises of religion have long been subject to ordinary health and welfare regulation. However, now that “maintenance” is taking over, the notion of “health and welfare” policy is defunct. It has been completely destroyed by the “maintenance of important facts” concept. So you have to evaluate both the current U.S. economic problems–which are caused solely because we are in the midst of a regime change–and the debt problem, and potential default, in terms of the new regime which is stealthily taking over the country. Otherwise you will be surprised at developments, rather than being able to predict them.

    Avis au lecteur.
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    FM reply: Do you have citations (ideally links) to experts supporting these theories. People saying we’re ignorant are seldom taken seriously without evidence.

    Like

  13. vimothy permalink
    23 February 2010 12:25 pm

    A question can be good or bad according to whatever criteria you think relevant. Were Reynold’s question asked in good faith, it would merely be naive. You can see from his response to Bartlett that this was not the case, however.

    Also not sure why you cite This Time Is Different–Reinhart and Rogoff are clear that they are talking about sovereign default on external debt (i.e. borrowing in another currency). This is not relevant to the US. Furthermore, they fail to control for monetary system (float, peg, etc). Again, this makes apples to apples comparisons very difficult.
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    FM reply: Your description of Reinhart and Rogoff is wrong on all counts. I suspect (just a guess) that you have not read the paper, but only comments about it.
    * The title and abstract refute your statement that the authors “are clear that they are talking about sovereign default on external debt.”
    * The paper discusses episodes of default on both internal and external debts, observing (p84) “Usually domestic debt crises do not involve external creditors.”
    * Some of their most important conclusions concern domestic debt, such as (p40) “But we have also established that domestic debt has long
    been fully as significant as external debt in meeting emerging market financing needs. There is nothing “original” about it. And as we show in Reinhart and Rogoff (2008a), defaults on domestic debt appear to be associated with similar magnitudes of output loss as defaults on external debt.”
    * Foreign debts are not necessarily “borrowing in another currency”. To bring this home, they mention FDR’s 1933 US default. Their database includes other examples, such as China default through high inflation in the 12th and 13th centuries, and Mexico’s 1867 repudiation of 100 million pesos in debt.
    * Also note tables 9 and 10: Expropriation through Currency Debasement: Europe, 1258–1900. Some but not all of these had foreign currency external debts.

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  14. vimothy permalink
    23 February 2010 3:02 pm

    No it isn’t. Can you list examples of states with a fiat currencies and floating exchange rates that defaulted on domestic debt (i.e. debt denominated in the domestic currency but held by foreigners or the private sector) for financial and not political reasons? It must be a pretty long list–right? A sovereign fiat currency issuer borrowing in its domestic currency is never a credit risk:

    “Yesterday, we saw a sharp market reaction when one of the rating agencies that gave AAA ratings to mortgage-backed securities larded with subprime loans called into question the credit worthiness of Britain. As is the case with the United States and the Federal Reserve, Britain and its Bank of England have the ability to create new money if necessary to pay off its debt at maturity. There is no sovereign credit risk. There is no need for credit rating agencies to opine on the credit worthiness of sovereign debt.” (source)

    You are irradicating whatever nuance exists in Reinhart and Rogoff’s analysis.
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    FM reply: I don’t see how your comment relates to anything in my post. Try using quotes, rather than making things up. As for my comment, I corrected your incorrect description of the R&R paper. Note I gave specific supports for my statements: the title, the abstract, and quotes.

    “Can you list examples of states with a fiat currencies and floating exchange rates that defaulted on domestic debt”

    What does this have to do with anying in this post or thread?

    Like

  15. vimothy permalink
    23 February 2010 3:43 pm

    “Try using quotes rather than making things up”?!?

    I asked a (pretty straightforward) question: How many instances of sovereign default can you find that are comparable to the US as it exists at present? It is relevant because we are talking about a US soveriegn default. The US is sovereign issuer of a fiat currency, on a floating exchange rate, which sells debt demoninated in that currency. If “This Time is Different” is so relevant, it should be a simple matter for you to pull from their data a list of comparable defaults.

    I have read the paper, and I have read a lot of the research that has fed into this project. The problem with R&R is that people read their results as if all sovereigns are the same. For instance: you. When drawing on this work, they fail to control for the various forms of monetary systems (fiat, peg, etc). (You didn’t mention this in your “refutation”, BTW). They fail to adequately explain just why R&R’s “default virgins” exist and constitute such a large chunk of global GDP. Etc, etc. It’s basically the same as saying it’s happened in the past and it will happen in the future. Not very helpful.
    .
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    FM reply: If you read the paper, why did you misstate its topic? Also, another example of you just making stuff up:

    “The problem with R&R is that people read their results as if all sovereigns are the same. For instance: you.”

    As for your question, I asked why it was a relevant question to this post and thread. As for your opinion of R&R, how nice that you find it “not very helpful.” Since most of the economic and financial community consider this work to be timely, valuable, and brilliant. I’ll go with their verdict. Your comment about the paper misses its purpose.

    Like

  16. vimothy permalink
    23 February 2010 3:58 pm

    All this section is irrelevant: “We begin by discussing sovereign default on external debt (i.e., a government default on its own external debt or private sector debts that were publicly guaranteed.)”. Since the US only issues debt in its domestic currency.

    Furthermore, I invite you to find reference to any of the following terms: “Fixed exchange rate”, “Floating exchange rate”, “Flexible exchange rate”
    “Convertible”, “Non-convertible”. Incredibly, they only mention the phrase “gold standard” once, in passing. Even “gold” is only mentioned twice.

    So where are the relevant data….?
    .
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    FM reply: When someone says “we begin by discussing”, that does not mean the same things as “we only discuss’. As for the rest, you obviouslly want them to have written some other paper. I don’t understand what your point is, or its relevance to this post, or why you keep repeating it without (as I repeatedly asked) connecting it to this discussion.

    “they only mention the phrase ‘gold standard’ once”

    Using “search” is not the same as reading the paper. They refer to gold and silver backed currencies as metalic; this is a large part of their analysis. Silver is more frequently discussed, as it was more commonly used. A few references:

    “Although some writers seem to believe that inflation only really became a problem with the advent of paper currency in the 1800s, students of the history of metal currency will know that governments found ways to engineer inflation long before that. The main device was through debasing the content of the coinage, either by mixing in cheaper metals, or by shaving down coins and reissuing smaller coins in the same denomination. Modern currency presses are just a more technologically advanced and more efficient approach to achieving the same end.” (pp 39-40)

    “The predecessor of modern inflation and foreign exchange rate crises was currency debasement during the long era when the principal means of exchange were metallic coins. Debasements were particularly frequent and large during wars. Indeed, drastic reductions in the silver content of the currency provided many sovereigns with their most important source of financing. (p78)

    They includes much data on the debasement of metal-based currencies:
    * Table A1: “Defining Crises: A Summary of Quantitative Thresholds.”
    * Tables 9 and 10: “Expropriation through Currency Debasement: Europe, 1258–1900″ (tracking decline of silver content)
    * Figure 12: “The March Toward Fiat Money: Europe 1400-1850 — Average Silver Content (in grams) of 10 Currencies”

    Like

  17. vimothy permalink
    23 February 2010 4:05 pm

    FM: “As for your opinion of R&R, how nice that you find it “not very helpful.”

    Please–that comment quite obviously refers to the propensity of commentators to understand the reserach in terms of an undifferentiated “sovereign” constantly in default. E.g., your original post above. In general I find their research to be both interesting and useful, thank you very much.
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    FM reply: Since you are just making up the stuff about “undifferentiated ‘sovereign’ constantly in default”, this comment doesn’t say much. If you actualy read the paper you’d see that they “differentiate” defaults by several criteria (e.g., gold/silver backed, external/internal, trade balance). They did not include every possible criteria, obviously (to most of us, at least) due to limitations of data and resources. Like all research, it’s a step on a road — not the end.

    Try quotes. If you do, people might take these comments seriously.

    Like

  18. vimothy permalink
    23 February 2010 4:42 pm

    How can I quote what isn’t there? And you still haven’t produced a single comparable default from their data.
    .
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    FM reply: I have given multiple excerpts from the report showing that everything you said about it is incorrect. In response you just make stuff up. When asked to give some quote from the post or the R&R study supporting your assertions, you make up more stuff. I think the situation is clear to anyone reading this.

    Like

  19. John Ryskamp permalink
    23 February 2010 5:22 pm

    FM reply: “Do you have citations (ideally links) to experts supporting these theories. People saying we’re ignorant are seldom taken seriously without evidence.

    Expert schmexpert. Just look at the Abbott New Jersey cases, which have been going on for 30 years, and were prompted when the New Jersey Supreme court decided that the education provision of the New Jersey Constitution stood for a level of scrutiny for education HIGHER THAN minimum scrutiny. Look at what influence that is having on government spending in New Jersey. You’re painting with far too broad a brush, and you don’t want to get your hands dirty be delving into the FACTS. Reconcile this what you claim to know about public debt, by going to the very informative Abbott cases website:

    And on the subject of the individually enforceable right to education, see “Coomans, Fons, Justiciability of the Right to Education” (December 15, 2009). Erasmus Law Review, Vol. 2, No. 4, pp. 427-443, 2009. Available at SSRN.

    You simply have no idea what the relationship is between debt — either public or private — and individually enforceable rights, since you apparently wouldn’t know an individually enforceable right if you fell over one. Educate yourself, cloan.
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    FM reply: Perhaps. But after 3 decades in this game I know that theories by people who say “expert schmexpert” tend to be unreliable. And people who call others “clowns” but cannot cite any experts to suport their beliefs are almost always wrong.

    Like

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