Debt Default, the End of the World and Timothy Geithner's Thoughts

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Sunday, 09 September 2012 07:55

Real reporters and newspapers don't try to tell audiences what political figures think because they don't know what they think. But Bob Woodward does not fit the description of the former and the Washington Post does not fit the description of the latter, hence we have a front page account of the battle over the debt ceiling that concludes with a section beginning:

"Geithner thought there was one other consideration. He did not mention it to anyone, not even the president, but he had thought about it a great deal. It was not just that Obama faced an economic choice or a political choice. He faced a moral choice."

The piece then goes on to explain how Geithner thought it would be horribly immoral to default on the debt because of the price the country would pay for generations.

There are two points to be made here. First, Woodward and the Post do not have direct access to Timothy Geithner's thoughts. Either Geithner conveyed his thoughts to Woodward, in which case this section should begin: "Geithner said there was one other consideration."

Alternatively, someone close to Geithner told Woodward what Geithner said, in which case the section would begin: "according to Person X (ideally a person with a name as opposed to "someone close to Secretary Geithner"), Geithner said there was one other consideration." Okay, but this is the Post.

Let's get to the substance. While we don't have any clue as to what Geithner really thought, it is worth saying a word about the likely consequences of a debt default. First, it would lead to a serious downturn and big-time financial crisis. If U.S. debt was no longer 100 percent solid, it would almost certainly lead to a financial freeze-up that made the post-Lehman crisis look like a Sunday picnic.

However, the plus side of this would be that it would almost certainly wipe out the Wall Street banks once and for all. We would eliminate this massive parasitic structure that is draining hundreds of billions of dollars a year from the productive economy and is the largest single source of inequality in the economy today.

The other point is that countries do bounce back from financial crises. The best example here is probably Argentina. It had a complete financial meltdown in December of 2001. This led to banks closing and people being unable to access their money. The economy was in free fall for three months. It stabilized in the next three months and began 7 years of robust growth in the fall of 2002. By the middle of 2003 the country had made up all the ground lost in the crisis. In the case of Argentina, the people of the country are almost certainly better off today from having to endure short-term pain for long-term gain.

While economic policy makers in the United States may not be as competent as those in Argentina, even if it took twice as long to regain the lost ground (i.e. three years), the country could still be much better off in the long-run as a result of eliminating the bloat in its financial sector. It would be appropriate for a lengthy discussion of the crisis like the Post's piece to consider this issue, even if Geithner claims that it would be immoral to allow Wall Street to go under.