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Home Publications Blogs Beat the Press Defaulting on the Debt Is Not the End of the World

Defaulting on the Debt Is Not the End of the World

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Saturday, 09 April 2011 18:28

The NYT had a piece on the implications of the United States hitting its debt ceiling and running the risk of defaulting on its debt. The article exclusively presented the views of people who portrayed hitting the debt ceiling and defaulting on the debt as being an end of world scenario.

It would have been useful to present the view of people who do not consider a default on the national debt to be the worst possible outcome. While there can be little doubt that a default on the U.S. debt would lead to a financial crisis and would likely permanently reduce the role of the U.S. financial industry in world markets, it is also likely the case that the United States would rebound and possible rebound quickly from a default.

The experience of Argentina may be instructive in this respect. Argentina defaulted on its debt at the end of 2001. Its economy fell sharply in the first quarter of 2002 but had stabilized by the summer and was growing strongly by the end of the year. By the end of 2003 it had recovered its lost output. Its economy continued to grow strongly until the world recession in 2009 brought it to a near standstill.

Book1_22628_image001

Source: IMF.

While there can be no guarantee that the U.S. economy would bounce back from the financial crisis following a default as quickly as did Argentina, it's unlikely that U.S. policymakers are too much less competent than those in Argentina.

Readers should be made aware of the fact that countries do sometimes default and they can subsequently recover and prosper. Many people may consider the short-term pain stemming from a debt default to be preferable to the long-term costs that might come from policies adopted to prevent default.

For example, if Congress were to approve a Medicare plan along the lines proposed by House Budget Committee Chairman Paul Ryan, this would be subjecting tens of millions of middle class retirees to a retirement without adequate health care insurance and potentially devastating medical bills. Plans being put forward to cut Social Security could have similar consequences. Compared to these outcomes, a financial crisis and the subsequent slump that follows may seem like a relatively small cost.   

It is also worth noting that two of the people whose views were presented in this article, Jamie Dimon, the CEO of J.P. Morgan, and Robert Rubin, a former top executive at Citigroup, are both individuals whose situation is likely to make them view a debt default as an end of the world event. Both institutions would likely not survive a debt default. For the people whose wealth depends on the health of Wall Street financial firms, a default on the U.S. debt is probably one of the worst conceivable events in the world, however this group is tiny minority of the U.S. population. 

 

Addendum: Here is my response to Zero Hedge.

Comments (18)Add Comment
...
written by foosion, April 09, 2011 8:04
A default wouldn't be the end of the world, The earth would continue to spin around its axis. It would likely substantially raise the costs of borrowing by the US, which would not be helpful.

To say that defaulting would not be as bad as doing something monumentally horrible, such as adopting Ryan's plan, doesn't say much.
Default Versus Ryan's Medicare Plan
written by Dean, April 09, 2011 8:17
Foosion,

I didn't bring up Ryan's Medicare plan to create a straw man. Serious people in Washington take it seriously. Would you count on President Obama to stand up to it?
...
written by foosion, April 09, 2011 9:24
Dean,

I didn't think you brought up Ryan's plan as a straw man. Ryan's plan would be absolutely catastrophic, including for the reasons you have discussed, but that doesn't mean it couldn't be enacted.

Defaulting on the debt would be very bad, IMHO. It's true that there are things that would be worse, but that doesn't mean a default wouldn't be really bad. We likely would eventually pay off the debt (eventually probably being measured in days), so wouldn't get any benefit of decreased indebtedness, but a default would increase interest costs and create great turmoil, at least in the short run.

I don't regard anyone who takes Ryan's seriously as a serious person. I wouldn't count on Obama to stand up to anything.

I find it hard to believe that our corporate masters would allow a default. The only question is how badly can the Republicans bluff the Democrats. I'm not optimistic.

best regards,
...
written by Robert, April 09, 2011 9:25
Speaking of debt repayment, CEPR has been extremely quiet on the Icesave referendum.
Social Security Trust Fund
written by MicronEcon, April 09, 2011 9:28
Defaulting on debt held by banks and China is one thing; defaulting on the Social Security Trust Fund is another. In theory, general appropriations could make up the difference for the fund. In practice, the Republicans would try very hard to end Social Security at that point, saying that there is no money.

Agreed it's not the end of the world, but given the current Congress, we don't need more cans of worms opened.
Foosion?
written by Union Member, April 09, 2011 11:43

You say you wouldn't take anyone seriously who takes Ryan seriously but don't you see that the whole Ruling Class is foaming at the mouth, barking mad? Pete Peterson, the Koch brothers and innumerable other sources we can only imagine in paranoia because of Citizens United are buying the best demagogs money can buy.

Donald Trump got a "serious" front webpage profile in the NYT just last week as a Presidential hopeful. That same day they asked crazy ignorant hateful Terry Jones what he thought of Islam. Meanwhile millions of Americans (taxpayers and consumers) are unemployed and getting their over priced homes taken from them, yet their stories, their lives - by the editorial standards of the NYT - are relegated to life in the Quiet Desperation Class.

Don't you remember Sarah Palin was at the top of the Republican Party just two years ago. Don't you remember how "serious" people hounded Bill Clinton for years, nearly threw him out of office, over what's her name? On January 20, 2009, even Obama drank the Kool-aid.

...
written by Steve Athearn, April 10, 2011 1:01
"While there can be no guarantee that the U.S. economy would bounce back from the financial crisis following a default _as quickly_ as did Argentina..." Note the assumption that future growth is more or less inevitable, the only question being how quickly the economy will bounce back.

The sentence continues: "it's unlikely that U.S. policymakers are too much less competent than those in Argentina." Here's the assumption that the speed with which the economy bounces back is mainly dependent on the competence of policymakers. The author of these words has his head buried deeply in the sand, and so ignores the centrality of the drawdown of exhaustible fossil fuels in the history of economic growth, and hence the highly anomalous nature of the experience of the past couple hundred years.

People wishing to equip themselves to think clearly about these things would do better to read the actuary and energy expert Gail Tverberg than practically any economist. Here are some relevant words from her most recent column on ourfiniteworld.com :

"The long term basis for economic growth tends to be fossil fuel use. Fossil fuel use has been growing for 200 years–about as long as the US has been in existence, so economists have tended to assume this growth is the natural state, and can be counted on indefinitely. Unfortunately, this assumption is not true."
...
written by mjptrob, April 10, 2011 3:11
If a Medicare beneficiary incurs a medical co-payment beyond his means, he can decline to pay it, and most hospitals and doctors will write it off. In the rare circumstance that a hospital might seek to collect from the ailing oldster, he could declare personal bankruptcy. If he's too ill, his legal guardian could handle it. At this stage of life, his personal credit rating is not an issue. How is this so bad that the entire nation should consider defaulting on trillions owed worldwide to forestall it? America's most recent financial recession sent ripples of recession and financial crisis to the rest of the world, where many nations have yet to recover. How would a U.S. national debt default not produce a tsunami of worldwide depression, not just recession?

Citing Argentina as an example for a nation finding its way out of debt fails to take into account that Argentina's GDP was was hampered by decades of military coups and military regimes and didn't even have democracy by ballot voting until 2003.

In most parts of the world, debt default is viewed with extreme disdain. U.S. debt default would allow all who promote fascism, communism, and sharia-ism to point to America's dishonor as the failure of democracy, the failure of free markets, and colossal failure of responsibility.
In a word
written by JHM, April 10, 2011 6:33
On the rocks.
written by jhm, April 10, 2011 7:59
Would it be instructive to compare possible repercussions in the US and the more immediate ones facing Iceland after their second rejection vote?
...
written by dopp, April 10, 2011 8:28
Is there really a possibility that the corporatists who run the GOP and bankroll the 'baggers will allow the default? Aren't they the one with the most to lose?
Yeah, Let's Just Go Ahead and Default and See What Happens
written by Paul, April 10, 2011 2:01
After all, the RepubliCons have been whining forever that the U.S. is "broke", "bankrupt," etc., so let's just go for it and refuse to pay the bond holders. What are they going to do, sue us?

Oh yeah, maybe they could and then all the Cons would understand that we have unlimited money to pay our debts. So what's the point again of defaulting? Just playing around with out finances like a bunch of teenagers in dad's car?
...
written by foosion, April 10, 2011 5:00
Union Member,

While I agree that there are entirely too many insane people out there, with entirely too much power, what does that have to do with anything I posted?

The Ryan plan would be monumentally horrible. A US default would be incredibly terrible.
Foosion
written by union member, April 10, 2011 8:41

Sorry if I misunderstood your point. I thought you were implying that we need not fear Ryan's plan since level heads or rational thinking (serious people) would prevent its passage. I believe however reasonable debate is impossible in today's political climate since legions of voices are yelling fire in this crowded theater.

I also appologize for not reading any of this too closely, I immediately assumed Dean was making "A Modest Proposal" type argument and never thought anyone would take his statement in literal terms (ie seriously.)
...
written by PeonInChief, April 10, 2011 8:46
Actually some kinds of default are perfectly okay with the holders of debt. Social Security, pensions and anything else owed to the vast majority. The debt you can't default on is that owed to the rich.
Payment Burden
written by PeakVT, April 10, 2011 9:24
it is also likely the case that the United States would rebound and possible rebound quickly from a default.

I think Baker is being a little glib here. The US is different than most debt defaulters in that the current payment burden isn't all that high. Right now, the US national government's budget is much, much larger than it's net interest payments ($1500B vs $242B), so a default would have a huge impact without closing the budget gap. That means all of the demand in excess of $242B would still either have to be borrowed, or eliminated. That would be a crushing blow to the economy.
Quote
written by PeakVT, April 10, 2011 9:27
Blah. The first line in the preceding comment is a quote from Baker's post
http://www.hats-newera.com/New-Era-Hats_1.html
written by Red Bull Hats, April 11, 2011 3:44
Would it be instructive to compare possible repercussions in the US and the more immediate ones facing Iceland after their second rejection vote?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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