Is a U.S. Default Inevitable?
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We were blindsided. We never saw it coming.
So said Goldman Sachs CEO Lloyd Blankfein of the financial crisis of 2008. He likened its probability to four hurricanes hitting the East Coast in a single season.
Blankfein was reminded by the chairman of the Financial Crisis Inquiry Committee, Phil Angelides, that hurricanes are “acts of God.” Financial crises are manmade. Yet Blankfein was backed up by Jamie Dimon of JPMorgan, who said, “Somehow, we just missed … that home prices don’t go up forever.”
The Wall Street titans thus conceded they did not foresee the housing bubble ever bursting and they did not consider the possibility of a collapse in value of the sub-prime mortgage securities piled up on their books.
Backing up Blankfein’s plea of ignorance and incomprehension is this: The crisis killed Lehman Brothers and would have killed every one of them had not the Treasury and Fed, neither of which saw it coming, either, intervened with hundreds of billions in bailout cash.
Yet there were those who warned a housing bubble was being created like the dot-com bubble; others who predicted the Empire of Debt was coming down. As, today, there are those warning that the United States, with consecutive deficits running 10 percent of gross domestic product, is risking an eventual default on its national debt.
The warnings come from the Committee on the Fiscal Future of the United States, chaired by Rudolph Penner, former head of the Congressional Budget Office, and David Walker, former head of the Government Accountability Office and author of “Comeback America: Turning the Country Around and Restoring Fiscal Responsibility.”
With that share of the U.S. national debt held by individuals, corporations, pension funds and foreign governments having risen in 2009 from 41 percent to 53 percent of GDP, Penner and Walker believe it imperative to get the deficit under control. Unfortunately, it is not possible to see how, politically, this can be done.
Consider. The five largest elements in the budget are Social Security, Medicare, Medicaid, defense and interest on the debt.
With interest rates near record lows, and certain to rise, and back-to-back $1.4 trillion deficits, this budget item has to grow and has to be paid if the U.S. government is to continue to borrow.
Second, with seniors on fire against Medicare cuts in health care reform, it would be fatal for the Obama Democrats to curtail Social Security or Medicare benefits any further this year. Next year, they will not only lack the congressional strength but any desire to do so, after their anticipated shellacking this fall.
The same holds true for Medicaid. The Party of Government is not going to cut health benefits for its most loyal supporters. Indeed, federal costs may rise as state governments, constitutionally required to balance their budgets, cut social benefits and beg the feds to pick up the slack.
This leaves defense. But the president is deepening the U.S. involvement in Afghanistan to 100,000 troops, and the military needs to replace weaponry and machines depreciated in a decade of war.
Where, then, are the spending cuts to come from?
Can the administration cut Homeland Security, the FBI or CIA after the near disaster in Detroit? Will Obama cut the spending for education he promised to increase? Will he cut funding for Food Stamps, unemployment insurance or the Earned Income Tax Credit in a recession? For the near term, the entitlements are untouchables.
Is this Democratic Congress, which increased the budgets of all the departments by an average of 10 percent, going to take a knife to federal agencies or federal salaries, when federal bureaucrats and beneficiaries of federal programs are the most reliable voting blocs in their coalition?
What about tax hikes?
Obama has promised to let the Bush tax cuts lapse for those earning $250,000 but has pledged not to raise taxes on the middle class. Any broad-based tax would be politically suicidal for him and his increasingly unpopular party.
But if taxes are off the table, Afghan war costs are inexorably rising, and cuts in Social Security, Medicare, Medicaid and entitlement programs are politically impossible, as pressure builds for a second stimulus, how does one reduce a deficit of $1.4 trillion?
How does one stop the exploding national debt from surging above 100 percent of GDP?
America is the oldest and greatest constitutional republic, the model for all the others. But if our elected politicians are incapable of imposing the sacrifices needed to pull the nation back from the brink of a devaluation or default, is democratic capitalism truly, as Francis Fukuyama told us just two decades ago, the future of mankind?
What the looming fiscal crisis of this country portends is nothing less than a test of whether this democratic republic is sustainable.
Filed under: Economics, Politics
Default isn’t inevitable.
What is inevitable is that the US (and most countries in western civilization) will find some way to get out from under the significant debt loads that they have created.
This could be an outright default, but it probably won’t be. As long as most US national debt is held in dollar denominated bonds, then the most likely scenario will be higher taxes combined with massive quantitative easing (printing money).
Recent history in Argentina and Russia suggests that countries default in situation where they can’t inflate the debt away (because the debt is denominated in some foreign currency).
And I believe that you are right to suggest that the current fiscal situation (and foreign policy situation and entitlement situation) calls into question liberal democracy as a belief system. If I were a guerilla or national leader in the developing world, why would I choose to believe in a system of government whose end result is inevitable financial ruin?
Sorry to be the voice crying in the wilderness, but I have a theory about that burst housing bubble.
To deliver McCain/Palin their Oct 10th surprise, “speculators” (read big money-left) drove up the price of oil, and removed corn from the world’s food market.
This unintended detonator ignited the housing bubble, starting with the nation’s farms (the corn fed their animals, the price of transportation bled them, and petrolium makes their fertilizer – they were the first to begin defaulting on bank loans). Then it cascaded worldwide.
(We later found out that Goldman Sachs had computers in place that could manipulate commodities markets worldwide.)
US politicians scrambled to ship billions overseas to stay out of jail, then were relieved to find that the expected backlash never arrived, because politicians worldwide were using the same scams to enrich themselves.
The global warming hype has nicely made the whole issue recede into the distance, and the scams continue, as the supposedly “rich” countries dangle the “climate-guilt payments” in front of the little countries.
PJB, your entire article above is predicated on the assumption that the administration wishes to avoid collapse of the US financial structure.
Reality check.
Well, I think Obama got it partly correct in taxing the banks.
-Everyone who puts down less than 20% must pay mortgage insurance…so just make it mandatory for subprime and altprime regardless of whether they put down 20%
-Everyone knows it was the hedges, the derivatives, the credit default swaps, futures, and all the other shadow banking techniques that dwarfed the real banking industry.
DONT PUT FORWARD A TAX ON THE REAL BANKING INDUSTRY: SAVINGS, CHECKING, MORTGAGES, CREDIT CARDS, CAR LOANS, MUTUAL FUNDS
PUT A TRANSACTION TAX ON EVERY HEDGE, DERIVATIVE, FUTURES, SWAPS, ETC…AND MAKE IT PAYABLE REGARDLESS OF WHETHER THE TRANSACTION IS TRADED IN THE USA OR OVERSEAS BOURSE. IF THEY WANT THIS SHADOW BANKING THEN MAKE IT TRANSPARENT AND TAX IT PERMANENTLY.
” America is the oldest and greatest constitutional republic, the model for all the others. But if our elected politicians are incapable of imposing the sacrifices needed to pull the nation back from the brink of a devaluation or default, is democratic capitalism truly, as Francis Fukuyama told us just two decades ago, the future of mankind? What the looming fiscal crisis of this country portends is nothing less than a test of whether this democratic republic is sustainable.”
What must be done is purge all ‘democratic’ qualities out of the republic. It is precisely this democratism in capitalism that renders impossible the operation of a free market, where people would willingly accept whatever sacrifices would be necessary to amend any arising crises rather than passing the buck to later generations. It could be that democracy (i.e the entitlement ethos) and the federal reserve (the only banking system that can facilitate these entitlements) are entwined.
Barney,
Central bank’s cheap money + government guarantees = apparently consequence free environment for speculation = asset bubble. Is it a plot, or are they just that stupid? The romantic in me likes the idea of a plot. Either way, I’m out of debt, and my garden is in order.
BLANKfein??? That’s drawing the picture right there!
I think that more likely,considering the criminal nature of the government that there will be a massive devaluation of the dollar thereby defrauding everybody dependent on it. The true measure of the honor and integrity of government is it willingness to protect the value of its’ currency.
“Somehow, we just missed … that home prices don’t go up forever.”
The myth of monotonically increasing home prices is a subset of a much greater myth: The belief, of many Americans, that they are entitled to the guarantee of ever-expanding wealth be it in their homes, stocks, etc… After all, Americans didnt’t just stop saving for a reason. In retrospect, consider how ridiculous it was to be making financial predictions out 10, 20 , or 30 years!
After the financial collapse started, proponents of government expansion saw their chance and pounced. Americans stood by powerless. With the exhaustion of what little savings they had left along with the dwindling values of thier assets, they happily traded away another portion of one of their remaining assets: liberty.
“…if we are universally vicious and debauched in our manners, though the form of our Constitution carries the face of the most exalted freedom, we shall in reality be the most abject slaves.”
-Samuel Adams
GB wrote:
“After the financial collapse started, proponents of government expansion saw their chance and pounced.”
Wait a minute, it wasn’t the usual “proponents of government expansion” suspects that pounced, it was George W. Bush. AIG, Fannie, Freddie … you name it, he started it.
The sad fact is that when times are bad proponents of gov’t expansion of course have their chance. But that when times are good they have their chance too … because the times are good. Witness, again, Bush and the prescription medication program.
It’s funny that it doesn’t seem to be known who said that democracies will succeed only until its citizens realize that they can vote themselves their national wealth, but it’s still a great one. Maybe epitaph-great even.
TomB wrote:
“Wait a minute, it wasn’t the usual “proponents of government expansion” suspects that pounced, it was George W. Bush.”
No argument here… In my mind, GWB definitely was undoubtedly a proponent of big government as evidenced by his profligate spending and actions such as the creation of the enormous bureaucracy mess called the Department of Homeland Security. I cannot say with certainty, given GWB’s background and education, whether he made decisions with the preservation of our republic foremost among his concerns.
TomB, I’m not sure about the quote you mentioned but here is another one I like:
“Say… whether peace is best preserved by giving energy to the government, or information to the people. This last is the most certain and the most legitimate form of government”.
-Thomas Jefferson
The big question in my mind is this: If an “informed” people decide to give excessive energy to government, what can be done? In my mind, given the current framework, the answer is very little for the time being…
The previous government understood that principle well enough – at least, well enough to understand that giving disinformation to the people was every bit as empowering. For the government.
GB wrote:
“If an ‘informed’ people’ decide to give excessive energy to government, what can be done?”
GB, since we’re dealing quotes apropos of this question I’ll just give Mencken’s answer: “Democracy is the theory that the people know what they want, and deserve to get it good and hard.”
Sounds about right to me.
Mark wrote:
“The previous government understood that principle well enough – at least, well enough to understand that giving disinformation to the people was every bit as empowering. For the government.”
Couldn’t agree more which is why I put “informed” in quotes when I wrote it. So we must ask ourselves why the disinformation worked, whether the source was FDR or GWB. Maybe education?
The education of the founding fathers, born of many hours of study and reflection, lead them to found the greatest republic in the history of man. So, why do so many adults not desire to emulate their example in the education of our youth? Americans seem to know more about the science of making excuses than the science of government.
TomB wrote:
“GB, since we’re dealing quotes apropos of this question I’ll just give Mencken’s answer: “Democracy is the theory that the people know what they want, and deserve to get it good and hard.””
The American people will learn the hard way as their expectations get smashed beyond illusion. In other words, the “there is a program for that” or “there is a war for that”, mentalities converge to the same limit that government excesses always seem to converge: tyranny and corruption. The challenge comes in rebuilding, assuming of course, we have the materials and builders.
“This leaves defense” Given the choices if I were Obama and the Democratic majority I’d make cuts in the defense budget and hold the line as much as possible elsewhere, unless they really had information that demanded our resources be fully invested in defense. Even then share the evidence and demand that the rest of the world contribute. Dems don’t get many votes from military hawks anyway, and if we don’t have another 9/11 or similar they will continue to hold power and the balance sheet sould look better. If we do get attacked they’d probably lose anyway as the public sees the Republicans as better re security.
Interesting reading. We all are waiting to see what will happen over the next few years. The average Joe is the one who will have to pay for all of this through higher taxes and less services in the long run. The US is on financial life support.