Saturday, July 16, 2011

Default Hysteria

Failing to raise the debt limit by August 2 will push the U.S. Treasury into defaulting on their debt and this would be a catastrophe. So says Jamie Dimon, CEO of J.P. Morgan Chase & Co. The aptly titled Daily Beast tells us that only crackpots could be dismissive of the chaos caused by a default.

Not so fast, says Peter Klein. Citing a 1996 AER paper by William English, “Understanding the Costs of Sovereign Default: American State Debts in the 1840′s,” he notes that there is some historical precedent for sovereign states defaulting on their debts. When eight states and one territory defaulted in the early 1840s there were consequences in the form of higher bond rates for those countries, but not to "catastrophic" levels.
Amazingly, the earth did not crash into the sun, nor did the citizens of the delinquent states experience locusts, boils, or Nancy Grace. Bond yields of course rose in the repudiating, defaulting, and partially defaulting states, but not to “catastrophic” levels. There were complex restructuring deals and other transactions to try to mitigate harms.
A similar point is made by Robert Higgs, noting that the United States itself has defaulted before.
Has the U.S. government ever defaulted before? Yes, in 1933, by refusing to honor the gold clauses in its bonds, the Treasury engaged in a massive default. Ironically, for mainstream economists and economic historians, the government’s abandonment of the gold standard, along with its associated default on its gold obligations, is seen as the decisive government action that stopped the Great Contraction and set in motion a recovery from the Depression. (Don’t laugh: for some time, this interpretation has been the reigning view in academia.)

Higgs also reminds us of a point I made back in February. "It is customary for normal people, if they have taken on too much debt, to alleviate the problem by not borrowing anymore and by reducing spending until the debt is paid down."

Those in the media who predict catastrophe after a potential default do not explain just why there would be chaos and catastrophe. They merely assert.There are good reasons to believe, however, that while there are consequences for default, just as for any action, these costs may not be as bad as pro-debt opinion molders would have us believe.

By the way, a literature has developed reminding that default is not the Treasury Department's only option if the debt ceiling is not lifted. The government could sell off their assets to raise necessary funds.

No comments:

Post a Comment