Tuesday, July 26, 2011

US Debt Default

I would like to offer the following conundrum. 


If the US debt is downgraded, does it really matter?  Since US treasury debt is the benchmark on which other bonds are traded what does it matter if it is downgraded.  It is essentially the zero or plumbline on which everything else is based.  Does moving the plumbline really matter?

I have read some economists say it may cause some large bond portfolio managers to buy even more US debt as the trickle down effect will make everything else riskier. 

Perhaps the yield on US debt will drop as a result of a default?

Interesting time for sure.  If the US defaults, it's really a voluntary default as they have the resources to pay all debts/creditors. 


Best Regards,
Kevin

9 comments:

  1. "If the US defaults, it's really a voluntary default as they have the resources to pay all debts/creditors."

    Really? Define "resources".

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  2. Absolutely, it's called a printing press.

    Secondly the debt of the government is really the debt of the people. US debt to GDP is 64%which isn't bad at all. The problem is forcasting Obama's reckless spending going forward. Debt to GDP is forecast to rise significantly unless spending is controlled. Looks like the debate in Washington (going on as we write this) will take care of that.

    Best Regards,
    Kevin

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  3. On your definition of "resources," then, it's not a question of if the US will defaulted. On your definition, they have many, many times already.

    US debt to GDP doesn't seem particularly helpful in assessing the situation given that GDP includes deficit spending...nor I am sure how you came up with the centile of 64.

    There's no problem forecasting Obama's spending going forward. That's the one constant in all this: He will continue to be reckless. :)

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  4. Besides being able to print the money here is what else they can do.

    "The federal government has about $400 billion in gold, which the president has the legal authority to sell. The president also could sell many of the hundreds of billions of dollars of mortgages, housing bonds and other special purpose bonds the government owns. He could sell government equity holdings in companies like General Motors. The government also owns hundreds of billions of dollars of unnecessary buildings and military bases, as well as stockpiles of metals and other unneeded goods. Combined, this stuff is estimated to be worth more than $2 trillion."

    Read more: http://dailycaller.com/2011/07/28/obamas-choice/#ixzz1TZ1euYVZ

    Regards,
    Kevin

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  5. Printing money is a form of default. It's default by inflation. The idea that this is a "resource" is quite strange.

    For the sake of argument, let's assume the US has $2 trillion in assets, the selling off of which is a best-case scenario. As Thomas Woods would say, "That's 10 cents off a trip to the moon!" There's still at least $12 trillion in liabilities, probably more (which makes me scratch my head about where that ratio of 64% comes from). It's not a question of whether the boat is sinking. It has sunk. :)

    Anyhow, have a great long weekend, Kevin. Always enjoy reading your blog!

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  6. Hi Joel,

    I'm not going to beat a dead dog but I need to respond... for the sake of argument.

    First printing money is not a form of default. If you sell bond denominated in US dollars, you are entering a contract to pay a certain amount of interest (in US$) and at the end of the term you pay back the principle (in US$). The buyer agrees to this. If you happen to own the printing press why is it default if you print the money and pay it back. Inflation is a byproduct but you've met you obligation.

    It's no different if Apple entered into a contract to recieve cash and instead of paying interest in dollars you pay in a specified number of iphone's and at the end of the term you pay back the debt principle in macbook air's. If the buyer agrees it is not a default because Apple owns the factory where these items are made.

    As for debt to GDP that is the amount of debt relative to the size of the economy. You are making the error all of the so called economics over at the mises institute make. You cannot count future liabilities to the current debt and compare to GDP. The debate in Washington right now will making some changes to these so called liabilites. Like I've always maintained, if you can't pay them they won't get paid.

    Enjoy your weekend also!
    Kevin

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  7. Kevin,

    "If you happen to own the printing press why is it default if you print the money and pay it back."

    Firstly, I should point out that there's no happenstance involved in the state's ownership of the money supply. It's an unauthorized encroachment of the state that has been taken by force.

    Secondly, the printing press is a form of default because the state wouldn't engage in this immoral activity (theft via counterfeiting) if it could actually pay its bills. Just because financial institutions and investors accept debased currency as payment for liability doesn't mean the perpetrator of currency debasement hasn't defaulted. On the contrary, it's a telltale sign that the perpetrator has.

    "It's no different if Apple entered into a contract to recieve cash and instead of paying interest in dollars you pay in a specified number of iphone's and at the end of the term you pay back the debt principle in macbook air's. If the buyer agrees it is not a default because Apple owns the factory where these items are made."

    It's very different. The analogy breaks down quite quickly because the state has no assets backing the money it prints out of thin air. The state is not a productive or wealth-generating institution. So back to your analogy, when the state prints money to monetize its deficits, it is stealing iPhones and Macbook Airs from private citizens, not drawing on some government store of Apple products that it has purchased in the past.

    "As for debt to GDP that is the amount of debt relative to the size of the economy."

    Ignoring the fact that a debt-to-GDP ratio is very flawed given the limitations of GDP as a statistic, show me your work. :) How did you arrive at 64%? What's the debt? What's the GDP? When you refer to "debt," do you mean "deficit"?

    "You are making the error all of the so called economics over at the mises institute make."

    How can I be making an error when I'm simply asking you to reveal how you arrived at the number of 64%? Simple question. :)

    "You cannot count future liabilities to the current debt and compare to GDP."

    Sure you "can." Our disagreement would center on whether one "should." :)

    "The debate in Washington right now will making some changes to these so called liabilites."

    The "debate" is nothing more than theatrics. The country will continue to be less and less productive, the state - whether run by Dems or GOPs - will continue to overspend by the billions and trillions.

    Good exchange, Kevin!

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  8. Hi Joel,

    I don't have time to respond; today is my wife's birthday.

    Why is it immoral to repay in US$ if both parties agree to that? The contact does not stipulate that you cannot debase the currency to repay the debt.

    My question is why would a rational person accept such terms? That is the real question. What is immoral is that the masses are being unknowingly robbed. I agree that it is encroachment of the state but it is not taken by force. We are free to "lose faith" in fiat currency and use some other standard.

    Now, I strongly disagree with you that the US has defaulted. That doesn't square with reality. Do you realize the thousands of people are willingly lending the US government billions of dollars for less than 3% interest over a 10 year term. Doesn't sound like a huge credit risk, in fact I don't believe anyone else in the world gets those terms, but perhaps I'm missing something. Who am I suppose to believe?

    As for debt to GDP, you can find it at the Bureau of Economic Analysis (www.bea.gov) website. I don't have time right now.

    I, like yourself, love good exchanges like this.

    Best Regards,
    Kevin

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  9. Hi Kevin,

    Hope the birthday celebrations went well!

    "Why is it immoral to repay in US$ if both parties agree to that? The contact does not stipulate that you cannot debase the currency to repay the debt."

    Morality isn't derived by consensus. It's immoral because God's Law says its immoral: "The LORD detests dishonest scales, but accurate weights find favor with him." (Proverbs 11.1) It's not even considered legal in the eyes of the state when private citizens do it (counterfeit). God's Law, and even the current criminal codes in the US, are against it.

    That two parties agree to engage in immoral activity is hardly relevant. Morality is not a function of consensus.

    Furthermore, if morality were a function of consensus, adequate consensus has not been reached by all parties involved. The state and the bondholder are not the only parties involved. When currency debasement is employed by the state, everyone holding US dollars is defrauded.

    "My question is why would a rational person accept such terms? That is the real question."

    The state accepts such terms because they get to spend the counterfeit money before it has time to ripple through the economy and lower the purchasing power of the dollar. There's much to be gained by the first users of new money. The bondholder accepts such terms because s/he wants a guaranteed return on investment and/or is ignorant as to the damage that currency debasement does within an economy, particularly to those on fixed and low incomes.

    "I agree that it is encroachment of the state but it is not taken by force. We are free to "lose faith" in fiat currency and use some other standard."

    Yes, it is taken by force. Legal tender laws. Monopoly on money supply. End of story.

    "Now, I strongly disagree with you that the US has defaulted. That doesn't square with reality."

    It sure does square with reality. $14 trillion in debt and a currency that has lost 95% of its purchasing power in the past century spells bankruptcy. Could it be any clearer?

    "Do you realize the thousands of people are willingly lending the US government billions of dollars for less than 3% interest over a 10 year term. Doesn't sound like a huge credit risk, in fact I don't believe anyone else in the world gets those terms, but perhaps I'm missing something. "

    Bankruptcy, like morality, is not a function of consensus. On any dictionary definition of bankruptcy, the US is bankrupt.

    Cheers,

    Joel

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