Jan 16, 2009
Potential U.S. Government Default
I have long been predicting an eventual U.S. government default on its debt. Sunday's Washington Post has an excellent article by Greg Ip on this potentiality, linked to by both Greg Mankiw and Tyler Cowen. Ip reports that as a result of the government's fiscal stimulus, both implemented and projected, credit default swaps have raised the probability of a U.S. default over the next ten years from 1 to 6 percent. (Credit default swaps have been unfairly maligned as a major cause of the current financial crisis, although recent evidence indicates they have weathered the storm quite well.)
Ip also considers whether the U.S. might resort to inflation rather than default in a fiscal crisis, pointing out that Russia in 1998 is just one recent example of many where governments chose debt repudiation over inflation. He however overlooks an even stronger argument. Now that the Fed is paying interest to banks on their reserves, it effectively eliminates much of the remaining revenue (seigniorage) from inflation. Increasing the monetary base is now just an alternative way of issuing government debt.
Meanwhile, Senator Tom Coburn (R-OK) said the following on the floor of the US Senate on Sunday, January 11th:"I believe we are at the ultimate tipping point in this country. I believe if we don't make drastic changes over the next year and a half, that 2012 will see the default of the U.S. Government on its bills. I honestly believe that. There are a lot of economists who agree with me on that point." Full text and video is available here.
Hat Tip: Marc Joffe
Ip also considers whether the U.S. might resort to inflation rather than default in a fiscal crisis, pointing out that Russia in 1998 is just one recent example of many where governments chose debt repudiation over inflation. He however overlooks an even stronger argument. Now that the Fed is paying interest to banks on their reserves, it effectively eliminates much of the remaining revenue (seigniorage) from inflation. Increasing the monetary base is now just an alternative way of issuing government debt.
Meanwhile, Senator Tom Coburn (R-OK) said the following on the floor of the US Senate on Sunday, January 11th:"I believe we are at the ultimate tipping point in this country. I believe if we don't make drastic changes over the next year and a half, that 2012 will see the default of the U.S. Government on its bills. I honestly believe that. There are a lot of economists who agree with me on that point." Full text and video is available here.
Hat Tip: Marc Joffe