Debt, Default and Leadership

Well I honestly thought the US debt ceiling crisis would be resolved by today given the past examples of American political theater when it comes to fiscal issues.  As I write this morning, it seems that the US is heading towards defaulting on some of its debt interest payments.  It appears to me that the act of a small limited default will now have to be the political trigger needed to reset the debt ceiling negotiations in America.

In other words, I think the issue will get resolved but the game of political chicken over the debt ceiling has been taken up a notch.  This does not bode well for the next time the debt ceiling is reached – once you have been there and done the limited default, how will the ante be upped the next time?  Its not so much the short-term economic impact of a default that is the issue but what the act signals to the rest of the world.

Despite being the world’s dominant economic and military power with its financial system underpinning the world economy and its currency as the world reserve currency, the United States no longer believes in its role.  Borrowing from the mythological language of Hollywood and Spiderman – the United States no longer believes that with great power comes great responsibility.  While domestic concerns have ultimately always been predominant in American policy, this latest episode is the most serious illustration yet that the United States is tired of leading. 

There are two basic reasons for a default on your public debt.  Either, you are unable to pay your bondholders because the economy has become a basket case and the government is unable to raise the necessary revenues.  Or, you simply decide you do not want to pay your bondholders.  While the American situation can be ascribed to political deadlock, it really falls into the latter category because despite the impact of the 2009 recession and financial crisis, the United States is still a rich country and has the capacity to service its public debt.  Not fulfilling its obligations in this capacity is really a default on its leadership role.

Comments

[Mandos]

But it's kind of hard to say in this context, "The USA believes." The US system allows a small component to break its "leadership role" if consensus is not reached. If one small part---enough to elect a senator---believes it no longer needs consensus with the rest of the country, you have this leadership role failure, regardless of the remaining 80%.

[hosertohoosier]

The problem is that the United States is becoming un-governable, not that there has been any particular shift in willingness to act as a global leader. Indeed, plenty of Republicans endorse a vision of strong US global leadership (albeit a unilateral and militarized form of leadership). The sad reality is that it was rational for many Republicans to endorse a hard line on the debt ceiling, flirting with default in the process. Even in a bad election year, like 2008, the GOP held onto 178 districts. The vast majority of Republican legislators live in very conservative places, and face a much bigger threat from primary challenges than they do from the general election. The cause of this problem is polarization (which is happening in the Democratic party as well).

See page 4 for Keith Poole's data, for instance: http://www.ou.edu/special/albertctr/extensions/fall2005/Poole.pdf

It is worth noting that the last time the US was this polarized was during the early 20th century - a period in which the United States largely abdicated it's global leadership responsibilities as well (e.g. not joining the League of Nations, Locarno, etc.). So this isn't a matter of any particular person saying "we should let the world go to hell." Rather, it's about the development of a political environment where the risk of self-destruction is worth it, if you can stick it to the other guys.

I should add that it is precisely because the US is so powerful and because it is the global leader that it can get away with this. I mean, do you have a better global reserve currency? The Euro? The Yen? I don't think so.

[Frank Restly]

Livio,

"There are two basic reasons for a default on your public debt. Either, you are unable to pay your bondholders because the economy has become a basket case and the government is unable to raise the necessary revenues."

Tax revenues used to service debt can come from any point in time. What gets governments in trouble is the use of coupon securities that make regular interest payments (all debt being concurrently serviced). All a government needs to do is switch to accrual securities and adjust term structure to match the available revenues.

[Patrick]

"the United States no longer believes that with great power comes great responsibility."

I think their are still plenty of people who could come to the party and fill the empty seats at the grown-ups table. But I understand why they are staying home. You would too rather than be stuck rubbing elbows with the likes of Michelle Bachmann while she expounds on her ideas about public policy as a tool to hasten the rapture.

[Ralph Musgrave]

Will everyone please stop using the word “debt” so often? The negative connotations behind the word play straight into the hands of Republican debt-phobes. Instead of using the phrase “national debt”, use the phrase “national savings” from time to time. It sounds better, and as Isabella Kaminiska pointed out at the end of a Financial Times article recently, the phrase “national savings” is marginally less misleading than the phrase “national debt”. For Kaminska see:

http://ftalphaville.ft.com/2013/10/11/1664302/why-the-level-of-government-debt-may-not-matter/?Authorised=false

See also:

https://sites.google.com/site/nationaldebtsave/

[Frank Restly]

Ralph,

Are we economists or are we political consultants? From the article:

"Austerity in recent years has been driven mainly by the delusion suffered by most politicians and numerous economists, namely that national debt is directly comparable to a debt owed by a microeconomic entity like a household or firm. And since debts owed by microeconomic entities are best kept to a minimum, likewise the above economic illiterates think national debts should also be kept to a minimum."

There is a Republican delusion that terms like "bankruptcy risk" and "solvency risk" which can apply to microeconomic agents (you, me, or any other private enterprise), also apply to the federal government. Those terms do not apply. However, there is are good reasons that a government should limit it's issuance of public debt:

1. Because a government lacks bankruptcy and solvency risk and because most governments refrain from competing with the private sector in the production of goods, a government's expenditures boost consumption only. This has inflationary risks originating with a government's spending habits.

2. Incentives - because of the legal protections involved, the interest payments on sovereign government debt are guaranteed (safe). It is my opinion that a government should not limit itself to issuing liabilities that offer a risk free rate of return because of reason #3.

3. The zero bound - When a government sells a risk bearing asset that has a potential rate of return greater than the cost of servicing private debt, the zero bound for private debt no longer applies.

[Philippe]

Frank,

Government expenditures don't "boost consumption only".

What does your (3) mean? Could you elaborate please?

[tbqoqaine]

7ST4yW qfxcpoyykhbk, [url=http://oedjizkbdvpl.com/]oedjizkbdvpl[/url], [link=http://vzajuutneqqq.com/]vzajuutneqqq[/link], http://zsrecaorpghl.com/

[genauer]

well Livio,

wiki/It_ain't_over_till_the_fat_lady_sings

That was certainly not the right time for an American Götterdämmerung.

Wait for 15th of February to be asked again: "Shall we dance"

http://www.youtube.com/watch?v=30QzJKCUekQ

Or a version from a slightly different angle:

http://www.youtube.com/watch?v=NbNv7njA-Aw

See you in Bayreuth / Beirut : - )

[Frank Restly]

Phillipe,

You borrow at 5% per year. Federal government sells you a risk asset with a potential return of 7% per year. Your cost of servicing debt assuming risk asset pays off is negative 2% per year.

[Philippe]

so why would that abolish the ZLB?

[Frank Restly]

Negative 2% is less than 0%, hence, 0% is not the lower bound.

[Philippe]

you borrow at 5% and buy an asset that yields 7% and therefore there is no ZLB...?

[Determinant]

Frank made a math error. He confused a simple case of risk arbitrage with an attempt to create a negative rate. It doesn't. It's not a negative coupon rate, it's the rate of profit realized by the investor in a risk arbitrage transaction, and it's still positive as the investor gains it and the borrower (the Treasury) pays it.

[Frank Restly]

Determinant,

Isn't that what the U. S. equity and housing bubbles were all about - creating risk arbitrage opportunities? In this case, with the government setting the potential rate of return, market volatility risk is eliminated - no bubble possible. Realization risk would still apply.

[Ralph Musgrave]

Frank,

Re your No.1, you are saying that government debt should be limited so as to limit public spending. I suggest there are two issues there that need separating. First, there is the question as to what proportion of GDP should be taken by public spending. That is an ENTIRELY POLITICAL issue which should be decided by, and to large extent IS DECIDED BY the electorate and politicians.

Second, there’s the question as to how much public spending should be funded by tax vis a vis borrowing.

Re your Nos 2 & 3, you’re kind of addressing the latter point. I don’t fully understand what you are saying, but I sense you’re saying something I go along with, which is the claim made by Warren Mosler and Milton Friedman, namely that governments certainly shouldn’t offer investors / savers a better deal than they can get from private borrowers. In fact both those two individuals have argued for keeping the return on government debt at or near zero.

That means government debt becomes almost the same as monetary base (which normally pays no interest).

If that policy is adopted, then demand is regulated simply by having government / central bank adjust the amount of monetary base created and spent into the economy. But government never offers anyone any significant interest for holding monetary base for a fixed period (which is what “debt” is).

[Frank Restly]

Ralph,

Okay.

"Re your No.1, you are saying that government debt should be limited so as to limit public spending. I suggest there are two issues there that need separating."

Agreed. Separate the financing decision from the spending decision - too many politicians cannot make this leap of logic.

"...namely that governments certainly shouldn’t offer investors / savers a better deal than they can get from private borrowers."

I would add the following. Also, a government should make sure that private borrowers get a better deal than the government. Because the federal government lacks bankruptcy and default risk, it typically pays less to service its debt than private borrowers.

Currently the U. S. government offers some debt relief in the tax code (mortgage interest deduction, student loan interest deduction, corporate interest deduction, etc.). Going a step further, a government could sell a risk asset whose rate of return is realized against a future tax liability.

[prednisolone prednisone]

prednisolone 20mg,