Friday, January 14, 2011


The Obama administration has said that if Congress fails to increase the legal limit for federal government borrowing, which is currently $14,292 billion, the result will be default on the national debt.

You can't make your debt payments unless you borrow more money?    Superficially, this seems to be a transparent lie or a sign of complete insolvency.    First of all, the government regularly rolls over its debt.  The roughly 14 trillion dollar national debt is made up of government bonds.   As these government bonds come due, the government sells new bonds to pay off the old bonds.    This continual refinancing procedure does not require that the government borrow more money.  

On the other hand, the government has a high interest expense, projected to be  $414 billion in 2011.   If the government collected less than $414 in taxes, then it would be necessary to borrow to cover this expense.    This would be true financial irresponsibility.    Anyone who lent to the U.S. government in such a situation would be a fool.

Fortunately, tax revenues are projected to be $2,567 billion in 2011.   This allows the government to pay the entire $414 billion in interest expense, and have $2,153 billion to spend on other things.    Having interest payments at 16 percent of revenue seems a bit high to me, but that still leaves 84 percent of revenue to spend on other things.

Unfortunately, government spending is projected to be $3,834 billion in 2011.   The projected budget deficit is $1,267 billion.   And so, the government actually wants to expand its borrowing, and so, the national debt, by $1,267 over the coming year.    Failure to increase the legal limit on the national debt will prevent this from happening.

And, of course, that is exactly why the "Tea Party" Republicans newly elected to Congress are balking at the increase in the debt limit.   They want to stop the administration's plan for deficit spending.   They don't want the government to borrow an additional $1.2 trillion and spend it.    Refusing to raise the legal debt limit doesn't require default on existing debts.  It requires that the budget be balanced immediately.

So, when the Obama administration says that if the legal debt limit is not increased, then the U.S. will default on its debt, what they are really saying is that making payments on the national debt (paying interest and paying off bonds as they come due) is less important than other spending.    What they are saying is that they will fix roads, buy military equipment, send out social security checks, and then tell bond holders that we are out of money.

It is simple to understand.   Rather than first making the mortgage payment, and then buying groceries, and if you are short, going hungry or living on rice and dried beans, the government will go with the plan of spending what you like at the grocery store, and then seeing if there is enough money left at the end of the month to pay the mortgage payment.   If not, then don't pay it.

So, suppose government spending is cut immediately to the projected $2,567 billion in revenues.  This is a 33 percent cut.    That is significant.    The resulting level of spending would be a little higher than it was in 2005.    Of course, there has been inflation over that period.    The real volume of government goods and services that could be purchased would be a little more than was purchased in 2003.  (These figures are for outlays which include interest payments and transfers, not just government purchases of goods and services.)

My view is that federal government spending was much too high in 2003, and so, I have no problem with cutting it back to that level and even lower.    Of course, those who believe that all of those government spending programs are essential would favor tax increases, rather than spending cuts.   Ignoring any adverse impact on the incentive to work, save, or invest, (and monetary policy failures,) this would require a 50 percent increase in taxes next year.    

Well, I guess that's why the Obama administration is saying that they would rather default.    A 50 percent tax hike?   Voters will never stand for it.   Cut government spending back to the level of the dark ages (2003,) civilization would collapse.   So, default...

Or, maybe it is just a threat.  

P.S.  Governments default often, as explained by Reinhart and Rogoff, This Time is Different.     Partial default is the usual approach.   For example, stop paying interest and as bonds come due, give new bonds in place of the old bonds.   You had better plan on balancing the budget after that--at least for awhile.   Until lenders decide, that this time is different.

P.P.S.   The Fed should keep money expenditures (NGDP or Final Sales of Domestic Product) on a 3 percent growth path no matter what--including massive sudden drops in government spending (like 33 percent) or a partial or complete default on the national debt.

1 comment:

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