Friday, October 11, 2013

Default on the National Debt.

I think the U.S. government should pay the principle and interest on the national debt.    Failure to do so would be default on the national debt.

The United States has a statutory debt limit.   The U.S. Treasury can only borrow up to a certain limit.   Once that is reached, it cannot borrow more.

If the limit is reached, the current government expenditures will be limited to current government revenues.   That is, the budget must balance.  

Robert Murphy reproduced CBO estimates for 2014, here.

Since the amount of money appropriated by Congress exceeds current revenues by nearly $600 billion, the government would have to spend less than what has been appropriated--about 16 percent less.

President Obama and his supporters in Congress are using the term "default" to mean failure to obtain enough money to spend everything appropriated by Congress.   That is a dishonest.

If the debt limit is reached, then as government bonds come due and the principle paid off, the national debt will fall below the limit.   The government can sell new bonds to raise the funds needed to pay off the next set of bonds that come due.  

However, the interest that is paid on these bonds is a current expenditure of the government.  The net interest is about $250 billion per year, which is approximately 8% of the approximately $3 trillion of government revenues.   The government collects way more current revenue than is needed to cover interest payments. 

So, the government can pay interest and principle on the national debt with no problem.   The cuts in all other government spending would be slightly deeper, a bit more than 18 percent, rather than 16 percent.

Certainly such deep cuts in government spending are no joke.   It is approximately 4% of the total economy.   Of course, that does leave 96 percent of the economy.    And what is sacrificed is the value of the government goods and services that aren't provided.   Normally, I would anticipate that the production of private goods would only gradually expand as resources are freed, and further, if the reduction in government spending is temporary, that increase in private production would never occur.   However, what if the government reduces transfer payments?     Also, I believe the current production of private goods is well below capacity, so there is room for a rapid increase in the production of private goods and services.

What does President Obama and his apologists say to arguments that default isn't necessary?   Mostly, they just repeat their dishonest talking point.   Failure to spend whatever Congress appropriated is defined as "default."

But there have been some arguments.   Supposedly the Treasury is not up to the job of making sure that interest and principle are paid on the national debt.   It is just too complicated.    If that is really true, the Secretary of the Treasury should be fired and President Obama should resign in shame for incompetence.    Just because the Treasury has considered its job to be coming up with the money to cover all appropriated expenditures in the past, does not mean that they shouldn't be prepared to face a hard budget constraint--limit spending to what is available rather than assume an unlimited ability to borrow.

And, of course, the Obama Administration has opposed legislation officially making debt and interest payments a priority.     I heard an administration apologist on the radio already making the argument that interest and principle shouldn't be a priority.    Which is more important, paying the Chinese (interest and principle on the bonds,) or Grandma (social security.)   Cutting social security checks and failing to pay interest and principle on bonds when due is a choice to default.    Of course, Social Security payments are running about $700 billion, so $3 trillion in revenue would be enough to cover those payments as well.  

The bottom line is that if the government fails to pay principle and interest on the national debt, it will be because President Obama decided that is what he wants to do.   It is a policy determination that other sorts of government spending, say on Obamacare or food stamps, is more important.

Some claim that it would still be a default if the government didn't pay all of its bills.    Well, to the degree that the government has already committed to a vendor to purchase a good or service, and especially if it has already received delivery, it does owe the money.   Once a payroll is due, the work has already been done.   That is a debt of sorts.   Of course, when you are running out of money, you need to stop ordering new products.   And it is also when you start implementing furloughs and layoffs.   You stop making commitments to spend money you won't have.

However, appropriations by Congress aren't the same thing as goods and services already purchased and outstanding bills.      I heard on the radio someone argue that if you pay the mortgage and don't pay your utilities, your credit rating will still suffer.

Admittedly, it would be difficult to do without electricity.   But consider the following scenario.    The family made a budget for the year.   They plan to spend all of their income, and use their home equity line of credit to go into debt.    They are careful planners and decide up front to start going to a healthier restaurant once a week rather than the fast food restaurant they had been patronizing.   And they finally get cable TV, with all the bells and whistles.

In the middle of the year, the line of credit is cut off.     They stop going out to eat at the health food restaurant and return to fast food.   Is that a default?    No, not in anyway.   But President Obama is defining government default to be any cut in planned spending.   Suppose they cancel their cable subscription.   Is that a default?   No.   

But suppose they just don't pay the last cable bill because they need to money to make their mortgage payment, including the payment on the home equity line.    Is that a default?   Yes.   And it would hurt their credit rating.

Now, what does the bank collecting their mortgage think about that?   While it would be better for the family to have paid their last cable bill and then cut off the service, maybe skipping the fast food restaurant meal and staying home for dinner, the banker would actually like that they treat the mortgage as a priority.

In my view, failure to raise the money appropriated by Congress that has not actually been spent is not a problem at all.   It is like economizing by purchasing less expensive food at the grocery story and spending less on recreation.    It would be a clear positive from the point of view of bond holders.   This is especially relative to the status quo where President Obama is threating not to pay them even when there is 10 times more money than what is needed to pay them because he wants to spend on his favorite new programs.

Now, if the Treasury were to stiff vendors who had already delivered goods of some types, say jet aircraft and used the savings to maintain spending on other goods where no commitment had been made, that would be bad.   It is like continuing to eat at the health food restaurant while failing to pay the cable bill received for last month's services.   A sign of irresponsibility.     

However, it is still true that if the Treasury won't pay for the jet aircraft already produced and delivered, and the reason is that they needed that money to pay interest and principle on the national debt, that would help reassure those holding the debt.     They have made the debt a priority.

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