So far in this series we’ve established that the United States government is spending a lot more than it gets in revenue. Because of this excess spending, it has borrowed a lot of money. Our government has also promised to pay for certain programs for which it has not set aside money to fund. If things continue on this way, sooner or later the government will be insolvent. What exactly does this mean for our government?
Up until now we’ve been scaling our numbers to create the fictitious example of Joe — a worker who makes $25,000, spends $35,000, has $200,000 in debt, $1 million in unfunded liabilities, and has other financial pressures. Any reasonable person would agree that Joe is already very far down the road to disaster. He will default on his debt, his credit will get shut off, he won’t be able to pay his liabilities, and he’ll most likely end up declaring bankruptcy. Some of his assets will be taken and sold, and without much access to credit he’ll be forced to live within his means all at once. Joe’s comfortable life is about to come crashing down, and his parents are in some serious trouble, since Joe had promised to help support them.
While all of this and more would happen to Joe, this is where our Joe example stops working. The federal government has powers that a private citizen such as Joe does not have, including the power to print more money. With those powers the Federal government can avoid defaulting on its debts — if it chooses to.
The US Constitution gives Congress control over how much money the Federal government can borrow. The limit Congress sets is called the debt ceiling. Since the government owes so much money, each year, when the debt ceiling needs to be raised to avoid default, there is an increasing resistance to doing so. If that resistance gets high enough, and Congress does not agree to raise the debt ceiling, the federal government will be left without enough money available to pay its bills. Even if that did occur, the government could work around that problem in various ways. For example, there has been talk recently of the executive branch having the US Treasury mint platinum $1 trillion dollar coins and then borrowing against their alleged value, to work around any failure of Congress to raise the debt ceiling.
What would happen if the US government chose to default on its debts? If both the legislative and executive branches refused to authorize an increase in money so that there wasn’t enough available, a default could theoretically happen.
The government’s credit rating would be hit hard. Access to additional credit from foreign sources would be reduced dramatically and the cost – meaning interest rates – of borrowing would increase. Foreign investment would also be hit hard, as this willful default would be viewed as a dangerous instability; our government would be viewed as broken. Someone, likely the President, would need to decide what to do with the money we did have, meaning who or what would be paid and who or what wouldn’t be paid. Many government workers could be sent on furloughs – effectively, unpaid vacations. National parks could be closed, some government offices might close for business, and non-essential services could be suspended. There are many arguments that other serious negative consequences would ensue, even if the default was short-lived.
The fallout on the state and local level would be particularly damaging. With the federal government’s credit rating in disarray, and without money to spare, little to no assistance from the federal level would be available. As a group, state and local governments are spending more than they get in revenue, just as the federal government is. Unlike the feds, they cannot print their own money. To borrow, they must rely on money actually being lent, mostly in the form of government bonds – essentially, IOUs that promise to pay back a certain amount at a certain date. Bonds are investments purchased by individuals, companies, and foreign governments. With any investment, there is the risk of default. The less financially solid a bond-issuing entity seems, the more they must offer to pay back in order to make a bond purchase worth the risk. If the risk is viewed as high enough, no one would purchase their bonds at any price.
Imagine what would happen to a local government whose budget was suddenly reduced significantly. Where would they cut? Communities spend most of their money on their schools, public safety such as police and fire, public works including roads, and the salaries and pensions of municipal workers. Schools are already stretched thin in many places, with old textbooks and aged buildings in need to repair. Police in most cities and towns can barely handle the level of crime in existence today, never mind the increases we’ll see if things get worse. Roads and bridges are decaying at an alarming rate already. Salaries and pensions can’t legally be cut in most cases, but in any event cuts to any of these programs would hit hard.
It is unlikely that the US government would allow a default, causing those bad things to happen. Instead, the alternative to default is for the federal government to continue to monetize its debt. Monetizing means that they can print more money, or perform actions that are essentially the same as printing more money. When a debt comes due, they can just claim they borrowed this newly printed money, and pay the debt with it. This is what they do today, and it is very likely this is what they will continue to do, despite all of the arguments against raising the debt ceiling. Because of all the disastrous effects that would come in the short term, politicians may talk tough about our debt but in the end, either they will raise the debt ceiling or some other action such as minting allegedly valuable coins will take place.
The United States will become insolvent, and little notice will be taken of it. In fact, many people will argue and disagree, saying that the United States is not insolvent, regardless of how much financial and numeric proof is given that we are.
If so few will notice, why should anyone care? Because the financial misconduct of monetizing debt has far more devastating long term effects. Each time more money is printed, the currency is diluted: existing dollars such as the ones you hold in your savings account drop in value. It’s a lot like a company issuing new stock shares without raising the value of the company – existing shares drop in value because the total worth of all the shares is the same before and after the new shares are issued. The difference is that this is far less obvious when our government does it, especially since they have so many different ways of doing it, each with their own name. You will find many that argue, for example, that “quantitative easing is non-inflationary”, even though it absolutely is, because we haven’t felt the effects yet.
Countries that continue to monetize their debt on a large scale have always ended up with a currency crisis. As the value of a currency becomes more and more diluted, no one wants to hold on to it. Governments, people, and businesses holding the currency sell or exchange it, or purchase things with it, to get rid of it. This significantly increases inflation, and as it increases, more and more currency is dumped. When the currency drops enough, or inflation rises high enough, everyone gets rid of the currency at once. Runs on banks collapse the banking system and hyperinflation sets in.
While defaulting on our debt would be bad, hyperinflation is far worse. Imagine inflation of 100% a year. After just 2 years, your savings would be reduced in value by 75%. Now imagine inflation of 100% a day – the same thing would occur in only two days. Hyperinflation is a complex subject, and will be covered in a later series of posts, but in history the damage from it has been horrific. The collapse of a country’s currency is true national insolvency.
Those who are trying to point out that we are headed for a currency crisis are often ridiculed as if they were “Chicken Little” misinterpreting the data and being alarmist. There is a bizarre lack of general agreement about the government’s spending and revenue patterns that can only be a form of cognitive dissonance*. Propaganda is being written to soothe our fears and get us to continue on the same way as we are now that many are choosing to believe. We can’t even rely on our government to tell us the truth. For example, the federal government calculates an inflation rate that excludes the things that are rising in price the most, calling them “volatile”. This means that the inflation rate they publish is much lower than the real inflation rate – they are hiding the real inflation rate from us.
* Cognitive dissonance is the name given to the process the human mind goes through in manipulating its own beliefs when presented with conflicting (dissonant) beliefs, such as information that requires an unpleasant change in behavior.
It isn’t enough to watch the debt and deficit if the federal government is going to print more money to avoid default. We need to watch the new money being created in so many sneaky ways, and the real inflation rate that results.