Why the default threat is a sham

Alexis Zarkov writes:

In my view, the debt negotiations going on are pretty much pure political theater. Additional borrowing will get authorized by Congress and signed by Obama into law. Both parties are pretty terrified as to what might happen if they don’t. That being said, I have the following observations on the whole matter.

1. If Congress needs to raise the debt ceiling for the Treasury to make timely payments of interest and principal on its bonds and notes, then in effect the U.S. is in default anyway. In effect Treasury has to borrow from Peter to pay Paul. Paul does get his money, so technically there is no default. But what’s changed? Treasury ends up with more debt not less. This means the income into Treasury is insufficient to service the national debt—Ponzi Finance. This happened to New York City in the mid 1970s where the city kept rolling over its debt until it ran out of buyers for new bond issues, and had to go whining for help from Washington.

2. The U.S. debt is denominated in dollars, and our dollars are pure fiat money. As such, with help from the Federal Reserve (the Fed), the U.S. can always pay off its debts. It never has to go into default. Treasury would sell bonds (using an investment bank as an intermediary) to the Fed. The Fed pays for the bonds with its “magic checkbook,” in other words, created money. Thus if we went into default, then the Fed would be responsible, not Congress. Let’s not forget that the Fed did exactly this over the past year with Quantitative Easing 2 (QE2). It created $600 billion (yes billion) and bought Treasury paper. So what would be the big deal about having a QE3 to prevent a default? Compare and contrast to Argentina. In the year 2000 Argentina went into default because its debt was denominated in dollars, not pesos. Argentina can’t print dollars, so they had no choice but default.

3. The U.S. has ample tax revenue to meet its debt obligations. But without a rise in the debt ceiling, something else would need to get cut. Like the ethanol subsidy. Or perhaps the African-American Museum in Washington D.C. Of course we know nothing is as important as the African-American Museum. Better to stiff our creditors.

Obama also threatened to withhold Social Security checks, which brings us to the next item.

4. The Social Security System (SS) was set up as a pay-as-you-go program circa 1937. This is a very poorly structured system because it’s highly vulnerable to changes in demographics. Current SS taxes pay for benefits to current retirees. Until 2010 SS tax revenues exceeded payouts with the surplus going to the so-called Trust Fund. Now Obama threatens to cut off payments to retirees if Congress doesn’t lift the debt ceiling. A reasonable person might ask, “If current SS taxes don’t cover current benefits to retirees, then just draw from the Trust Fund, that’s what it’s there for?” Obama should keep his mouth shut about this because he’s reminding people that there is no Trust Fund. All the surplus money from SS taxes has been spent. The Trust Fund consists of “special issue” Treasury bonds which don’t trade in the secondary market. In other words, the Trust Fund has to hold the bonds to maturity. If the Trust Fund held a portfolio of tradeable securities, then it would sell just what it need to meet a short fall in revenue. Obama has engaged in shameful demagoguery.

5. If we were really in danger of default then you would see a panic in the money markets. Most people use money market funds instead of checking accounts. A default on the short-term debt would destroy the money markets. It’s not going to happen. The Fed would intervene first.

For all the above reasons and many more, I regard the whole debt ceiling as a bogus issue. One way or another, the U.S. will not default on its debt, and there is no reason it will ever have to as long as that debt is held in dollars, and as long as dollars are pure fiat money. Of course, those dollars might not buy very much in the future. But that’s a different and more important issue.

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Buck O. writes:

Various “experts” have explained that, when everything is added up—city, state and federal; SS, medicare, etc.—we’re $100 trillion to $120 trillion in debt. The government is borrowing $200 million every hour just to pay the interest on the debt that it accrued the hour before, and will continue to do so … until when? Until what happens? What stops it? And, what actually happens when the United States has borrowed twice what its total production and all of its assets are worth?

How does a ponzi or pyramid scheme end when everyone is involved?

When Social Security began, it was “anticipated” that very few who would live past age 65 to collect benefits. There were 33 earners paying into the system for every one receiving benefits. Now, the ratio is 2.5 to 1 and we’re living to age 80 and longer. Everyone, and I mean everyone who was the least bit interested, knew this and they know this now.

So, what actually happens when the total U.S. debt approaches or reaches the value of the global economy? The global economy is $72.45 trillion. 6.9 billion people times $10,500 average per person. If the U.S. alone is that much, or more, in debt and is adding to that debt at an accelerating rate, how is this resolved?

It makes my hair hurt thinking about it.

Back in the early 1980s there was a rash of pyramid games started in my area. These have been around since money. I got a call and a couple of us went to a meeting room in a shopping mall. This is how it works. A person sits at a table in the front of the room with a 32 slot pyramid drawn on a board. Participants come with the person who invited them and $100 cash (or more). All competent adults. Everyone there knows exactly what it is. At the appointed time, when the room is full, the door is closed. The current “top” of the pyramid (who paid for the room) then invites the participants to bring him $50 in cash and to give another $50 to the person that brought them, who is now even. When the 32 names are filled in, the “top” leaves with his money and perhaps moves to the next higher game, hopefully progressing to multiples of thousands of dollars. The board of 32 names splits into two 16 person games and it continues. The bottom row of 8 now invites someone so they can get back to even and fill in the needed bottom row of 16. Then they wait two games to sit at the head table. Either you make it or you don’t. But, everyone goes home and back to work.

Now, this is not legal. But, why? Everyone in the room is an adult. The game is very simple. The risk is obvious. It’s certainly no worse than Las Vegas. It’s certainly easy to understand than Social Security and rational for QE2. And it’s totally voluntary. But it’s illegal and Social Security and the Federal Reserve is not.

Are there any adults in the room?

Hannon writes:

Mr. Zarkov says, “The U.S. has ample tax revenue to meet its debt obligations,” but I am not so sure. A statistic I read in a recent book review (sorry I lost the reference) gave these very informative figures regarding revenue and expenditures for the “big ones”, Social Security and Medicare: in 1950, there were 16.5 workers paying into the system for every retiree taking from that same system (16.5:1 ratio). In 2000, the ratio was 3.5:1. It is not difficult to imagine the impact of such a drastic demographic change on revenue overall. Income has certainly not gone up enough to make up the difference, and if unemployment were 0.1 percent we would still be nowhere near the ostensibly healthy 16.6:1 ratio. The rising percentage of elderly in the population is important, but more important is the fact that net producers (tax payers) are not reproducing like they used to. Unfortunately such an understanding forms a strong basis for promoting unfettered immigration.

Paul Nachman writes:

Alexis Zarkov is a valuable commenter, but I disagree with him on part of this:

Obama should keep his mouth shut about this because he’s reminding people that there is no Trust Fund. All the surplus money from SS taxes has been spent. The Trust Fund consists of “special issue” Treasury bonds which don’t trade in the secondary market. In other words, the Trust Fund has to hold the bonds to maturity. If the Trust Fund held a portfolio of tradeable securities, then it would sell just what it need to meet a short fall in revenue. Obama has engaged in shameful demagoguery.

I don’t think it’s true that the “trust fund’s” bonds need to be held to maturity—they’ve already been “cashing in” bonds to meet the cash-flow deficits that started in Social Security in FY2010.

But in any event, the main thing about the “trust fund’s” bonds is that they’re not an economic resource (as Mr. Zarkov, indeed, acknowledges); they’re just an IOU from one part of the government (the U.S. Treasury) to another part (the Social Security Administration). And whenever these bonds get paid off (presuming taxes aren’t increased) the Treasury has to either stiff other federal programs or borrow additional money from “the public” (which includes foreign governments) specifically to redeem the bonds.

My point of dispute, again, is about the maturity date of the special issue bonds. I think that’s of no significance.

Paul K. writes:

The United States is currently in the position of Bernie Madoff shortly before the fall. As long as his investors were content with receiving interest payments, he managed to go on for quite a long time. It was when they started asking for their money back that his scheme collapsed.

China will never get back the trillion dollars it has loaned us, except, as Zarkov suggests, in vastly inflated currency. Surely the Chinese government realizes that by now. I have this fantasy that, as a condition of maintaining their loans, the Chinese will send a financial minister over here with authority to strike items from our budget that we can’t afford.

Robert B. writes:

There is only one problem with Mr. Zarkov’s analysis — OPEC turning against the dollar. If that were to happen, and if the IMF were to go with the original post WWII plan (wherein there was supposed to be an international currency for settling debt) the dollar would collapse over night. Since most of the Western countries backed that international currency and still do, this is not an alarmist theory. If the U.S. continues to export massive amounts of inflation, this is a distinct likelihood.

Posted by Lawrence Auster at July 20, 2011 09:44 AM | Send

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