Jeffrey Rogers Hummel’s article, “Why Default on U.S. Treasuries is Likely,” is troubling.

In it, he argues that inflation alone won’t be enough to compensate for the coming Social Security/Medicare budgetary shortfall and that Treasury will instead repudiate a large portion of its debt. I recommend reading the whole thing.

Defaulting on our debt would be bad.

Right now, U. S. treasury bills are traded as essentially “risk free” investments. They form the backbone of the global financial system.

He closes the article with this:

All the social democracies are facing similar fiscal dilemmas at almost the same time. Pay-as-you go social insurance is just not sustainable over the long run, despite the higher tax rates in other welfare States. Even though the United States initiated social insurance later than most of these other welfare States, it has caught up with them because of the Medicare subsidy. In other words, the social-democratic welfare State will come to end, just as the socialist State came to an end. Socialism was doomed by the calculation problem identified by Ludwig Mises and Friedrich Hayek. Mises also argued that the mixed economy was unstable and that the dynamics of intervention would inevitably drive it towards socialism or laissez faire. But in this case, he was mistaken; a century of experience has taught us that the client-oriented, power-broker State is the gravity well toward which public choice drives both command and market economies. What will ultimately kill the welfare State is that its centerpiece, government-provided social insurance, is simultaneously above reproach and beyond salvation. Fully-funded systems could have survived, but politicians had little incentive to enact them, and much less incentive to impose the huge costs of converting from pay-as-you-go. Whether this inevitable collapse of social democracies will ultimately be a good or bad thing depends on what replaces them.

Only four things can happen when the bills come due:

1)  We can raise taxes to cover the shortfall.

This is problematic for several reasons. Revenue does not increase linearly with tax rates and higher tax rates reduce growth rates which further reduces revenue. The target rates, as Hummel points out, would need to be in excess of 45%, a level that far exceeeds anything Americans have shown a willingness to put up with. I think this is a political non-starter. Taxe rates would have to climb across the board and I don’t see any politician in the next twenty years seriosuly campaigning to double the taxes on middle-class earners.

2) We can cut benefits and services, end Social Security and radically reduce Medicare commitments.

Political suicide. No politician will do it. Won’t happen.

3) We can radically inflate the money supply.

Hummel argues that we actually can’t do this because there’s so much private money in the world. I think he’s probably right, but I’ll offer another reason why we can’t do this, and it’s the same as the reasons we won’t do 1) or 2). It’s political suicide. Hyper-inflation affects everyone equally. Everyone’s wealth is reduced both here at home and abroad. Think this recession looks bad? Significant inflation would cripple the global economy.

4) We can repudiate some of our debt.

In other words, we’d just default on T-bills. But of course, we wouldn’t default on the T-bill rate, we’d default on particular T-bills. I’m guessing we’d default on debt obligations held by foreign banks and foreign governments. I’m also guessing that we’d be less likely to default on our debt obligations to Western Europe than we would be to default on our debt obligations to China.

The economic fallout of debt repudiation would be bad, very bad. We’d likely lose the dollar as the world’s reserve currency, some inflation would likely attend any debt default, and the global economy would take a significant hit. But the consequences would obviously be most dire for whoever holds the debt we choose to default on. How will our creditors respond?


3 thoughts on “Sobering

  1. I don’t know if I’m on board with the prediction that the social democracies will collapse. Although I get the sense that he may speaking ~very~ long term.

    In the long term, I’d venture that social democracies will decay into explicitly authoritarian states which will decay further until those governments are replaced by liberal republics which will dissolve into social democracies, etc… etc….

    The hope of course, is always that we can save the republic, or maybe preserve enough of it that it can be resurrected somewhere else. Cato vs. Ceasar.

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