How could the US ever default on its debt?

allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893

It has been suggested in some of the recent stock market crash books that the US could default on its massive debt.

How could this happen?

The gov does not even have to print money nowadays. It just magnetizes a silicon chip to create billions. What would hold it back from magnetizing a few more microns to pay its debt whether it is billions or trillions?

Jack · Dark Lord Joined: Aug 11, 2004 Posts: 5123

Inflation.
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hope_full · Heavy Crude Joined: May 27, 2008 Posts: 254

Olle · Tar Sands Joined: Jun 28, 2006 Posts: 93 Location: Sweden

Micki

As mentioned, that is the decision they have to make.
If they don't have enought to pay the debt they need to default or print. Printing fuels inflation and also drives down the value of the currency compared to other currencies.
As a result, the nation won't be able to import and can't afford buying things that are sold on the international market.
i.e. oil may shoot up to $250/bbl so that Americans can't afford it but foreigners will as their currencies will have strengthend.

Defaulting is really not an option. People want their pensions, companies want to continue existing, foreigners want to be paid what they are owned and Federal Reserve wants to continue existing.

Inflation option allows for all the above....for a while.
The problem with inflation is that the house of cards get taller and taller and trying to then break the cycle makes the deflation much worse than it would have been earlier on.

According to Mises (and logic I would argue) there is however no way of avoiding a collapse if he inflationary path is chosen.
Eventually people lose all their faith in the currency and only barter trade remains.

In a paper or coin based society there is also physical limit to how debased the money can become.
i.e. when metal value of coins is much higer than the face value of the coin, noone will use the coin to pay as per face value.
In weimar one example of paper money having lost most of its value was when people started using paper money in the fireplace instead of buying firewood. i.e. the paper money gave the more fire than the firewood it bought would have.

Right now neither scenario is pretty as the house of cards already is tall as the tower of babel. (i.e. 1.3 Quadrillion dollars in over the counter derivaties waiting to casue a financial meltdown.)

Politicians however always chose the option that causes least pain
in the short term.
Central bankers have in the past also declared that keeping off disaster, even if only for some months, is worth a high price.
Finally, Bernanke has made a career of being a deflation fighter and has so far indicated that the central bank will do what ever it can to keep off deflation.

I am therefore in the inflationary camp.
(Actually in stagflationary as I think salaries will drag and energy prices will take off more and more resulting in stagflationary conditions. ) But generally I think necessities will go up in price.

On a positive note, a really weak currency can create good conditions for export again. But that is years away as muh of manufacturing etc has been dismantled. Furthermore there will be a brain drain and good companies will be taken over by foreigners.
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allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893

Olle · Tar Sands Joined: Jun 28, 2006 Posts: 93 Location: Sweden

allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893

$15,000 like a nickel?

Don't know. They are bragging how wages are not going up...so no wage inflation.

Sure everything else costs more, but wages are stuck.

The gov says inflation is low...it must be true?

It is in the gov favor to keep the inflation figures low so they do not have to pay high % rates on inflation adjusted bonds.

This is what is scary. The gov has lied so much they are starting to believe their own lies now.

allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893

Thanks for all the replies.

Inflation has hit most of the world and not just the US.

Where is the tipping point for the US with its money creation scheme?

Or it there no one point and it is just a gradual loss of faith in the dollar?

TreeFarmer · Heavy Crude Joined: Jun 26, 2007 Posts: 347

My take on this goes back to human nature. Human beings are always trying to get something for nothing. It happens over and over and over, in fact Napoleon Hill in his book Think and Grow Rich cautions aginst this over and over.

What apparently happens is that politicians get elected by promising something-for-nothing (i.e. the government will provide it without higher taxes) and then a downward spiral gets started that the politicians don't have the will to stop.

Another good example of this is something that pops up here on peakoil.com all the time, THE CAR THAT RUNS ON WATER. People are lusting mightily after that something for nothing.

If you had economics in college, or maybe in your regular readings you ran across the TANSTAAFL acronym, There Ain't No Such Thing As A Free Lunch. http://en.wikipedia.org/wiki/TANSTAAFL

That is the crux of the problem, people vote for whoever promises the most without having to pay for it and self-centered politicians run-up however much debt to get reelected.

TF

Olle · Tar Sands Joined: Jun 28, 2006 Posts: 93 Location: Sweden

MrBill · Expert Joined: Sep 15, 2005 Posts: 5642 Location: Eurasia

There are responsible governments running budget surpluses that have positive real interest rates. That is not inflationary. The inflation is being caused by governments running current account deficits as well as those with negative real interest rates. That is bad stewardship of their economies and not a flaw in the system.

Gold is not the answer. Balanced budgets and fully funded future liabilities as well as positive real interest rates are the solution.

I am not convinced that all fiat currencies eventually collapse. Sterling has been around for several centuries and is still serving its purpose. In the meantime many nations have come and gone. So it may be the nation state that is less durable than fiat currencies per se.

Mises said that no asset has an absolute value, but all assets trade relative to one another. Gold also has no intrinsic value, but trades relative to the value of other assets including cash or income earning assets. In an environment of low, stable inflation and high real interest rates gold is not worth much. That is not where we are in the global economy right now, but that is ideally where we should be headed.

In the meantime I am happy with a basket of non-US dollar currencies as a dollar hedge. Gold and other commodities have had a good run, but I am affraid the deflationary forces of deleveraging are very powerful at the moment. It is not as simple as just turning on the printing presses if there is no demand for money.

To be honest given the unfair terms of the Treaty of Versailles and war reparations Weimar Germany had to pay, I can hardly blame them from inflating their way out of debt. Albeit with unforeseen consequences. But that is another story for another day.
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allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893

What was difference in the old days? Volker? FDR? Whomever? Was gov more ethical back in the day?

Or was free flowing, cheap oil and managing a relatively small US population the difference?

allenwrench · Intermediate Crude Joined: Apr 23, 2008 Posts: 893