Thursday, May 21, 2009

Even a doom-monger like John Hussman says that Treasury bonds are “default-free securities”

From Reuters:

Felix Salmon

is summer arriving?

May 21st, 2009

Can America’s debt get too big to pay?

Posted by: Felix Salmon
Tags: economics

Reader Matthew Kelley writes with a question:

Our national debt is over $11 trillion, it is not unreasonable to think that in my lifetime I will see a quadrillion dollar national debt. Do you think that there is a level of debt at which the United States would pull a ‘latin america’ and just default on the debt?

First, it’s a bit of a stretch to think that in your lifetime the national debt will hit $1 quadrillion. Let’s say you have 50 years to live, and let’s say that, pessimistically, inflation averages 5% a year over that time. US GDP is now about $14 trillion, and if real GDP growth averages 3%, then we’ll have nominal GDP growth of 8% a year for 50 years, which would take us to about $650 billion. So a quadrillion-dollar national debt in 50 years’ time would require a debt-to-GDP ratio of about 150%. It’s all possible, but if you just tweak the numbers a little — say you have 45 years to live and inflation averages 2.5% and real GDP growth is 2.5% — then GDP is just $125 billion when you die, and there’s no way you could have a quadrillion-dollar national debt.

But more to the point, for all the rhetoric from campaigners about countries struggling under their debt burdens, there really isn’t much of a correlation between the level of a country’s debt and the probability that it’s going to default — especially not when that debt is wholly denominated in domestic currency. Countries with low debt-to-GDP ratios can default — just look at Ecuador right now — while countries with very high debt-to-GDP ratios can stay current on that debt indefinitely — Japan is the most obvious example, but there are many more.

If you want to come up with a scenario where a developed country defaults on its debt, you’re most likely to look at a case like Italy, where the debt is denominated in euros and there’s a non-zero chance that the country is forced out of the eurozone; in general, if you want a sovereign default, the best way to get one is to find a country with hard-currency borrowings which then has a massive devaluation. That can’t happen in the US — there’s no currency mismatch between its tax revenues and its liabilities.

Even a doom-monger like John Hussman says that Treasury bonds are “default-free securities” and that the worst-case scenario is not 5-6% inflation for a year or two, but 5-6% inflation for ten years. (Which he calls “a near-doubling of the U.S. price level over the next decade”.) Neither of these things are likely to increase the chances of default — in fact, quite the contrary. Since the US has only a tiny number of inflation-linked bonds, a strong dose of inflation would therefore substantially decrease the real value of the US national debt.

Essentially, the only way to get to a quadrillion-dollar national debt is via inflation — but inflation manages to reduce debt levels all by itself, meaning there’s no need to default any more. So a US default is almost certainly not going to happen."


Generally, I don’t think that people are asking an economic question about a US Default, but a political one. It reminds me of the social security debate. As near as I can tell, the fear is that taxpayers would refuse to pay the projected amount of taxes at some point, by having their elected representatives change the terms, perhaps drastically.

Such is the case with a US Default. What’s being assumed is that the servicing of the debt would necessitate sacrifices that taxpayers and voters, at some point, decide that they don’t want to pay, or, the least, not all of it. It seems to me that Buiter believes that should happen fairly soon.

Perhaps, if you could explain to me how Ecuador, I think it’s Ecuador, can just decide it doesn’t want to service a debt, and seems to be getting away with it, I might see this option as more unlikely in the US. Instead, I can see the idea catching on. Maybe California will tell us something about how the US feels when it gets into a real fight between cutting costs and raising taxes. Frankly, I’d pay good money to see Arnold play Correa:

“Monday, April 20, 2009
Ecuador says wants debt buyback at a “big discount”

QUITO, April 19 (Reuters) - Ecuador will offer investors of its defaulted debt a buyback with a “big discount” on its nominal value, President Rafael Correa said on Sunday.

Ecuador plans to reveal its debt restructuring proposal on Monday, more than four months after the leftist Correa refused to pay $3.2 billion in 2012 and 2030 global bonds over charges the debt was “illegally” issued by past administrations.

“The proposal is basically to try to buy back that debt at a big discount,” Correa said during a television interview. “The source of the debt’s illegitimacy was its overvalue when it was renegotiated in 2000 at a time (when) our country was in shambles.”

Correa, a former economy minister whose presidential campaign slogan was “life before debt,” has said his government could seek a buyback at a price similar to the market value of the defaulted debt when it was restructured in 2000.

Correa said the global bonds, which were issued as part of the 2000 renegotiation, were valued at around 20 cents on the dollar at that time when a crippling financial crisis forced Ecuador to default on its foreign debt.

Even as Ecuador’s revenue plummets on lower oil exports, the U.S.-trained economist has said the OPEC-member nation has enough funds to buy back the defaulted debt.

Local media has speculated his socialist government silently bought back a large percentage of the debt when Correa threatened to default in November. If Ecuador controls a great part of the debt the cost of a buyback will be much lower.

The debt restructuring plan also comes only days before Ecuadoreans decide whether to re-elect Correa in general elections. Some analysts say Correa will seek big concessions from bondholders in the restructuring to boost his popularity before the April 26 vote.
The debt default has shutdown international credit lines to Ecuador and its private businesses at a time when the government is scrambling to cover a widening fiscal deficit this year.”

In looking up this post, I came upon the following blog: uador+4044.twl


I also came upon a blog called “Ecuador Rising” that’s worth a read, but I’m not linking to it because I’ll turn up as a bot. Did ‘bot’ come from ‘robot’? I’d like to know, because I’m trying to answer Steve Hsu’s question to me on his great blog “Information Processing” if a robot can discover that it’s a robot.

- Posted by Don the libertarian Democrat

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