Dedicated to Deposits: Deals, Data, and Discussion

What Happens if the U.S. Defaults on Its Debt?


One of the fiscal ideas floating around recently, championed by Ron Paul, the well-known Texas Congressman and Republican presidential candidate, is that the United States should "declare bankruptcy" and begin defaulting on some of its debt. This comes as the debate in Congress over whether or not to raise the debt ceiling rages – mostly acridly along party lines. Treasury Secretary Timothy Geithner predicted that the U.S. government can meet its obligations until August 2, 2011, thanks to some creative accounting. Once that deadline passes, he predicts, the government will begin defaulting on its debt.

What Happens if the Debt Ceiling Isn’t Raised?

When countries default on their debts, it doesn’t work the same as when individuals declare bankruptcy. In many cases, the default results in restructuring, and the debt is repaid over a longer period of time, or new terms are hammered out, or some of it is forgiven (but this doesn’t happen much for wealthy, developed nations). What really happens when a country defaults on its sovereign debt is that confidence in that country’s assets is reduced.

In the Wall Street Journal, two economists at UBS Investment Bank shared some insights into what they think could happen if Congress refuses to raise the debt ceiling:

The main impact on markets would come from sharply reduced liquidity in the U.S. Treasury market, as financial firms’ procedures and systems would be tested by the world’s largest debt market being in default. …

All the legal commitments and limitations in a complex financial system mean a shock from an event that is viewed as inconceivable – such as a U.S. Treasury default – can cause the system to stall. …

[I]f the political impasse continues and the U.S. defaults, it would not simply be a question of whether Treasury investors would get their money; eventually they would. It would be a question of whether the U.S. would lose something that made it special. The answer would be yes and the consequences for U.S. growth could be significant."

U.S. economic growth could see even more issues, and the U.S. bond market, and the U.S. stock market could experience severe problems. Not only that, but the U.S. would lose its credit rating. Indeed, Standard & Poor’s is threatening to cut the U.S. credit rating to a D if the debt ceiling isn’t raised, according to the Financial Times. That’s a long way to fall, and it would mean that rates on U.S. Treasury bonds would head higher, meaning that the U.S. government would have to pay more in interest to those willing to borrow. Plus, the U.S. would no longer be seen as the most stable place to park the world’s assets. Some are even going so far as predict that the default could mean a loss of faith in the dollar to the point that movement away from the greenback as the world’s de facto universal currency would gain true support, rather than the posturing that is the main feature of such suggestions right now.

But How Can We Fix the Nation’s Spending Problem If We Keep Raising the Debt Ceiling?

If we want to maintain the good name of the U.S. in global fiscal circles, and if we want to prevent another global financial meltdown, many believe that the debt ceiling needs to be raised. On the other hand, though, there are those that point out that raising the debt ceiling will only encourage more of the same poor decisions that got us in this mess to begin with. Where do we draw the line? We have to stop the insanity somewhere.

This is why some politicians are insisting that budget reform be part of the legislation needed to raise the debt ceiling. But it might be too late for spending cuts to make a real difference in our government’s spending problem. Some argue that revenue increases are needed as well. Yes, spending needs to be cut. But our problem is so severe at this point that taxes need to be raised as well.

The main argument on one side is that serious spending cuts could solve the deficit problem. On the other side, the argument is that raising taxes is the solution. Very few are willing to say that the pain has to come from both ends: Programs need to be cut, and taxes need to be raised. It’s not fun, but in the U.S., politicians have been content to spend and spend – and voters have been largely content to let them.

Raising the debt ceiling won’t fix the fiscal irresponsibility that has become part of Washington culture. It can only keep the U.S. from losing face before the world (although there is some truth to the argument that we already have), and it will keep the U.S. stock market and the global economy from collapsing in despair. But it won’t solve our country’s financial woes. Long-term solutions have to include better spending habits going forward, and will most likely require higher taxes – at least on the wealthiest individuals and corporations (which are raking in record profits in spite of difficulties many small businesses and individuals are still facing).

A Wake Up Call – And An Opportunity

There are those that view the current situation as a wake up call with an opportunity. It is clear that the fiscal policies adopted by both parties over the past few decades are irresponsible and unsustainable. The current debt ceiling crisis is a chance for us to recognize that and wake up and actually do something about it. It is an opportunity to open debate about national priorities, and what we want to spend money on as a nation (assuming we can do this in a civilized manner). It is also an opportunity to have a meaningful debate about the tax system. Our current system hasn’t been working very well. Could it be time to truly consider the merits of a flat income tax? Or perhaps to consider a consumption-based tax instead of focusing so much on income? There are a number of alternatives that could be considered.

The real question is this: Are we willing to wake up and make painful changes? Or will we simply go on as before, until there is no stopping the complete collapse of the system?



Related Posts

Comments
24 Comments.
Comment #1 by pua posted on
pua
Considering that our government often behaves in a socialistic way, there's a possibility that, in case of default, small investors might be given more favorable treatment than large investors.  Therefore, when investing in U.S. government bills, notes, and bonds, my suggestion is to keep the total value of your investments slightly lower than a nice round number.  For example, instead of having a total of $500,000, make it $499,900.  Instead of a million, make it $999,900.  Just in case the fed decides to make everyone with a total of $500,000 or more (or a million or more) take a certain percentage "haircut" while smaller investors get all their money back.

21
Comment #2 by Hoody posted on
Hoody
"The real question is this: Are we willing to wake up and make painful changes? Or will we simply go on as before, until there is no stopping the complete collapse of the system?"

 

So who is it thats hurtin? I still see everybody walkin or drivin with a cell phone glued to their ear,I can't afford one, even a tracphone requires min every month used or not, I don't know many people like me still on dialUp (cause its cheap). And all I use is a 19" old model TV with basic cable no HBO or showtime, like those poor unemployed or college grad folks. that have all the time to watch all thise new movies and sports games. Yet I'm the group who is supposed to be living so high on those "entitlements" and needs more cuts. yeah right,.... my #@%%!!!

When I see a lot less of those things I may be ready to "feel pain" myself, but if I can't afford any of those items myself , hell if I will.......

46
Comment #3 by Anonymous posted on
Anonymous
Okay, I was totally against bailout money given out... so what have we got from that method so far? Someone explain to me what good did bailout money do to us. I was hoping all these financial institutes fall apart from their mistakes and we rebuild from scratch correctly..

7
Comment #4 by Anonymous posted on
Anonymous
Well, since AIG had insurance on large teacher pension funds, we were in essence bailing out teachers among others. If banks were not allowed to invest in crazy instruments this would not have happenened.  More regulation of banks that makes them keep more cash in hand would be a start. The banks wouldn't as easily fall if they had greater capital requirements in the first place. 

7
Comment #5 by Spider Man (anonymous) posted on
Spider Man
It seems what we have here is a failure to communicate.

Google the Money Masters or The Secret of Oz and see whats really going on.

6
Comment #6 by silver man (anonymous) posted on
silver man
if you had a brain you already bought silver.if something happens i am ready for a new life in thailand .beaches girls and non usa currency

4
Comment #7 by Anonymous posted on
Anonymous
Thhase value of the dollar and inflation has already happened. In November 2008 one $1.00 US

dollar in Chile equalled 700 pesos; tdoday, I get 457 pesos per dollar. This is a 35% decrease

in value.

4
Comment #12 by Anonymous posted on
Anonymous
It used to be that Justice Federal Credit Union only admitted members of the justice system.

1
Comment #13 by Anonymous posted on
Anonymous
alan greenspan and ben bernanke should be the first to pay higher taxes followed by the congress  hail the revenge of the countrys  SAVERS who have been raped over the last 4 years

5
Comment #14 by Anonymous posted on
Anonymous
We should not cut civil programs, we should not raise taxes on everyone, and we should not slash and burn federal budgets like education, civil services, and welfare. We should cut down that $1-$1.5 TRILLION dollar military budget we have. What so we need all this money for the military for? Are we expecting something? Chinese invasion? Aliens? Zombies? No other country spends as much money as we do on the military, and quite frankly we dont need it. If we cant afford to police the world, than guess what? We cant police the world.

9
Comment #15 by Anonymous posted on
Anonymous
Two words, BUY GOLD!

3
Comment #17 by Anonymous posted on
Anonymous
I totally agree with this guy - and  it:s even more compounded by the mess in Europe and how that:s going to be ground out. Too many countries are losing faiths in their assets. The systems will start to collapse like a gigantic ponzi scheme.  

3
Comment #18 by Superman. (anonymous) posted on
Superman.
Two things we need to do. First find out how we got into this mess. And know guessing on how it was created. That is our kingsize IOU. [#2] Make sure it never ever happens again.

2
Comment #19 by Truth Seeker (anonymous) posted on
Truth Seeker
To the guy who says "buy gold" I would say I agree that gold is good. I own a lot of gold. But, platinum is better. There are strikes in S Africa, continuing instablity, and continuing demands for huge wage increases. Even now, after a runup in price due to the instability situation, platinum is selling for about $100 per ounce less than it costs to take it from the ground and refine it into either a bullion bar or a sponge for use in catalytic converters.

If platinum prices don't rise significantly, a lot of mines will close. 80% of the stuff comes from unstable S. Africa...it is the "buy" of the century, right now, at these low prices. The percentage rate of return will be the increase in price. This will be a "normalization" amount to get the mines back to modest profitability, which would take the price to about $1,800, plus S. African inflation. The S. African economy is suffering about 15% per year in dollar terms. So, your "interest rate" on platinum will probably be in the range of 25% per year.

All that, of course, assumes no further quantitative easing from the Fed, ECB, Bank of England, and Bank of Japan. But, QE is inevitable. And, it has a similar effect on platinum as on gold. If there is more QE, platinum prices and net "interest earned" as a result of a rise in prices, will end up much more. So, why keep money in a static CD?

2
Comment #20 by Bigbill (anonymous) posted on
Bigbill
It is time to look at yourself forget about the government they will not stop spending. If you are not buying gold an silver now you better. Because the dollar is going down.

2
Comment #21 by Randy (anonymous) posted on
Randy
It's either put up with the pain now and hopefully recover, or face a massive collapse later.  I would rather get it over with now whether that means higher taxes, less funding, declaring bankruptcy, or a combination of the three.

Unfortunately, our 16 trillion dollar party has to end.  The more the politicians and higher powers stall, the more WE pay the price in the long run.  The government is like that saying: "women, can't live with them but can't live without them" (joke ladies).

2
Comment #22 by Anonymous posted on
Anonymous
Start by cutting the salaries of Congress.  Make them buy their own healthcare.  Stop furnishing FBI security to past presidents.  Once out of office, security stops.  Make Medicare send a copy of the billing to the patient for their scrutny to see if they received what was actually billed.  Clean up the tax system.  It should be a straight across the board rules and regulations that even the dumbest person could understand.  LET SOCIAL SECURITY ALONE.  It will hold if the holes and leaks are stopped such as sending checks to someone who is already dead.  Do away with all unnecessary and duplicate departments in the government.  All organizations such a charitable, political, advertising agents etc. pay the same postage rate at the rest of us.  Change the way we vote so that the popular vote wins and confine the spending of election money and campaigning to four months before the election.

5
Comment #23 by MDCCLXXVI (anonymous) posted on
MDCCLXXVI
The U.S. Debt Notes "Dollar" and the Federal Corporations chartered here "Government" were established to transfer wealth from the colonies back to the royal families and spread its power throughout the world. (Use the Colonies as Collatoral for Global Expansion)

The debt instrument uses the citizens as collatoral for the debt and is designed to bankrupt a nation eventually, transfering all the wealth of those citizens outside of the system from where the debt was incurred.

Fiat currency is worthless. Its Value is Zero.

It is a tool used historically to transfer power and wealth from those that use it as a medium of exchange.

.

2
Comment #24 by LG (anonymous) posted on
LG
Anonymous - #22 is RIGHT ON!

2
Comment #25 by Clockwork Apocalypse (anonymous) posted on
Clockwork Apocalypse
The big problem here is communication and values. The citizens scream "We dont want to pay these taxes!". The government, hoping to please those who are greedy and do not understand taxes, does this so as to make people happy, disregarding the future. Later, when the government realizes that the current path may be starting to hurt us, they try to hide this so as to keep everything how it is and to maintain thier status. But when we sink lower into the pit, the citizens scream "How could you let us fall into this mess! Fix it!!" So the government tries to find ways to fix the economy. But the citizens scream "No, we don't want to do that! We want to stay how we are now!" Because the citizens have accepted this idea that the government has given them; that things can continue how they are. So the government gives up and tries to push everything back, keeping issues at bay. And this makes everybody happy. For now. But the doom keeps amounting. And soon, when this generation has passed on responsibility to the next, we will have to face this monster that was created to make our fathers happy. We will have to pay for the wrongdoings of our mentors. And if we are taught these corrupt and ill-planned ideas, can we do any better? Or are we doomed to send our union plummeting into despair? In short, we must bear up and tackle the problems now. STOP playing the blame game. STOP trying to get what is best for you and not what is right for our union. STOP the generaly accepted idea that what is being done now won't affect the children. STOP the facades of parties and one-track thinking. STOP these self-destructive habits and get some god-**** work done.

2
Comment #26 by Anonymous posted on
Anonymous
The Us can turn everything around by slashing military spending down to equal that of the second highest spending nation.  Currently that is china, spending less than a quarter of what the us spends, at $280 billion.  In contrast the us spends $1.25 trillion.  A trillion dollars in savings with the stroke of a pen.  Seeing as the us is upset that china is so rapidly expanding its military with brand new aircraft carriers, radars, ships, and modern jets, im sure that the us can get by on spending the same to maintain the high tech toys that they already have.

Being the global policeman and projecting power all over the globe is expensive.  Focusing on national defense is far cheaper and still gets the job done.  I doubt that the average american would be upset at learning that they are hurting the economy of uzbekistan by closing a military base, and thats just one example.

1
Comment #27 by Anonymous posted on
Anonymous
Why can't we just STOP giving our money to other countries?.....it's time to watch out for the USA, take care of our own business, and let places like Egypt take care of theirselves. How many billions do we send to Egypt every year?......WHY?, Egypt just being an example, there are many more! Believe it or not, my redneck opinion, is the same as a lot of other Americans, just tell me why it's so important to pay other countries, like we owe them?

1
Comment #28 by Anonymous posted on
Anonymous
It's funny how the media...our government, casts the portrait of pain and suffering be the direct consequence of something positive. Ceiling the debt is a must. The cutting of Government is a must. Quit scaring people. We are Americans and will survive.   

1
Comment #29 by Anonymous posted on
Anonymous
This is a ludicrous predicament. If the US does default it will be because of the wealthy that have lavished on the blood, sweat, and honest work of the less fortunate. The govt. has catered to the requests of the wealthy, which now must take responsibility for putting the US in this situation. Bottom linr; TAX THE RICH !!!!!!!

1