Thursday, December 2, 2010

The Politics and Economics Of a U.S. Default | zero hedge

In their 2009 book This Time is Different, economists Carmen Reinhart and Ken Rogoff note that defaults are most likely when the debt/GDP ratio (not including unfunded liabilities) rises above 100%. The fact that we have yet to breach 100% has given optimists comfort, along with the fact that the cost of capital for the U.S. Treasury remains low. Mind you, Reinhart and Rogoff add that both Mexico and Argentina have defaulted when their debt/GDP ratios were in the 50% range. At the very least that tells us we're already in the danger zone.

One argument that supports optimism concerning our budget deficits has to do with the historical fact that the U.S. has never defaulted. The problem here is that default as it's traditionally understood is too narrowly defined. If calculated on a currency-value adjusted basis, Washington has short-changed its creditors before and it continues to do so. That has serious economic consequences, because capital flows away from economies where it is penalized rather than rewarded.

If default is thought of in traditional terms whereby investors are simply given a haircut on monies owed, default is less scary, less economically harmful, and internationally commonplace. In such circumstances the currency can remain sound and the damage to lending is not spread to those who are funding the growth of the private economy. As it applies to the United States, there's therefore an argument that an honest default would be better than what we are doing by stealth.

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