A few years back, I proposed an alternative budget for the UK. IIRC, it involved cutting taxes by a quarter, spending by a third. Even assuming no increase in economic growth (that would boost sales tax revenue), this would have created a massive budget surplus that could have cut the UK national debt by over 10%.
I opposed default then for what I still think were good reasons: first, many private individuals and institutions bought bonds in good faith; but second, because the UK nearly had to surrender to Nazi Germany in 1940, and had refused to confront Hitler when war was still not necessary partly because of the consequences of a partial default on war bonds from the First World War. In essence, appeasement was the necessary policy of 1930s British governments because they could not expect to borrow so had to pay in gold and whatever the British public could be persuade/forced to raise (yes I know pacifism was big too, but the financial imperative meant that it was the only option).
Whether we take an interventionist view or not, the re-militarization of the Rhineland in 1936 was the moment when, without firing a shot, Hitler could have been stopped.
What does this have to with events in Europe and the USA today? In short, I think the financial situation is so dire, and the political solutions on offer so inadequate, that default is now the only credible outcome. I therefore conclude that it needs to happen very soon, rather than after wasting more resources on more “bail-outs.”
We will just have to take our chances that no one decides to, invade the Falklands, or grab Gibraltar, or build nuclear weapons and give them to terrorists, or blow up US embassies. I explain why below. The US debate on “raising the debt ceiling” misses an essential point. The credit ratings of many governments are on the brink of being downgraded unless there is an improvement in the debt/asset ratio or there is clear evidence of economic recovery without inflation. Neither of these outcomes is clearly at hand.
To increase the debt ceiling by any amount merely worsens the over-borrowing of the past two decades. If anything, the debt ceiling should be cut not raised. There are exactly four ways of doing this: default, print “money,” cut spending or raise taxes.
As Barack Obama put it so eloquently during his US presidential election campaign: “raising taxes in a recession is stupid.” Putting up rates will probably not raise revenue because the people and businesses that are driven to bankruptcy will more than offset any marginal increase in revenue.
Cuts is spending are almost impossible: contractual obligations have been made, any cuts to public sector pension payments will be challenged and, judges being so-to-retire-public-sector-persons, they might not interpret the law the way spending cutters would like. The sad truth is that the commitments cannot be met, but only a default will prove the legal way for governments to stop spending.
Printing “money,” is actually the current strategy, and it looks OK, until inflation kicks in. When it takes a wheelbarrow of banknotes to buy a loaf of bread and cash registers have to count pounds by the hundred million, such a policy could lead to political instability and revolution.
I’ve outlined two problems with defaulting: bondholders are punished and in a real emergency, the government would not be able to raise money. There is a third problem, which is an opportunity: once a default has been called, the interest rates for government bonds have to go up, a lot.
This normally bad thing means that entire government programs will simply have to stop because the money to pay for it cannot be raised. It means that private borrowing becomes harder too, at least for those whose credit ratings are not good. But it also means people quickly have incentives to sort out their own over-borrowing and to start saving: those savings accounts offering 10% suddenly look quite attractive.
It is by cutting excessive debt and re-building deposits that the financial system can re-build itself.
I’m therefore praying for the most childish behaviour from the American politicians and for someone to say “No” in Europe to propping up the Greek welfare state.