The end will, most likely, be terrible – but at least it will be the end.

That is some comfort.

Antoine, this one’s for you.

I would take issue with Laird’s statement that there is nothing to take the dollar’s place as a reserve currency. The dollar obtains an enormous advantage from its reserve status and so to compare the reserve dollar and the non-reserve euro is misleading. Were the euro to become the reserve currency, capital would flow out of the US and into the EU, solving all the piggie problems at a stroke and leaving the US is a very precarious position indeed.

The US will not allow this to happen as it would be virtual suicide, but it would not be that much of a problem to the rest of the world if it did. In any case its hard to see how the reserve currency can change while the petrodollar system remains in place, and that is enforced by half the world’s military, which happens to be American.

1) Default on our debt will not happen unless the Obama administration makes a conscious decision to do so, which would be an impeachable act. There is plenty of revenue to meet all debt service obligations, and any maturing debt can be “rolled over” without exceeding the current ceiling, as it would simply be replacing existing debt. When Obama and Geithner threaten default they’re lying, plain and simple. (Yes, I know: quelle surprise.)

2) Certain government pension obligations are indeed contractual, but the big ones (Social Security, Medicare and Medicaid) are not. The Supreme Court long ago specifically ruled that SS payments are not a right or a contract, but rather can be changed (raised, lowered, even eliminated outright) by simple act of Congress. (The same applies to all other welfare schemes.) Whether Congress would ever do so is an entirely separate question, but the fact remains that these payouts could be reduced should Congress have the will. (This is why I object to calling them “entitlements”; they are nothing of the kind, but mere expectancies.)

3) Even the truly contractual pension obligations might not be quite as sacrosanct as you think. Yes, the courts would probably rule otherwise, but a Congress with the courage to reduce Social Security and other welfare payments would also have the courage to invoke sovereign immunity and repudiate the contracts. That’s beyond the reach of the courts.

4) A downgrade is inevitable, as you say, whether or not the debt ceiling is raised. Rumors are that S&P has already privately told the Administration that only spending cuts in the range of $4 trillion would prevent it. None of the proposals being bandied about come anywhere near to that level of cuts. It won’t happen, but a downgrade will. And it won’t be the end of the world, just a modest increase in our debt service cost.

5) As you say, the current “strategy” (if one can dignify it with that term) is to inflate our way through this mess. That is a short-term solution at best, and it can’t continue for too much longer: price inflation is already beginning to take its toll, notwithstanding the government’s best efforts to pretend it away by playing games with the CPI index. But nascent inflation is already “baked in” to the currency; “excess” bank reserves (discussed by Midwesterner in his article last summer) are today 60% higher than they were then (see this). Sooner or later they’re going to start “leaking” out into the general economy and trigger massive inflation.

6) If the US were to truly default on the payment of its bonds, the results would be very bad not only for us but for the rest of the world as well. Greece can default; the US cannot. For good or ill, the dollar is still the world’s reserve currency, and there is nothing apparent which could take its place. But rather than default, the more likely scenario would be a simple inability to incur additional debt, as the Chinese (and others) cut back on their purchases. That will happen sooner or later (debt ceiling notwithstanding), and it would force massive spending cuts and some pretty serious economic dislocations. And not just here: remember, when the US gets a cold the rest of the world gets pneumonia. (If we get pneumonia I shudder to think what will happen elsewhere.) In the long run getting our spending back to some normal, sustainable level will be a good thing, but the transition will be extremely unpleasant.

I’d start looking at hard assets.

Who will be the lenders of the additional credit sources required?.

Ancilliary:

What will be the sources of capital for those lenders; and from what other uses will that capital be diverted?