So what would happen is the US decided to just zero out its debts overnight?

[ChrisBooth12]

We owe quite a bit of money to people. What would happen if we just gave them a call and said hey we dont owe you that money anymore bye.

[Der Trihs]

Our economy would collapse due to our foreign trade vanishing, I'd think. Who's going to want to trade with someone who unilaterally declares their debts void ?

[Lumpy]

Various governments tried this or the near-equivalent (see below) in the past, and the results were never pretty. Every person, institution and government that counted on their US bonds having some value would suddenly find that a large part of their assets had vanished into thin air. Not only would there be the immediate impact of trillions of dollars of paper wealth disappearing, but the chain reaction of bankruptcies and insolvencies would bring down much of the world economy. To make a long story short, there would be a worldwide financial collapse that would make the Great Depression look like a market hiccup.

To get a mere shadow or glimmer of what would happen, look what happens when governments try to water down their debts by printing money. The resulting hyperinflation brings down the rest of the economy.

[Huerta88]

Many of the people the U.S. owes money to are U.S. citizens -- treasury bills are one of the main sources of debt for the government, and are also widely owned by investors.

Also, to the extent the U.S. relies on T-bills to finance its ongoing operations, or part of them, the intentional default on such debt would raise the cost of future borrowing for the government, assuming they could find any willing lenders, sky high.

[Bosda Di'Chi of Tricor]

An economic disruption far, far worse than the Great Depression.

[kunilou]

I'll give you a teeny, tiny, personal story. Some years ago I was on a student tour of Europe when France devalued the franc. One of us had already changed all his U.S. currency into French francs. Overnight, he lost 20 percent of what he had changed his American currency for. Worse than that, merchants along the German and Swiss borders, who normally accepted any of those three countries' currencies, wouldn't accept French francs.

So, even though my travelmate's francs bought the same in France what they had a few days earlier, overall he was screwed. Those of us who still had our funds in American dollars came out ahead.

Now, multiply that by several kazillion and it will give you some idea of what happens when a country bails on its debt.

[guyblond]

World wide economic collapse perhaps. But they don't have zero out debt. They or should I say we, are in the process of inflating our way out it.

This by printing dollars to try and keep interest rates low and solve the liquidity problem. The effect has been the devaluation of the dollar, which is part of the increase in the price of oil. There is also latent inflation in products that we buy form China. The Chinese lock the value of the dollar and their currency to keep their products cheap as to continue the current high economic growth.

So we are in the future going to pay down the debt with dollars that are worth less. If you have enough inflation, at some point the debt becomes meaningless.

However this is not going unnoticed by holders of US debt. The Chinese in particular are watching the value the paper they hold lose value. Remember that the Chinise are big savers and are buying lost of American debt. They are getting pissed off about losing value. But if they stop buying the paper, the effect would be a rise in interest rates of American debt and the corresponding inflation of the dollar along with an economic slow down resulting in less purchasing of Chinise products. So for the time being kind of a stalemate. But there can come a time when the Chinese loss confidence in the US economy or just to make a point, stop buying American paper.

So the question in my mind is: If we get into a political pissing fight with the Chinese, are we willing to bet that they aren't willing to suffer some economic hardship to bring America to it's knees?

[Measure for Measure]

"If I owe you a million dollars, it's my problem. If I owe you a trillion dollars, it's your problem."

[Hellestal]

Originally Posted by ChrisBooth12

We owe quite a bit of money to people. What would happen if we just gave them a call and said hey we dont owe you that money anymore bye.

At minimum, you're talking about the complete breakdown of the international financial system. The nicest result that could come from that is mass starvation, riots, mayhem, and anarchy.

For a concrete look at what a gigantic clusterfuck this would be, think about that magical go-juice that powers our automobiles. We chug oil down at prodigious rates like the whole nation is a frat house and every night is a kegger. But overnight, those pipelines would close. Why the fuck would anyone in their right mind send oil to us in exchange for worse than worthless US dollars? So our entire transportation network is going to collapse overnight. Now think about the armies of suburban homeowners who can't ever fill the tank of the SUV again, and worse, have nothing to eat. Sure, the US has got a lot of great farmland, but without the transportation network, how could we possibly get the corn from Kansas to New Jersey?

Now maybe, maybe, a competent leader could marshal the pathetically small strategic petroleum reserve for just long enough to institute one mass exodus of people away from their uninhabitable islands of suburbia and toward the promise of a cardboard shack in Iowa where they could do their damnedest to try to stay alive. Maybe. But if the government allowed the complete default of the debt in the first place, then you're not dealing with competence. So what you're probably looking at is the dissolution of the entire US government after the death of millions upon millions of its citizens.

Raging packs of sharp-toothed cannibals would roam the empty wastes looking for an easy meal until all the naive yuppies were dead, and then the cannibals, too, would succumb to the dull red pain of hunger. In this world, Mel Gibson is probably the only one who could save us.

Another slightly less cinematic possibility: The officials who allowed the default are summarily and publicly executed, and their hastily sworn-in successors promise, cross-their-hearts and hope-not-to-die-like-those-idiots-whose-heads-are-still-displayed-in-front-of-capitol-building, that the US didn't actually mean it when it said it was defaulting on its debt. We were just joshin', is all. The entire world suffers a nasty, barely tolerable depression (with riots), but eventually our collective economy recovers. Economics becomes a mandatory high school subject.

[Sam Stone]

A large part of U.S. debt is held by Americans. Suddenly voiding the debt would bankrupt numerous retirement plans, wipe out vast amounts of savings, and the government would wind up having to pick up the tab anyway.

[Hellestal]

Originally Posted by Measure for Measure

"If I owe you a million dollars, it's my problem. If I owe you a trillion dollars, it's your problem."

This is cute, but it's still somewhat misleading if we're not talking about commercial banks.

If one country owes another country a trillion bucks, then it's everybody's problem. The world is far too interdependent for just one side to be affected.

Originally Posted by guyblond

World wide economic collapse perhaps. But they don't have zero out debt. They or should I say we, are in the process of inflating our way out it.

No, we're not. The recent spike in inflation is mostly due to commodity costs. We're not deliberately inflating our way out of debt.

Originally Posted by guyblond

This by printing dollars to try and keep interest rates low and solve the liquidity problem. The effect has been the devaluation of the dollar, which is part of the increase in the price of oil.

We're not "printing dollars" in that way, and recently, the US dollar has stopped it precipitous decline and is regaining some small ground internationally.

Originally Posted by guyblond

So the question in my mind is: If we get into a political pissing fight with the Chinese, are we willing to bet that they aren't willing to suffer some economic hardship to bring America to it's knees?

Maybe, but China can't "hurt us" without them hurting themselves right back. That's what interdependence is all about.

There's a lot of economists who advocate trade not just because of its benefits from comparative advantage, but also because of the enforced cooperation that a worldwide financial system creates. If everybody is getting richer, then it decreases the chances of some dumb schmuck rocking the boat with unnecessary posturing and aggression, up to and including wars.

Needless to say, this ideal does not always correspond to reality.

[sailor]

Originally Posted by Measure for Measure

"If I owe you a million dollars, it's my problem. If I owe you a trillion dollars, it's your problem."

It makes a fine sound bite which is often repeated with the implication that there is no problem for America if foreign governments own large quantities of American public debt. Those who think that way are deluding themselves. If China owns huge amounts of American public debt it has huge control over the value of that debt and therefore over the American economy. While everything is going well everything is fine and China benefits from collecting interest from America and Americans. Americans in the meanwhile are working and paying taxes to pay this interest. Already China is coming out ahead here.

But let us suppose China and America start having some serious disagreement which might even go so far as to lead to military confrontation. At that point collecting interest on that debt or even the principal becomes of very low priority and harming America and its economy becomes a much higher priority. And at that point China has great power over America's ability to borrow and over the value of the dollar. It only has to flood the market with American debt and that debt plunges in value and America's ability to borrow is seriously damaged. Why fight your adversaries when you can just bankrupt them?

You don't think this is possible? It has already happened.

China threatens 'nuclear option' of dollar sales

10/08/2007

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Blog - Dollar to collapse?
Fistful of dollars - China's trade surplus reached $26.9bn in June


Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.

Read this.

Anyone who thinks America can borrow indefinitely without serious consequences is just deluded. Overspending was the cause of the downfall of many empires and it is already being the cause for America's downhill slide.

[RickJay]

Originally Posted by sailor

It makes a fine sound bite which is often repeated with the implication that there is no problem for America if foreign governments own large quantities of American public debt. Those who think that way are deluding themselves. If China owns huge amounts of American public debt it has huge control over the value of that debt and therefore over the American economy. While everything is going well everything is fine and China benefits from collecting interest from America and Americans. Americans in the meanwhile are working and paying taxes to pay this interest. Already China is coming out ahead here.

It's funny how, when the subject of the U.S. federal debt comes up, everybody talks about China, as if China's the big debtholder.

Of course, it isn't. China's holdings of the U.S. debt are a fraction of what's held by Americans themselves. Zeroing out the U.S. debt would, more than anything, screw ordinary Americans.

[sailor]

Originally Posted by RickJay

It's funny how, when the subject of the U.S. federal debt comes up, everybody talks about China, as if China's the big debtholder.

Of course, it isn't. China's holdings of the U.S. debt are a fraction of what's held by Americans themselves. Zeroing out the U.S. debt would, more than anything, screw ordinary Americans.

If Americans (through their government) were to decide to screw themselves by defaulting on their public debt that's their problem. Some Americans, the debt holders, would be screwed over while the general American public would come out ahead momentarily by not having to pay that debt in their taxes. But that was not the subject of my post at all. I was responding to a very particular point which I have heard repeated many times and that is that foreign creditors are screwed because they are at the mercy of America and I say this is far from the case which is in fact very much the opposite. I chose China because it is a good example of a nation who may have conflicts of interest with America in the not so distant future and which holds a substantial amount of American debt.

China does not need to hold a majority of American debt in order to be able to leverage this into being able to greatly influence the value of the debt. A rather small percentage can give them a great influence just like controlling 10% of world oil production gives any nation great influence in affecting the price of oil.

As a matter of fact Wikipedia says

A traditional defense of the national debt is that Americans "owe the debt to ourselves", but that is increasingly not true. The US debt in the hands of foreign governments is 25% of the total[26], virtually double the 1988 figure of 13%.[27] Despite the declining willingness of foreign investors to continue investing in US-dollar–denominated instruments as the US Dollar has fallen in 2007,[28] the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public.[29] About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt.[30] This exposure to potential financial or political risk should foreign banks stop buying Treasury securities or start selling them heavily was addressed in a recent report issued by the Bank of International Settlements which stated, "'Foreign investors in U.S. dollar assets have seen big losses measured in dollars, and still bigger ones measured in their own currency. While unlikely, indeed highly improbable for public sector investors, a sudden rush for the exits cannot be ruled out completely." [31]

In 2006, the central banks of Italy, Russia, Sweden, and the United Arab Emirates announced they would reduce their dollar holdings slightly, with Sweden moving from a 90% dollar-based foreign reserve to 85%. [32] On May 20, 2007, Kuwait discontinued pegging its currency exclusively to the dollar, preferring to use the dollar in a basket of currencies.[33] Syria made a similar announcement on June 4, 2007.[34]

A list of the foreign owners of U.S. Treasury securities is listed by the U.S. Treasury:

Japan 592.2 billion
China 502 + Hong Kong 63 = 565 billion
United Kingdom 251.4 billion

My point is that anyone who says China has a problem because it holds 565 billion in American debt is deluded. It is America who has a serious problem, not China.

[Measure for Measure]

Originally Posted by sailor

It makes a fine sound bite which is often repeated with the implication that there is no problem for America if foreign governments own large quantities of American public debt. Those who think that way are deluding themselves.

Agreed, and I was kidding.* A default would be a Very Bad Idea.

I wouldn't say that China has the US over a barrel though. It is definitely not in China's interest to have the value of their assets denuded. Neither side should be tempted to rock the boat unduly.
---
I also might mention that defaulting on US debt would be unconstitutional.


All that said, a few Latin American countries defaulted during the 1930s. Surprisingly, world capital markets didn't shut them out for an extended period of time.


* JP Getty said something like my quote (If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.), but I had in mind some Treasury Secretary from the 1970s.

[Hellestal]

Originally Posted by sailor

It is America who has a serious problem, not China.

Yet again, this is not true.

The US and China are sharing a small dinghy navigating the treacherous waters of intergovernmental finance. The US can threaten to capsize the boat. China can threaten to capsize the boat. But if someone actually goes through with the threat, then they both get wet.

It's simply not possible to offload half a trillion bucks worth of assets before you've destroyed the value of those assets. And more than that, the repercussions from the collapse of the dollar would destroy China's export-based economy. If they weren't able to ship their goods to our nation's big blue box warehouse Wally-Worlds, then their factories would have to shut down. The US would enter a severe recession from such a hit, but China would enter a depression. The entire reason why they bought up so much damn debt in the first place was to keep the dollar stable so that we could continue buying their shit. They have the power to undo all that, but not without severe repercussions for themselves.

[Mosier]

Originally Posted by ChrisBooth12

We owe quite a bit of money to people. What would happen if we just gave them a call and said hey we dont owe you that money anymore bye.

I don't mean to pile on here, but I just want to point out that the whole idea of a modern economy, from the concept of currency all the way up through stock markets, is based upon the assumed validity of debt and investment. If debt and investment no longer mean anything, then nothing even resembling a modern economy could possibly exist.

America defaulting on its debts would have a terrifying effect on the world economy. Dollars would be worthless. Anyone invested in the US government, which includes foreign nations and individuals, local corporations, average citizens buying bonds for their children's college fund, middle aged people saving for retirement, and everyone else in the whole world even remotely tied to the world economy.

[sailor]

Originally Posted by Kendall Jackson

Yet again, this is not true.

The US and China are sharing a small dinghy navigating the treacherous waters of intergovernmental finance. The US can threaten to capsize the boat. China can threaten to capsize the boat. But if someone actually goes through with the threat, then they both get wet.

It's simply not possible to offload half a trillion bucks worth of assets before you've destroyed the value of those assets. And more than that, the repercussions from the collapse of the dollar would destroy China's export-based economy.

Of course it is better for everybody if no one rocks the boat. My point is that things may change and it may be advantageous for foreign debt holders to rock the boat if by doing so America suffers greater financial harm than they do. Countries spend money for the sole purpose of harming other countries all the time and China may be more willing to spend money by causing the American debt to devalue than to put the money into their military. It's cleaner.

I find the notion that debtor and creditor are in an equal relationship rather silly. China is lending money to America. China is not using that money. America is. If that money becomes worthless China is in the same situation except they don't have that claim any more. They are out of a future asset which they were not using at present. America on the other hand finds its ability to borrow seriiously impaired and its currency devalued.

China's "export-based" economy is another myth as I explained in another thread. China has a huge internal demand and of its foreign buyers it is Japan who is #1. If America stopped buying Chinese stuff clearly China would suffer but it still has huge markets in Asia and Europe. America would suffer even more.

My point is that already the situation is unhealthy for America and good for China but specially that if the current trend continues for years, and it looks like it will, then China's position becomes increasingly powerful. The notion that "the more we owe China, the more powerful our position is" is just plain silly. By that rule Latin American countries in the 1980s would have been in a position of tremendous power. Their example shows that countries cannot continue to borrow indefinitely and that sooner or later comes the day of reckoning when accounts have to be settled. America is trying hard to believe that rule can be ignored and that you can borrow your way to riches.

[msmith537]

As a comparison, look what happens when a few million Americans decide to just zero out their mortgage debt.

[mazinger_z]

Originally Posted by sailor

My point is that already the situation is unhealthy for America and good for China but specially that if the current trend continues for years, and it looks like it will, then China's position becomes increasingly powerful. The notion that "the more we owe China, the more powerful our position is" is just plain silly. By that rule Latin American countries in the 1980s would have been in a position of tremendous power. Their example shows that countries cannot continue to borrow indefinitely and that sooner or later comes the day of reckoning when accounts have to be settled. America is trying hard to believe that rule can be ignored and that you can borrow your way to riches.

You can continue to think that China is in a better position, but you would be wrong. If the US dollar is an increasingly bad investment, as noted by the recent dollar tankings, why is China buying so much of it? The answer is that they are buying so much of it because they fixed their Yuan to the Chinese dollar. They monkey around with the currency to make their exports seem cheap by comparison. Without this ability (because the US refused to pay out debts) will destroy the Chinese economy. The US will hurt as well, but since the US has the reputation for paying its debt, is a first world nation, and still has a large and diversified market. The US will recover eventually (after the worldwide global collapse, the actual definition of "recover" will vary. China will probably under go a revolution and a civil war, that's my guess. US businesses will try to recover by using foreign banks (assuming anyone has any faith left in them) and move or at least centralize operations out of the US (or China). China will not have this benefit because of the way Chinese business are operated (essentially by the state) and prices won't make any sense because of rampant hyperinflation (usually the first thing that happens when a currency loses its backing/value) and everything of any importance was subsidized anyway. At best, China can hope for an Argentinian type recovery.

Your cite of the Nuclear Option is not going to happen. China is already letting the Yuan rise. The dollar is already rising. The Nuclear Option didn't make any sense anyway. What is China going to do, sell it's US t-bonds? So what, it will decrease the price of them and decrease China's overall wealth (think of Bill Gates trying to sell all his shares of Microsoft all at once.) China couldn't keep buying up T-Bonds as fast as the US could print them, something was going to give. It's definitely not an efficient or preferred way of normalizing the markets, but to think that China has the upper hand is ridiculous.

[msmith537]

Originally Posted by sailor

China's "export-based" economy is another myth as I explained in another thread. China has a huge internal demand and of its foreign buyers it is Japan who is #1. If America stopped buying Chinese stuff clearly China would suffer but it still has huge markets in Asia and Europe. America would suffer even more.

Do you have a cite for this statement? From what I've always seen, it's US, Europe and then Japan as a distant 3rd.

[sailor]

Originally Posted by msmith537

Do you have a cite for this statement? From what I've always seen, it's US, Europe and then Japan as a distant 3rd.

You may be right. I remember finding a cite some time ago which supported what I said but I may be misremembering or it may be calculated differently. This page supports what you say. But I have found that you can find different pages giving wildly different numbers for public debt holders and such things. I suppose there is no simple way to calculate such things and so the calculations are just based on different parameters.

That page shows Japan is #1 in imports into China so I may be mixing things up. It shows Hong Kong as #2 importer from China but that is stuff which is re-exported and we would need to know where it goes. At this point counting HK as a separate country does not make sense.

mazinger_z, we'll have to agree to disagree and time will tell who was right. I have no doubt that America cannot continue to have a 114.2 billion yearly trade deficit with China indefinitely. Sooner or later the day of reckoning will come.

[Measure for Measure]

Tyler Cowen, a libertarian-leaning economist, presents the nightmare scenario that applies if Fannie Mae and Freddie Mac went bankrupt. The same story applies if the Federal Government renegs on its Treasuries except it becomes *much* more likely and even more intense.

Originally Posted by Tyler Cowen

But let's say that the Treasury did not support the debt of the mortgage agencies. The Chinese bought over $300 billion of that stuff and they were told that it is essentially riskless. The flow of capital from them and from other central banks, sovereign wealth funds, and plain old ordinary investors would shut down very quickly. The dollar would fall say 30-40 percent in a week, there would be payments system gridlock, margin calls at the clearinghouses would go unmet, and only a trading shutdown would stop the Dow from shedding half its value. Most of the U.S. banking system would be insolvent. Emergency Fed/Treasury action would recapitalize the FDIC but we would lose an independent central bank and setting the money supply would be a crapshoot. The rate of unemployment would climb into double digits and stay there. Many Americans would not have access to their savings. The future supply of foreign investment would be noticeably lower. The Federal government would lose its AAA rating and we would pay much more in borrowing costs. The deficit would skyrocket.

Substitute "Federal debt would be considered an international joke" for "lose its AAA rating" and stir.

There's a link in the post with a contrary point of view by the libertarian Jeffrey Rogers Hummel: he is in the extreme minority and may even be thought of as a quack. For example,

Originally Posted by Jeffrey Rogers Hummel

But my major disagreement with Tyler and Arnold is that I believe that a U.S. government default, rather than being "the end of the world," could possibly be a good thing. I even advocated repudiating the national debt in a 1981 issue of CALIBER (the newsletter of the California Libertarian Party), long before predicting a default. My arguments were moral, economic, and political, and I would only soften them slightly today.

Good for a few laughs. That said, Mr. Hummel is certainly learned and he's not exactly a crank in my view. But I view his position with extreme trepidation.