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.
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 ?
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.
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.
An economic disruption far, far worse than the Great Depression.
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.
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?
“If I owe you a million dollars, it’s my problem. If I owe you a trillion dollars, it’s your problem.”
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.
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.
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.
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.
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.
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.
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.
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.
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
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.
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.
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.
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.
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.
As a comparison, look what happens when a few million Americans decide to just zero out their mortgage debt.
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.