Next Time, Dammit, Just Default

Democrats feared a monster called “default”—but it’s just another Washington scare story.

12 June 2023 by James K. Galbraith

The debt deal is now law. Far-right Republicans were unhappy, because it doesn’t cut spending by enough. Center-left Democrats (there are no far-left Democrats in Congress) are unhappy, because they got nothing: It’s all concessions to win Republican votes.

True, it could have been worse. The fiscal effects are small (for now), and the deal lasts only two years. The problem is that it institutionalizes debt-ceiling hostage taking; the precedent is set, and the pattern will repeat.

Why did the Democrats cave? They feared a monster called “default.” This horror, we are told, would sink our national credit, drive up interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
, destroy the dollar, wreck the economy, and undermine our national security. Vladimir Putin and Xi Jinping, Hillary Clinton told us, would have been the true victors if the deal fell apart.

It’s a typical Washington scare story, for two reasons.

The first, as I have written for The Nation previously: The Treasury Department had legal paths to avoid default with no need for cuts or caps. They were rejected only because President Joe Biden chose to negotiate and make concessions. And once the terrible deal was struck, most Democrats were too terrified to vote it down.

So, what about that specter of “economic catastrophe” in case of “default”?

The debt ceiling exists for only one reason: to authorize the Treasury to issue bonds. Contrary to many claims, breaching the ceiling would not have stopped any checks from going out. The Treasury has no power—and also no procedure—to stop or delay making payments ordered by law.

Without bonds, there might have been a problem when the banks tried to clear those payments at the Fed FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank :
. What would have happened if there were no funds in the Treasury’s General Account? Without violating the debt ceiling, the Fed could have given the Treasury a no-interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. , unsecured line of credit. This is highly contentious. But it is arguably legal. And it would be better than bouncing checks. If that had happened, the pitchforks would have come out, and the Fed (or the Republicans) would have buckled. Any other scenario is absurd.

Once payments cleared, maturing bonds would convert to bank deposits. Since 2008, the Fed has already been paying interest on bank reserves, so US banks no longer need to buy Treasury bonds. Anyone wanting interest can hold a bank deposit.

It’s likely that unless the Fed reacted by raising rates to the rafters, the dollar would fall as investors bought some other government’s bonds. Import costs would rise. Some cheap imported comforts would disappear. But then domestic production would start to revive. US workers would recover bargaining power. The global banks would shrink; some might have to be reorganized to concentrate on making business loans at home. Wall Street would suffer; Main Street would gain. In short: The US position in the world economy would change. And this could be a good thing.

Moreover, precedents exist. A new article by the historian Eric Toussaint reminds us that the US has done this before. In April 1933, Franklin Roosevelt abrogated the gold clause in debt contracts and banned almost all private ownership of gold. He later devalued the dollar. This was a default. But it survived the Supreme Court. And it worked. Debts lost value. Working people regained confidence, and the economy grew for the next four years. Going off gold was a key early step in the New Deal.

If bondholders were to take a bath, the media, the lobbies Lobby
A lobby is an entity organized to represent and defend the interests of a specific group by exerting pressure or influence on persons or institutions that hold power. Lobbying consists in conducting actions aimed at influencing, directly or indirectly, the drafting, application or interpretation of legislative measures, standards, regulations and more generally any intervention or decision by the Public Authorities.
, and the kept politicians would scream. Just as they did in 1933. But these changes would help bring about desperately needed economic and political reforms. This could mean creating more good jobs at better wages, generating new industries, transforming the energy industry, effecting social renewal—and (best of all) putting an end to the death grip of Big Finance on our national life.

Maybe it’s time to end the 40-year suffocating reign of the God-Almighty Dollar. It might be the beginning of something great—a new era. You might call it a new New Deal. Next time, Democrats, show some spine and bring it on.

For detailed analysis on the debt ceiling, see Debt ceiling: Radio Silence Concerning United States President Franklin Roosevelt’s Repudiation of Debts published in May 2022.

Source : The Nation

James K. Galbraith

holds the Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the Lyndon B. Johnson School of Public Affairs, the University of Texas at Austin. He is a former executive director of the Joint Economic Committee in the US Congress.



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