Tuesday, October 15, 2013

Default? Default? Don’t Talk about Default!

I know it's not Christmas, (or the holidays for all you politically correct folk out there), and Halloween is just around the corner, but do you hear what I hear? Yes, that is right, the United States of America is headed for a disaster so great if the debt ceiling is not raised. Phrases such as "global crisis," and words like "default," are tossed around by the average citizen and conniving politician. "It has never happened in the history of our country!" Is that true? We always paid our bills? In full? On time? The truth is: default is not automatic if the debt ceiling is not raised and this country has defaulted on more than one occasion.

I'm going to set you on the path of truth. As gravity dropped apples on Sir Isaac Newton's head so he may understand, I am going to drop knowledge so you may understand. How? You will understand the tear "default." You will see the options the country has if it does not raise the debt ceiling. You will also see that yes, the United States has defaulted before, and the sun still rose in the east and set in the west. With that said, let us learn what default is.

The politicians and talking heads are using the term "default" incorrectly. The politicians use the word to mean "missing any payment to fund government" as well as "paying the interest on Treasury Bills," (bonds). The meaning of the word "default" is the "failure to pay back a loan," (Sullivan and Sheffrin, "Economics: Principles in Action"). A Loan consists of the principal, interest, and date of repayment, i.e. a bond. All monies that fund the government are not loans. No person loaned money to government programs, social security, or Medicare; these are funded through taxation. However, people loaned money to the government with the purchase of government bonds, just like a bond in the private sector. Think of it this way: if corporation "X" was using revenue to support a charity, yet fell on hard times and was going out of business, not paying bondholders is a default; not paying the charity is just unfortunate. Now that we understand "default," let us see what options the government has if the debt ceiling is not raised.

Just because the debt ceiling is not raised, it does not mean an automatic default. What is does mean is that the government cannot borrow more money to pay its debt. Therefore, the government has two options. First, it can prioritize. The government expects to take in $250 billion a month in revenue; the interest due a month is about $30 billion. Simple subtraction tell us the government can pay its bondholders their interest. That means no default; however, now the government must prioritize what it will pay after that. Second, the government can do what private businesses do when facing the same situation: sell assets. You know, the government can do both of these things. So, there is no automatic default if the debt limit is not raised. Let us now see those times when this country did default.

In John S. Chamberlain's article, "A Short History of US Credit Defaults," he shows us that the government defaulted on at least five occasions: the first issuance of debt in 1775, in 1862, in 1934, and in 1979, (some economists will even tell you that if the government has to print money and purposely set interests rates low, then it has already defaulted, but that is a different topic). Life went on. Let us review, shall we?

A default is when a loan cannot be paid; only the purchase of government bonds are loans. All other funding is through taxation and not paying that funding is not a default. Not raising the debt ceiling does not equate to a default: the government has the money to pay bondholders; the government can even sell assets, or do both. Even if there is a default, it has happened before, and life carried on.

So there you have it. You are now learned. Do not let the government scare you. Do not fall victim to their whipped up hysteria. Why do they want to do this? Maybe it is because they know they do not have to default and will prioritize. However, what happens if voters who were promised certain things from politicians are no longer a priority? What if they fall into "nonessential discretionary expenditures" as Chamberlain puts it? Then they no longer vote for those politicians who made them such, and what politician wants that?

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