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Let the Government Default on Its Bonds — And Build a Better Budget on the Ruins

Research & Commentary
September 16, 2013

by Salvatore Babones

Conventional wisdom in Washington and New York is that a US default on its interest payments due to bond investors is unthinkable. Editorial after editorial proclaims that a US default would be catastrophic for the world economy. The moment the US treasury fails to pay a bondholder IOU, the world will come to an end.

A US government default would be very unpleasant for a lot of very rich people (and their bankers). But would it really hurt the rest of us? Yes, but not nearly as much — and not as much as the doomsayers claim.

We can look to the examples of other governments that have defaulted to see what happens. Mexico’s default in 1982 brought down Citibank. Russia defaulted in 1998 and the Dow Jones Industrial Average fell 1000 points. Argentina defaulted in 2001 and no one really noticed.

In all three countries economic problems caused the default. The defaults themselves seemed to have little effect — except on investors. Would a US default have much impact beyond the investment community?

A default would almost surely cause financial gridlock in New York on a scale many times larger than occurred during the Lehman Brothers collapse of September 2008. But while Wall Street teetered on the precipice in September 2008, the rest of the economy felt hardly a ripple.

Yes, the country was falling into recession, but the country had been falling into recession for most of a year at that point. The Lehman collapse froze credit markets. But it didn’t freeze the economy.  It simply continued its slow descent.

Frozen credit markets didn’t help much, but they didn’t hurt much either.

The most likely effect of a US government default would be the collapse of several large banks and investment banks. Some Americans might consider that good news. And with the government shut down we wouldn’t have to worry about a second bank bailout.

The pain would extend beyond Wall Street, but it might be worth it for the catharsis delivered to the rest of society.

In the end, crises are about redistribution. The 2007-2008 crisis saw a massive redistribution from the rest to the rich. A 2013-2014 crisis might be worth it if it resulted in a massive redistribution from the rich to the rest.

The rich have been promising for forty years that a rising tide would lift all boats. For forty years the tide has been rising. Only the super-yachts have risen along with it. Everyone else has been swamped.

Let the government default on its bonds. See how much pain Wall Street and its servants in Washington can bear. Then build a better budget on the ruins.

Our price for re-starting interest payments should be higher taxes on high incomes, aggressive enforcement of corporate taxes, and more generous social security benefits. We should re-start interest payments only if Obamacare is expanded. We should refuse to accept status quo ante when Wall Street comes begging for a bailout.

Above all, we should reject the terms of the debate that have been dictated by Washington and New York. Washington and New York need the America a lot more than America needs them.

Call their bluff. Take the plunge. Go over the cliff. See who’s left standing in the new post-default America. I bet it won’t be the bankers. It’s more likely to be you.

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