Time for the U.S. to Declare Bankruptcy?

|Chris Coyne|

Scott Beaulier and Pete Boettke answer this question in their  latest op ed in the East Valley Tribune.  Drawing on Adam Smith's discussion of the public debt, they conclude that:

Rather than erode debt obligations through inflation, the debt could be repudiated through bankruptcy proceedings. Like individual bankruptcy cases, the United States government would admit that it is unable to pay off existing debts. The repudiation would force future politicians to credibly commit to sounder economic policies and, perhaps, would help to avoid future cycles of deficits, debt, and debasement.

Of course, our call for debt repudiation is not a new one. Like many good ideas in economics, Adam Smith was there long before us. “When it becomes necessary for a state to declare itself bankrupt ... a fair, open, and avowed bankruptcy ... is both least dishonourable to the debtor, and least hurtful to the creditor,” he argued. In other words, when the financial storm arrives — and it will — the juggling tricks must stop.

Comments

[John Ayres]

Excellent point ... and one that makes a great deal of sense given the U.S's (Obama's) proclivity for unfettered spending.

However, our elected officials are either too ignorant or not ready to take responsibility for this to ever happen.

[Bill Stepp]

"The repudiation would force future politicians to credibly commit to sounder economic policies and, perhaps, would help to avoid future cycles of deficits, debt, and debasement."
--
You are joking, aren't you?

[Jerry O'Driscoll]

I take the serious seriously, but it raises serious questions. In what court could the bankruptcy case of the U.S. government be heard? It is mind-boggling. There is not even a procedure for bakruptcy of a state. There is a municipal bankruptcy code, and we are likely to see many of those cases in coming years.

[commonsenseliberty.wordpress.com]

I tend to agree that there are some serious questions of how the bankruptcy would be administered were the U.S. to declare voluntarily. Also, we can ALWAYS pay our debts--by printing more money. The consequences of doing so are what worry me.

[Mario Rizzo]

Treating the "bankruptcy" idea as a metaphor, I imagine that the federal government isn't fooling anyone but fools right now. The interest rates will ultimately reflect the reality more precisely than any words or sham legal procedure can.

[James Oswald (azmyth)]

It'll be awhile before this happens. Japan has 170% debt to GDP ratio and their politicians haven't even started to discuss default. The U.S. just reached around 83%, although by the end of the financial crisis stuff it'll likely be over 100%. I think in the long term though it's inevitable. Each bit of federal spending is well protected by special interest groups, whereas the holders of U.S. debt are large and varied. By a Mancur Olsen story, it is unlikely that the debt holders will win a politician influencing contest to raise taxes and cut spending. In addition to the normal debt, there is a $20 trillion shortfall in social security and a $30+ trillion projected shortfall in Medicare as the baby boomers retire. Add it all up, and it seems inevitable that there will have to be a default of some sort.

If the current structure of the Fed remains, we'll probably get at most 15%-20% inflation which will put a dent in debt, but not eliminate it. Since the debt is sovereign and dollar denominated, Congress can oversee its default. I don't think the U.S. would tolerate an outside arbiter.

[Jerry O'Driscoll]

Foreclosure may not discussed within the Japanese political culture, but it is certainly being discussed by outside obervers. It is the foreward looking debt ratios for the US that are the problem. Inflation rates of 15-20% are scary and dangerous; and, as you indicate, they wouldn't solve the problem. I don't see how a debtor can either hear his own case or oversee his own bankruptcy.

[Barkley Rosser]

All talk of legal bankruptcy is irrelevant, as is talk of outside arbiters. What would be done would be repudiation, we would simply declare we are not going to pay either interest or principal, and that would be that, tough bananas to all the creidtors of the US Treasury. The upshot, of course, is that then nobody for some time would lend the US Treasury any money, which would force massive internal changes in fiscal and monetary policies.

New York state repudiated its debt to British bankers on the bonds that financed the building of the Erie Canal. Nobody went to jail, but the British banks never did get paid off. However, after a few other states pulled the same shenanigan, we ended up with a system where all the states, except Vermont, have some sort of balanced current account budget rules, with borrowing usually requiring on referenda, although some states have clearly bent their rules beyond recognition, such as California.

[James Oswald (azmyth)]

I completely agree with the "scary and dangerous" part. Inflation is no good, and inflationary default undermines popular faith in the political structures leading to extremism. However, a government can certainly oversee its own bankruptcy. Governments have a comparative advantage in violence and the U.S. has an absolute advantage in it. If a group has the power to coerce, they can redefine property rights however they like, including instating a 100% tax on debt.

[James Oswald (azmyth)]

Sorry for posting twice, but I thought of something else. Unlike a normal bankruptcy, governments have no assets or collateral to speak of. Their only stream of revenue comes from their ability to tax their citizens. When a government declares bankruptcy, they are essentially saying that the future tax revenues can not fund their debt liabilities. Normally in bankruptcy, a holder of debt has a claim against the party who borrowed. In the case of sovereign bankruptcy, the holder of debt simultaneously has a claim against all the citizens of that country and can't make a claim against any individual at all. Would it be just to take property from private citizens who don't own government debt and give it to those who do? Would such an action be practical?

[Barkley Rosser]

James,

Ultimately this depends on the military/political power (and willingness to exercise it) of the creditor vis a vis the debtor. So, sovereign bankruptcy, or a rough equivalent, became the excuse/reason for Great Britain taking over rule of Egypt in the 1880s. When more recently we have seen countries default, all that has happened is what I described above: nobody would lend to them for some extended period, and they were thrown back on running balanced budgets, at least for some time.

[Jerry O'Driscoll]

I think folks are confusing force majeure and a legal/bankruptcy proceeding. If the latter, it can't happen the way some folks are outlining. The federal courts are part of the government declaring bankruptcy.

The amzing thing is that I am listening to my second discussion on TV today of possible US gov't. bankruptcy.

[James Oswald (azmyth)]

In the case of a debt denominated is your own fiat currency, a bankruptcy court would conclude that the government could pay off the debt, no matter how big. If the U.S. hands the bond holder green pieces of paper, they have legally paid off the debt no matter what the purchasing power of those pieces of paper. Without force majeure, fiat denominated currency can not be defaulted on since the debtor technically always has the ability to pay the loan back. But I understand Beaulier and Boettke to be arguing for force majeure, because without it hyperinflation is necessary.

[Barkley Rosser]

If somehow we were to experience a "bankruptcy" or default or repudiation, there might well be differential treatment of domestic creditors versus foreign ones. Domestic ones presumably would be able to pursue their claims in US courts and might well get paid off with US currency.

Such a move would probably be triggered by an international disagreement, most likely with China, and there force majeure would operate with the US daring the Chinese (or whomever) to collect it.