A question for the economists

Would a US government default on its obligations necessarily or even likely mean that private companies would have a harder time borrowing money?

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18 Responses to A question for the economists

  1. Rafn says:

    Based onon our tabletop discussions, the government is more likely to try and print its way out of a default – it’s the solution used by governments in the past.

  2. Timmeehh says:

    Government default would likely trigger hyperinflation.

  3. ecurb says:

    Wut? Is that just the standard response these days? What would be the mechanism for that, exactly?
    Inflation is a way to AVOID government default (especially with the kind of maturity structure you get by selling the Chinese loads of 30-year treasuries).

    The answer to the original question is “yes”. Partly due to bank liquidity (writing off assets reduces the liabilities you can hold, making it impossible to issue more loans), party due to sheer panic, and partly because corporate demand for credit would increase as the government stopped paying companies what it owed them. It’s what’s happening in Spain right now, at the local level.

    So yes, government default is something sensible people would like to avoid. It wouldn’t even help revolutionaries, because nobody’s in a position to benefit from it.

  4. ScottH says:

    We will never default on our debt regardless of how high the debt goes simply because we print the very money to pay for it. So checks will always go out; bills always paid.

    Course, I’m not saying that printing such checks will buy much of value. Your SS check will always be printed; just it may not go far when a cup of coffee is $500, electric bill $1000/month. Your pay may not keep up with inflation. Nor the cost of food and other commodities.

    And so long as there is the Federal reserve which creates capital, there will be money available for businesses to borrow. The Fed and politicos will ensure that is never disrupted regardless of how many times we bail them out in the future

  5. Mike Edgar says:

    Yes, as has been noted. Like it or not the federal components, major banks, and by extension minor banks, are too closely intertwined. GE might feel it a some, but the small/medium business owners would get destroyed as credit would dry up worse than it already has.

  6. A US government default on financial obligations would, I believe, put the banks into total-lockdown risk-aversion mode; they wouldn’t loan anything to anybody, for quite a while.

    Thing is, interest rates on T-bills were *dropping* as we approached default last time. The investors, even then, believed that that was the safest place to put their money. It’s a strange world!

    • Sean says:

      Because it is still safer than the alternatives. Which is scary. What else are you going to do, put it in European bonds?

  7. Kristopher says:

    It would mean that you would have a hard time getting a loan for a reasonable rate that was denominated in US federal reserve notes.

    Banks would have to use variable rates to keep up with the government printing presses.

    If you can float a loan denominated in Euros or Canadian Dollars, you could get a more reasonable fixed rate. You would have to work with a bank that was based overseas.

  8. Oleg,

    This is a multifaceted question. The issue becomes the fact that the Federal Reserve is an unknown, and it controls the banks. We don’t really have free markets in lending per se.

    Contrary to what others have stated above, a default is not “bad” in any sense of the word given the right circumstances. Iceland did it, and their interest rates overall did go up. About 18 months later, they reduced significantly.

    The country is borrowing money that it cannot possibly pay back. The question becomes how is the country going to account for that debt? The government has the Federal Reserve do some monetary tricks that devalue the currency, but the other issue is that banks and other financial institutions have off-book assets allowed by FASB to be marked to book value instead of marked to market value.

    So, essentially, the reason that banks are not really lending like they were before and will not lend like that for the foreseeable future is because when you look their whole value, it’s significantly lower than what it appears to be. The Fed actually pays significantly more money for member banks to hold reserves with them then they feel they can get given all the risk out there with the economy and given their overvalued assets. And we haven’t even touched the government entities like Fannie and Freddie that are basically bankrupt and money-pits.

    Defaulting on our debts would raise the interest rates for private companies, but given the environment, the Federal Reserve has been holding the rates at below market value, so it needs to happen anyway. The market is out of equilibrium and you are seeing the effects of the distortions this causes.

    As long as the country would default on its debt, AND cut spending accordingly, while allowing companies that are technically bankrupt to go bankrupt, the restructuring would be good for the country and we would rebound from this within 18 – 24 months.

    The alternative is what is happening right now, kicking the can. The government is prolonging the pain, and will do so for as long as possible. Instead, they have socialized the risk and privatized the gains. They want the taxpayer to bear the burden of the debt that the government created. They will do this by both raising taxes and devaluing currency (in order to make the principal owed worth less — at the expense of the savers, elderly, and the poor).

    All things being the same, if free markets really existed and were allowed, private companies would have no issue borrowing money should the government not pay its obligations. However, because everything we are basically in a soft-fascist state, the outcome is harder to predict.

  9. Tim says:

    What foreign lender is going to want to hold onto the collapsed dollars in order to lend it to a private US company? That is probably a secondary consideration anyways, since I believe we are required to use dollars in the exchange of debt.

  10. Will Brown says:

    An aspect I haven’t seen clearly addressed yet; from whom might you borrow that isn’t more-or-less directly US government controlled/regulated, and what US$-denominated security could you offer as assurance that a potential lender would accept (read: collect on should you default)?

    A government default would certainly disrupt US domestic markets and make export questionable too.

    • ecurb says:

      That’s a problem, isn’t it? It would be very hard for a Chinese bank to repossess your car if you defaulted!
      It’s also very difficult to buy small sums of foreign currencies, should you try to borrow against foreign assets in order to buy Dollars.; you know what terrible exchange rates you get on vacation.

      As Mike said, larger companies with overseas branches would have a much easier time shifting assets, but small US-based companies would be hurt the most.

  11. Rob Morse says:

    Private borrowing will be squeezed by public debt even if the government does not default. Government borrowing leads to less investment available for the private market. Private borrowers will have to pay more to compete for the remaining funds. Prove it to yourself by looking at the opposite example; if the government stopped borrowing then banks would stop buying government bonds and have to loan to small businesses. It is true that many things would have to change to significantly reduce government borrowing, but the theory about competing for funds remains valid.

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