Friday, July 29, 2011

Should The US Default On Its Massive Foreign Debt?

A Brave Visionary Suggests That The US Default On Its National Debt!

Fri, 29 Jul 2011 at 5:59 am 

I am glad to see so many comments. Patrick I'm married to a wonderful Argentine lady. We lived through the sovereign default that took place in Argentina in 2001. When the default happened, it was a cataclysmic event. The Argentine peso crashed from 1 peso to the dollar to three pesos to the dollar. Unemployment shot up to Great Dperession evels of 25%-30%. Housing prices collapsed. My wife bought her condo in Buenos Aires in 1996 to $54,000 US. It collapsed to a value of $18,000 US in 2002. (This condo has now recovered in value to $100,000 US+)  In all of this turmoil fortunes were made by a lucky few who purchased the distressed real estate and businesses. The human misery was without equal. People literally starved to death. Since then Argentina has had a huge economic recovery. Economic growth last year was 8%. There is life after a sovereign default. But the poor suffer immensely.

Defaulting creates huge legal hassles. The creditors would be suing and freezing assets. It would get messy!

So why shoudn't we default?

By Fisk Wed, 27 Jul 2011, 9:43pm 1,146 views 55 comments Watch Quote Email Link Flag

Default essentially is a govt. bankruptcy. As we know, filing for bankruptcy generally benefits debtors financially as they can remove or reduce the debt payments. Which is why new bankruptcy laws had to be made a few years ago to limit this practice - that would hardly be needed had debtors not benefited from bankruptcy. Further, unavailability of significant loans over the next several years forces bankrupt into "balanced budget" and savings - a good habit that often continues even once the bankruptcy is deleted from the credit record and loans become available. Same happens with defaulted govts.

It is widely claimed that the US default would cause a "horrendous multidecade recession". Other defaulted countries show otherwise. The largest recent national defaults were Russia 1998 and Argentina 2001. Despite major differences between those countries and their economies, the course and outcome post-default were similar. First, a severe economic shock with abrupt drop of currency value by 3 - 4 times followed by rapid inflation led by imports and large spike of unemployment and corporate bankruptcies. The first year was rough indeed. However, by the middle of year 2 the economy stabilized and started growing, first hesitantly and then faster and faster. By year 6, the GDP and incomes (in foreign currency such as USD) have substantially exceeded the pre-default values and continued improving.

Why? First, the above effect of cancelled or reduced debt payments. But more important was dramatic currency depreciation that greatly reduced imports and increased exports. For example, if USD dropped 3 times vs. Euro or Yen, virtually all car imports would become utterly price-incompetitive and decrease by 80 - 90%. This would mean the demand for US-made autos growing ~3 times within months, plus a major gain in exports, a godsend for Detroit obviously. Typical Chinese or Indian salaries would kick from ~15% US to ~50% US, making outsourcing there immediately incompetitive, considering the productivity differential of ~3 times. Production would return to the US en masse, creating the "Mother of all economic booms". That's what happened in Russia, btw.

Of course, the import prices would also skyrocket, first of all oil. That would do in 3 yrs more for conservation (with proliferation of plug-in hybrids), nuclear energy, and public transportation/rail than 30 yrs of "fuel economy standards", tax rebates, and other govt. tinkering. Domestic energy exploration would instantly become hot over large swaths of the land, watch the ND and TX shale booms x 10.

Some say dishonoring debts is morally wrong when one can pay (aka "strategic default"). But curiously many here who see no problem with individual US homeowners defaulting and stiffing the US banks (and thus our govt. and investors) even when they could pay are aghast at us doing the same collectively to foreign bondholders. A mortgage loan is just a business deal involving risk for the lender, who did or should have considered the possibility of principal loss before lending, it is said. Then same is true for govt. debt - a lender certainly knew that govts. can and do default, and should have considered that when bying T-bills.

So let Chinese take "haircuts" - it's just business.