The Prospects for a U.S. Default, Continued

The party that holds the White House is the one that gets blamed. People think of the president as being more powerful than reality. This is in part because presidents pretend to be more powerful than reality.

I also, some time ago, projected a high probability of a default event, or an extraordinary level of inflation (currency devaluation) based on Government deficits and debt – just like these folks. I actually would have predicted the event to have occurred already, given the levels of deficit. Inasmuch as it hasn’t happened,I was wrong. Having been wrong, I had to find out why, and basic economics (and the law) explained why.

Currency has three features/characteristics – medium of exchange, unit of account, and store of value. As Benjamin Franklin noted over 200 years ago, a fiat currency automatically adjusts (inflates) itself when it is over-printed. And that’s true – but only when it is active as a medium of exchange! If a fiat currency is over-printed, but held in account only, it can’t and won’t automatically inflate.

Note that nearly half of Treasury (taxpayer) debt exists exclusively as a line item on the central bank’s (Federal Reserve) balance sheet. Furthermore, the Fed has the right and the legal obligation to buy any Treasury debt held by anyone else! China, Japan, your grandmother or anyone else who currently holds Treasury debt can redeem those bonds – for Federal Reserve Coupons (currency) – at any time for face value from the Fed! And the Fed controls interest rates, the “bond market” doesn’t!

So what about the current Federal Government debt-funded spending excesses? That puts the “excessively printed” fiat currency in play as medium of exchange – why doesn’t that create inflation?

Two reasons …

First, because the inflation has already occurred – 2002 through 2007. The housing bubble was the inflation. What current excess Fed-funded Government spending is doing right now is preventing (or at least controlling the rate of) deflation in the U.S. economy.

Second, because U.S. currency is the de-facto global currency. And it’s not just the global reserve, it’s very much the preferred global medium of exchange. As such, there is high demand for it outside the U.S. economy, both as medium of exchange AND store of value. And evidently, that demand hasn’t waned very much, at least enough to indicate a supply excess.

The upshot of all this is that the U.S. can’t and won’t ever default on it’s debt. Not ever! It has a central bank (and sovereign right) to redeem all its debt, on demand from any creditor, at any time, at face value, in U.S. currency. Inasmuch as the Fed IS and remains the single largest creditor (by far), the threat of a “bondholder-driven” increase in interest rates is unlikely.

One further comment …
Much of these discussions – and an enormous amount of crap political rhetoric – is based on the misconception that Bernanke and the Fed are somehow guilty of complicity in Federal Government spending excesses, via its supposed “independence”. READ THE LAW! The Federal Reserve, as the chartered Central Bank of the United States, is REQUIRED BY LAW to fund every single penny of Congressional-mandated Treasury debt. It’s not Bernanke’s choice. The Federal Reserve Bank is independent of the vagaries of political intrigue, but it is not independent of the law.