The US is unlikely to default
By Scott Sumner
David Henderson has a recent post discussing the likelihood of the US government defaulting on its debt, at some point in the future:
That motivated me to go back to an article that San Jose State University economist Jeff Hummel and I had published in Independent Review back in 2014 that, for some reason, I don’t seem to have posted about here. It’s titled “The Inevitability of a U.S. Government Default.” In it, we argue that the feds are likely to default, that money creation as an alternative is not likely to get them out of their fiscal fix, and that default is actually better economically than massively high inflation.
There is much that I agree with in their paper, but in the end I am somewhat skeptical of the claim that the US government will default. In the paper cited above, David and Jeff make this comment:
Nevertheless, the spending increases in the three federal programs highlighted–
Medicare, Medicaid, and Social Security–cannot go on forever. As one of author Henderson’s previous bosses, Herb Stein, put it, “If something cannot go on forever, it will stop.”
Because these spending increases won’t go on forever, they will stop. How will they stop? Of the answer to that, we are less sure. A reasonable guess is that eligibility for Medicaid will be tightened, and Medicare and Social Security will be means tested, all well before 2050.
But if these reforms are not made well before 2050, then a very likely outcome is a government default on the federal debt. The default could range from outright repudiation to partial repudiation.
This is precisely why I think default is unlikely. The fiscal trends in the US are unsustainable. They are unsustainable even if the US government defaults. Thus I see two options:
1. Stop running excessive budget deficits, and do not default.
2. Wait until immediately after defaulting to stop running excessive budget deficits.
Obviously the first option is much better, as default solves no problems, and causes much future distress. So why not avoid default?
A cynic might point to Greece as a cautionary tale. Perhaps the government will not cut back on deficit spending until it is forced to. A cynic might also point to the current trajectory of fiscal policy, which has become extremely irresponsible over the past 12 months—indeed worse than anything previously seen in America (when taking account of where we are in the business cycle.) So why am I less cynical?
The Greek government hid its fiscal problems through dodgy accounting tricks. The US fiscal problem is too big to hide. Thus the bond market would begin to show signs of worry long before a default was imminent. And this would put pressure on the federal government to slow the increase in spending.
Note that it does no good to say that both tax increases and spending cuts are politically impossible. Not only are they possible, they are certain to occur for precisely the reason provided in the Herb Stein quotation. Some combination of tax increases and entitlement reform will occur during the 21st century. The only question is when. Because doing this reform before a default is a far more sensible and far less painful option, I continue to see that outcome as the most likely, while acknowledging that default remains a possibility if the political system remains highly dysfunctional.