The Great Default

Gary North, frequent contributor to lewrockwell.com, is a bit eccentric in his thoughts and ideas, a true contrarian.  But he's always interesting to consider, and I have to say that his writing about 4-5 years ago convinced me that that our current economic prosperity was going to end in a big crash.  And it did, so I pay attention to what he says.  In a recent column, he forecasts that the US is going to default on its debt.

Because of the rapid growth in Federal debt since 2008, free market critics have become more pessimistic about the economic future of the nation. It is easy for non-Keynesian economists to see that the Keynesian policies of deficit spending and Federal Reserve credit expansion will harm this economy. These policies will indeed hamper the economy. They will not cripple it.

Why not? Because there is going to be a Great Default by the U.S. government. The old line by economist Herb Stein will come true: "When things cannot continue, they have a tendency to stop."

The Federal government will default. This is not a matter of intellectual speculation. It is a matter of financial speculation. There is no question that Medicare will break the bank in Washington. There will have to be cutbacks in spending. The promises will not come true.

The same is true for Social Security. FICA taxes today are not sufficient to cover the expenses of Social Security, which went into default at the end of fiscal 2010.

Then there are the projected on-budget deficits of $1 trillion a year between now and 2020, at which time the government forecasters cease to offer forecasts. But we also know, as Bernanke reminded us on October 4, that these deficits are unsustainable. He also quoted Herb Stein. The planners know that what the forecasters predict will not come true. There will be a default, or else there will be rising interest rates. If there are rising rates, then fewer of the promises by government will come true. The Federal budget will have to be reallocated to pay the interest expenses.

State and local budgets are facing the same problem. The pension and medical care promises to retired government workers will be impossible to pay. This is finally becoming obvious. Yet politicians refuse to face this reality. They are still in the clutches of the state employee unions, especially the National Education Association. But the unions cannot tell the politicians how to persuade voters to consent to the tax hikes that will be required to fulfill the promises. The tax revolt has begun.

People think the Tea Party is a short-lived phenomenon. It isn't. That is because the taxes required to eliminate the deficits are long-term issues. There is nothing but deficits ahead of us – on paper. The promises have been made. The tax base sufficient to meet these promises is now a thing of the past.

The voters are going to stiff the retirees. Those retired state or local employees who think they will still be collecting their money in 2020 are living in a fantasy world. Their children will have to pick up part of the tab. This may be a large part.

Default will not take any single form. The killer is Medicare. The government spends about $11,000 a year per Medicare beneficiary. The boomers are going to come on board in 2011. They were born in 1946 to 1958. By law, the first wave of them become eligible in 2011. They will automatically lose their private health insurance coverage. They have no choice but to enroll if they want coverage. Everyone wants it, especially when it is mostly free. They fear being without coverage.

The decision to hike the retirement age to receive full benefits for Social Security was made in 1983. There is no way that there will be a similar decision in today's political environment. There are too many oldsters coming on board. The boomers vote. No politician is going to get elected who says "cut Medicare." Not yet, anyway. Ten years from now, yes. But it will take a crisis in Federal funding to make such a proposal politically acceptable to enough younger voters to push up the age of eligibility to anything like high enough to save the system until 2030.

If things can't go on, they have a tendency to stop. But the political setting of that "end of the line" decision is not yet clear.

The default will come. It may come piecemeal: hiking the age of eligibility, or imposing means testing (sticking it to the rich), or reducing benefits, or inflating. It may come through an open default by Congress: a refusal to pay foreign holders of Treasury debt. This will be the preferred approach of Tea Party voters, whose ranks will swell as the deficits swell. Central bankers in Japan and China do not have large, well-organized constituencies in the United States.

The politicians dare not publicly identify which special-interest voting groups will have their benefits cut. The politicians will delay the day of reckoning. That's what most voters want them to do: lie and delay, lie and delay. They get re-elected for kicking the can. They know what they must do to get re-elected, and they will do it until voters finally decide to throw them out. But voters are not willing to identify which constituencies must be the first to lay their heads on the fiscal chopping block. That is why nothing will be done to solve the problem until the can is too large for Congress to kick.

Later in his column, North gives reasons for long-term optimism:

There will be a default. The expansion of the state will not continue much more. Americans are at their limit of tolerance. We are not headed for national disintegration. We are headed for a restoration of localism. Some sacred cows will be slaughtered along the way, but not the entire nation.


Think of these four words: "When Washington's checks bounce." That day is coming. It will restructure the allocation of political power.

The United States has some very great advantages. Here are a few:

1. A tradition of entrepreneurship
2. Ease of starting a business
3. Geographical mobility
4. Occupational mobility
5. English
6. Educated labor force
7. Dying trade unions
8. Widespread literacy
9. Freedom of the press
10. Internet replacing the press
11. Widespread gun ownership
12. Growing skepticism regarding Congress
13. 50 separate states
14. Independent county governments
15. Facebook
16. Politicians who are on the defensive
17. Political gridlock in Washington
18. Talk radio
19. An escape hatch: bankruptcy laws
20. High charitable giving

Americans can declare bankruptcy and start over. This is an important tradition.