The Myth and Ironclad Rule Against Government Default
Executive Summary
- Mainstream and private banking associated economists often talk of governments defaulting.
- The reality is that for governments that create their own money, there is no possibility of default.
Introduction
Governments cannot default on their debt unless forced to.
This is explained in the following quotation.
“A government borrowing in its own currency need never default on its debts; paying them is simply a matter of adding the interest to the bank accounts of the bond holders. A government can only decide to default—an act of financial suicide—or (in the case of a government borrowing in a currency it doesn’t control) be forced to default by its bankers. But a U.S. bank will always cash a check issued by the US Government, whatever happens.” – James K Galbraith
Warren Mosler Ask The Italian Head of the Treasury a Simple Question
This is further explained in the following quotation, which is an interaction with the Italian Treasury asked by Warren Mosler in a meeting held at the height of concern on the part of investors over the potential of the Italian government defaulting on its debt.
“Professor Spaventa, this is a rhetorical question, but why is Italy issuing Treasury securities? Is it to get lira to spend, or is it to prevent the lira interbank rate falling to zero from your target rate of 12%?” I could tell that Professor Spaventa was at first puzzled by the questions. He was probably expecting us to question when we would get our withholding tax back. Professor Spaventa took a minute to collect his thoughts. When he answered my question, he revealed an understanding of monetary operations we had rarely seen from Treasury officials in any country. “No,” he replied. “The interbank rate would only fall to zero, as we pay interest on reserves.” I said nothing, giving him more time to consider the question. A few seconds later he jumped up out of his seat proclaiming “Yes! And the International Monetary Fund is making us act pro cyclical!” My question had led to the realization that the IMF was making the Italian Government tighten policy due to a default risk that did not exist. Our meeting, originally planned to last for only twenty minutes, went on for two hours. The good Professor began inviting his associates in nearby offices to join us to hear the good news, and instantly the cappuccino was flowing like water. The dark cloud of default had been lifted. This was time for celebration! Over the next few years, our funds and happy clients made well over $100 million in profits on these transactions, and we may have saved the Italian Government as well. The awareness of how currencies function operationally inspired this book and hopefully will soon save the world from itself”
Source: Mosler Economics
How International Private Banking Interests Force Countries to Follow Their Monetary and Fiscal Policies
This describes the problem with private banking entities like the IMF forcing countries to follow monetary policies based upon the idea of governments defaulting at high debt to GDP ratios.
Private banking funds false information providing think tanks like CATO and Heritage like to draw comparisons between the debt of the US and the debt of EU member nations. The following is a perfect example of this.
Private Banking Propaganda from CATO and Heritage
“At some point, bond investors see the end coming, as they did for Greece. If they lend at all, they demand sharply higher interest rates. But if rates rise only to 5 percent, our current $20 trillion debt means an additional $1 trillion deficit. Larger debt makes it worse. Higher interest costs rates feed a deficit which feeds higher rates in a classic “doom loop.” The Fed is powerless to hold rates down, even if it is willing to buy $10 trillion bonds, since people demand the same high rates to hold the Fed’s money. And the Fed cannot end the crisis by raising rates, which only raises interest costs further.”
Source: CATO Institute
https://www.cato.org/commentary/our-national-debt-denial
Comparing Greece to the US is a ridiculous comparison because Greece is an EU member country. By joining the EU, Greece lost its ability to create or control its currency. The EU can remotely control Greece into doing a number of bad things for Greece. However, the US is not of the EU and did not hand over its ability to create its own currency.
Secondly, the US does not have to issue debt. It only does this because it gave up this ability to the Federal Reserve during the Federal Reserve Act of 1913. Throughout the history of the US, it has repeatedly created its own money without any involvement from any private bank. CATO never mentioned this because it would conflict with the private banking interests that are most likely funding them, and which CATO naturally does not declare.
However, comparing the US to far smaller countries (Greece’s population is around 10 M) with a completely different banking situation is common for these think tanks. Later in the article, CATO does admit that the US and Greece are different, as can be seen from this fearmongering quote.
“Yes, the U.S. prints its own money and Greece does not. But that fact only means that a crisis may end in sharp inflation rather than chaotic default. And it is not obvious that the U.S. government will choose inflation over default.”
This says directly that the US will default on its debt.
Why the US would do this is unclear. As CATO just admitted, the US can create its own money. Secondly, it is unclear why the other option would be inflation. Inflation is caused when there is too much money in the system. The existence of a large debt does not establish whether there is too much money versus the goods and services and investments desired to be purchased.
The CATO quote continues.
“Will Congress really prioritize paying interest to, as it will see them, Wall Street fat cats, foreign central bankers, and “the rich” who hold U.S. debt, over the needs of struggling Americans? Will our elected officials really wipe out millions of voters’ savings in a sharp inflation rather than devise a complex haircut for government debt? Don’t bet on it. But if bond investors smell a haircut coming, they will flee all the faster. When Washington can no longer borrow, our normal crisis‐mitigation policies disappear — the flood of debt relief, bailout, and stimulus that everyone expects — together with our capacity for military or public‐health spending to meet the roots of the crisis.”
This quote is lunacy. It is false and also highly irresponsible.
CATO is pushing a threat of default where there is none and a threat of inflation which is not explained. CATO continues
“What can be done? First, spend wisely, as if debt actually has to be paid off. It does. Even if the interest rate remains below the growth rate, that channel for reducing the debt‐to‐GDP ratios takes decades. When a fiscal reckoning comes, it will require a swifter reduction in debt. That will mean either sharply higher, European‐style middle‐class taxes or lower spending.”
The US government is not a household, and money does not mean the same thing or work the same way. There also is no “fiscal reckoning.” And the US government does not need taxes or use taxes to pay back its Treasury bonds. Every claim here is false and is misinforming readers. CATO authors either know nothing — or they are deliberately publishing false information on the topic.