Paul Krugman writes:
…the traditional immunity of advanced countries like America to third-world-style financial crises isn't a birthright. Financial markets give us the benefit of the doubt only because they believe in our political maturity — in the willingness of our leaders to do what is necessary to rein in deficits, paying a political cost if necessary. And in the past that belief has been justified. Even Ronald Reagan raised taxes when the budget deficit soared.
But do we still have that kind of maturity? Here's the opening sentence of a recent New York Times article on the administration's budget plans: ''Facing a record budget deficit, Bush administration officials say they have drafted an election-year budget that will rein in the growth of domestic spending without alienating politically influential constituencies.'' Needless to say, the proposed spending cuts — focused only on the powerless — are both cruel and trivial.
If this kind of fecklessness goes on, investors will eventually conclude that America has turned into a third world country, and start to treat it like one. And the results for the U.S. economy won't be pretty.
It is, of course, still a completely coherent position to think that without a fiscal stimulus there will be no recovery and thus this default risk will be all the higher; I presume that is Krugman's position. Still, in absolute terms, our worry about default risk should be relatively high. And if there's anything we've learned over the last two years, it is that "once in a lifetime" outlier events can happen.
Keep in mind that banks still need a lot more money. So that's a reason to be quite fiscally conservative on as many other things as possible.
Here are some interesting thoughts from Robert Waldmann. (How long will the liquidity trap last anyway?) And Greg Ip writes: "Last week, markets pegged the probability of a U.S. default at 6 percent over the next 10 years, compared with just 1 percent a year ago."