What would default look like?

As you may know, I do not wish to be a sensationalist on this topic.  As Felix Salmon has pointed out, the recent spike in short-term T-Bill prices still isn’t that big a deal.  So please consider this question as a (mostly) academic exercise.  And by the way, if/when they pass a short-term debt limit extension, you can simply update the specific dates given in this post accordingly, maybe you will need to add six weeks or so.

Anyway, here is one (unlikely) scenario.  As the evening of October 16th approaches, John Boehner is preparing to invoke the Hastert Rule when a car accident intervenes and he is temporarily out of commission.  Coordination collapses and some Republicans believe that on the 17th debt payments can continue while some other federal obligations are violated instead.  A combination of insufficient payment prioritization (for bizarre technical reasons) and angry Social Security voters, who irrationally fear missing their deposits, means that some payments are in fact missed on Treasury securities.  Some GOP representatives see this as a new chance to blame the Obama administration, and no one can agree quickly exactly how to reorder the payments, and so the mess isn’t cleared up immediately.

But before this accident gets well underway, word leaks out through various “insider trading in conjunction with investment banks Capitol Hill staff members” that not all is well.  Interest rates skyrocket and there are numerous collateral calls from clearinghouses and thus a squeeze on Treasuries.  Everyone is scrambling after Treasuries and suddenly T-Bill liquidity is quite scarce.  (Here is one FT post on collateral crunch.)  The next morning retail runs on money market funds commence and most redemptions cannot be made (another FT post here).  Those funds are shuttered and new commercial paper issues are put on hold.

By mid-morning of the 17th the payments system has shut down entirely.  The Fed tries everything possible, but even with a flood of monetary liquidity, T-Bills are “not what they used to be” and no flow of reserves can make up for this.  The monetary authority cannot become the fiscal authority in the span of an hour or a day, especially when it doesn’t have a fully credible fiscal authority behind it.  The payments system remains gridlocked.  Elsewhere, the Italian 10-year rate shoots over eleven percent, so the ECB has to invoke Outright Monetary Transactions, but the Germans get nervous and don’t go whole hog with this program.  A lot of European credit markets shut down too.  A major clearinghouse is nationalized.

Obama prepares the Super-Premium Treasury issue, and a few days later this happens.  By that time Boehner is again running the Republican Party and enough of the payments mess is sorted out for money markets to function again, albeit at slow speed, although some previously illiquid major financial institutions are now insolvent and they are nationalized.  No one knows which of the others are actually solvent, due to the interest rate spike, and so there is a general and longer-lasting credit collapse.

A full sorting out of the payments mess takes months.  In the meantime gdp has shed five or ten percent and borrowing costs are permanently higher.  Credit stays slow and the United States enters another major recession.  Scott Sumner issues a call for higher nominal gdp.

Fortunately, none of that is very likely to happen (except the part about Scott).

Addendum: By the way, we used to read that an attack of the bond market vigilantes would be good for the economy, but it seems this is no longer the case when the vigilantes are led by Republicans.  Hint: an attack of the bond market vigilantes is not good for the economy.


Here's the one part of this I'm absolutely, 100%sure is right:

"Scott Sumner issues a call for higher nominal gdp."

Sometimes I wonder if a majority of the New York Times's web traffic is people trolling through Krugman's archives for inconsistencies.

Not too much traffic, as you don't need to go too far.

lol you got me. It's also why I listen to his Y2K lectures. I'm quite fond of the 1990 version of Paul Krugman. The articles "Ricardo's Difficult Idea" and "Viagra and the wealth of nations" are must reads. His metamorphosis into a highly credentialed internet troll has been... quite interesting and even amusing.

Perhaps you would enjoy my Y9Z lecture.


Correction: 92nd Street Y lectures.

Germany leaves the Euro and the Deutschmark becomes a de facto reserve currency. Since Germany now faces an elevated exchange rate and a demographic problem, this is not an ideal situation, but it has its merits, particularly given the revolution in China and the splitting of that country into several warring states. The huge earthquakes around the Pacific Rim have proved a burden, especially on Japan and California. The Argentinian province of Greater Brazil has at last been pacified. In France the retirement age has been reduced to fifty. Happily, a new flavour of ice cream has been developed in New England.

And then the Capellans show up...

While I will be looking forward to the Hippy "Trail of Tears"
When the Republic of Texas is created, that joy will be quickly overshadowed by the tragedy of the retreat after Texan defeat at the Second Battle of Glorietta Pass.

Somehow I expect that Tyler's Scenario is less likely than a new Wikileaks revelation that Putin and Assad are both Zeta Reticulans and Al-Quaeda is humanity's only hope.

What is the name of the new flavor? american mud?

Not much faith in Eric Cantor here, yeesh.

As much faith as is warranted.

Let me pick it up from :

"By mid-morning of the 17th the payments system has shut down entirely. "

The general public gets wind of this and there is a run on banks. In Scottsdale an irate customer shoots a bank clerk after crowds overrun the branch. By the 19th all banks in the USA have closed their retail outlets. By the 20th the state of Alabama announces it has seceded. Texas follows and declares leaves to be the new currency. People start hoarding trees.

Anyone else care to take it from there??

"People start hoarding trees.
Anyone else care to take it from there??"

It takes days and much pleading before people on Twitter stop saying, "I guess money really does grow on trees!"

Human sacrifice, dogs and cats living together.....mass hysteria!

Yancey Ward wins the internet.

if by 'economy' you mean the stock market, then yes it would be bad.
i dont really care about the stock market.
enjoy the bonfire boys.

As someone who runs a business that depends on people feeling secure enough to make substantial purchases, I care a lot about the stock market crashing, even if I don't have much invested there.

+1. It's only a secondary market in the control of residual cashflows, but it's meaningful as a signal and causes feedback into the real economy.

I apparently haven't adjusted my Dow Jones antennae well enough; the only signal I am picking up is white noise.

Just let the congressmen know that if we default and fail the payment system, they need to walk home to their districts if they want to see their wives and kids again. No payment system = no paying for jet fuel.

In other news, the Italian government is working on a bailout of Alitalia as ENI, the national oil company, is threatening to stop selling it fuel...

If you're goin' down this road, why not throw in an invasion of space aliens?

Just what they've been waiting for, on the dark side of the moon. For a long time their skeptics thought that seeding America with IQ reducers (cleverly hidden in every pack of Slim Jims) was having no effect ...

Don't be ridiculous. Space aliens are not real. Zombies, on the other hand, are a very real problem.

Seriously, this is a great site but Tyler must have been drinking heavy at lunch today.

A default will only happen if the executive branch allows it to happen.

How many hours of tax receipts does it take to pay the interest charges? The Treasury gets $2.5 trillion or so each year in tax receipts, the interest on the debt is about $250 billion.

Default would only happen if the Executive makes it happen.

Exactly right. Anyone who raises default as a concern is a fear mongering, lying sack.

In a sane world, anyone who says "If I'm not allowed to borrow any more money, I won't be able to pay off my loans" would be mocked into oblivion. But in ours, they get a New York Times column.

The credit crisis hits small business lending operations in banks in the Washginton area especially hard, leading to the shutdown of many new restaurants, including Panda Gourmet, lauded by notorious food critic, Tyler Cowen, causing him to have a nervous breakdown until he can be revived by Scott Sumner calling for a higher nominal GDP, leading to things going back to normal eventually.

It looks to me that Tyler needs some austerity anyway.

"Don't eat at any restaurant that can afford to be open during a shutdown."

We could even call the Super-Premium issue the U.S. High-Grade Structured Credit Enhanced Leveraged Fund. Oh wait.

Yes! This is one of my favorite Tyler posts of all time. On the last part about Krugman, I've been chasing down that rabbit for a month now. I think I resolve the apparent paradox in this post.

Normative expectations ("Republicans should cave to Democratic legislative demands") are writing perceptions ("Republicans are shutting down the government") of reality ("Current law requires the government to shut down, and the parties haven't yet agreed on a fix") more strongly than usual. TC seems to have bought into the narrative. Note that his disaster scenario does not bother to explain the Senate's failure to ratify any of the previously passed house bills - only the Republican house is conceived of as an actor.

I don't get it- it must be a DC cocktail party invitation deal-breaker.

A story of A and B
A: I need money.
B: But I already gave you $3 trillion this year.
A: Gone. And then some. Overshot by $500 billion actually.
B: Hmmm. Good thing you’ve got that credit card.
A: Yeah, that’s why I need money. The card is tapped out.
B: But…but…splutter…I mean…$17 trillion?
A: Every last simoleon.
B: Oh ah…ok, here’s what we’re gonna do. I’ma up your limit another $500 billion-
A: YES!!!!!!!!!!
B: BUT, we gotta talk.
A: Dude, strings? Really?

Your analogy misses the part where A and B previously agreed on how much to spend, knowing that $X would borrowed, and B later decides not to borrow the money.

The "agreement" was illusory if they couldn't agree to raise the debt ceiling.

Gee, thanks for the civics lesson. LBJ, whaddayouthink?

"A health program yesterday runs $300 million, but the fools had to go to projecting it down the road five or six years, and when you project it the first year, it runs $900 million. Now I don't know whether I would approve $900 million second year or not. I might approve 450 or 500. But the first thing Dick Russell comes running in saying, 'My God, you've got a billion-dollar program for next year on health, therefore I'm against any of it now.' Do you follow me?"

The fact is, like a dieter trying to bind himself to a promise, our government has adopted conflicting policies on the understanding that they will be forced to a head from time to time. Kinda dysfunctional, but that's how she runs.

It's functional; I'm just not sure what function it performs. I'm edging towards it being a convenient contrivance. We must have something for elected officials to do so that those that make a living or pastime out of discussion political action can continue to do so.

" As the evening of October 16th approaches, John Boehner is preparing to invoke the Hastert Rule when a car accident intervenes and he is temporarily out of commission. Coordination collapses"

Either you don't know what the "Hastert Rule" means or you are confusing "invoke" and "revoke". Co-ordination has already collapsed in the Republican Party. There is no need to speculate about a car accident - the Republican Party is already one giant wreck. We may very well see Boehner forced to resign as the deadline approaches. Chances of a default are now probably over 20%.

Even if they manage to prioritize and pay Treasuries on time, the markets will have a hissy fit if Social Security, Medicare, military payroll, military suppliers etc are not paid.

Actually your last sentence is the worst case scenario: we won't miss a dime of payment on the Treasuries, but Grandma's checks will be stopped, and when she gets on the phone to Ted Cruz and the gang, the debt limit gets raised. No default.

Markets will have a rough week, then recover.

That's worst case, hopefully instead they do a face-saving can-kick in a week.

Actually, the House will pass a bill funding Grandma's checks, but it will be frozen in the senate as Reid won't bring the bill up for a vote.

Remember, The house wants to fund everything except for Obamacare.

For some values of "The House." And of course their next step is to fund everything but Obama's salary.

Grandma won't care about the nuances, in her mind the whole government is f*cked, and it's mostly the Reps fault (that may not be the truth of it but that's what Grandma thinks). She'll get her check.

Right, Republicans want lots of small business to go bankrupt from not being paid for the goods and services they provide the government.

That way they can point to lots of closed small businesses closed because of Obamacare because Obamacare too all their assets in bankruptcy.

When that happened in Illinois and California, it wasn't some Republicans shutting down the government. Same with Detroit.

Oh I forgot, money does grow on trees.

Like many other commenters, you are assuming the treasury bond yield will move the wrong way. The negative impact on the perception of US credit will be outweighed by a flight to quality and lower expected growth rates. Long term yields will fall, not sell off.

Heh. Remember how Treasuries got clobbered when the US credit rating was downgraded?

Yeah, I'm not certain how much flight to quality was a one-time trick

The front page of the N.Y. Times reads "Texas Tells Rest of Nation to 'Make Like a Tree and Leaf!'"

I think the earlier Krugman column was not written in the context of a possible default. I'm not sure the two columns are actually contradictory.

It isn't even possible for Krugman to contradict himself in a liquidity trap.

That's because everything's backwards in a liquidity trap, including the Law of (Non-)Contradiction.

I did read them, plus hundreds of others over the years. Pretty much every contradiction excuse involves something with the liquidity trap.

Okay, but what does this actually look like for your average Joe? I can see things like trouble buying groceries and gas for a day or two, but the first bank/creditor to get their shit in one sock gets ALL. THE. BUSINESS. That seems like a pretty massive incentive to un-f*ck things. And who knows, it might realign financial markets to be customer-oriented rather than rent-oriented.

Okay, but what does this actually look like for your average Joe? -


I predict a horrible comment section.

Kinda late for a prediction.....

To start, let me admit to vast ignorance regarding the US budget process, but...

Isn't there a huge amount of discretionary military spending, which could be cut quickly to free up money for debt interest and entitlements like Social Security? And wouldn't the President have authority to do that, at least for a short time - surely requirements that money appropriated for various projects be spent don't specify that such-and-such amount has to be spent every single day! And wouldn't the President in fact be obligated to cut such spending, in the short term, seeing as spending on debt interest and Social Security is actually mandatory on a day-to-day basis...?

Right, Obama can stop buying food, fuel, ammo for the troops in Afghanistan, Japan, Germany, and the Army simply goes out raiding the surrounding territory to confiscate the supplies they need.

Of course, if Obama cut off the military, the ones in control of the nukes could threaten to nuke DC...

Nice try, but US Nukes have positive control requiring authority from the National Command Authority, enforced by the Permissive Action Link control mechanism. Been like this for decades. A military coup would have to take place with conventional weaponry.

I'm not so savvy about this after reading Eric Schlosser's new book. I imagine there are plenty of unsecured or lightly secured nukes that a rogue Air Force general could get a hold of.

Hold on a sec. Didn't I hear just the other day that hitting the debt ceiling will lead to stability in the world's markets? What part of this don't you all understand? Sheesh.

You realize a general and long-lasting credit collapse isn't a bug for a frighteningly large amount of the Republican base, right? It's a feature. Far too many in the base hold fractional reserve banking responsible for everything that's wrong with the world, and bankers as monsters who won't rest until they've expropriated everything in America worth expropriating, leaving Real Americans who work at "real jobs" and go to church with nothing to look forward to but debt-peonage and ultimately extinction in favour of people who look like Barack Obama. Put plainly, their creed is the socialism of fools.

That's why Lloyd Blankfein (for example) hasn't been able to talk down anybody in the GOP in a position to do much about the shutdown or the ceiling. These are people who would greet news of the demise of Goldman Sachs with only a little more rejoicing than they would the news of another September 11 incident in DC---this time Chilean style.

Something important for you to know, Richard: The Colbert Report isn't real.

Far too many liberals have a completely delusional idea about what Republicans believe. Try getting out of your bubble and meeting some once in a while.

Are you saying Speaker Boehner isn't a Republican?

When he says "the American people...." I know he is not talking about me, Obama, Pelosi, Bernie Sanders, my sister, Ralph Nader, ...

In some public forums, conservative Republicans will say "Real Americans...."

A decade ago, it was "you are with us, or with the terrorists."

In the 60s, "love it or leave it".

Anytime someone asserts their point of view on a culture issue, conservatives/Republicans deem it a war on their point of view - if you want a Wiccan grave marker, its a war on Christianity.

Or are you arguing that what Republicans say has nothing to do with what they believe?

Are you talking about the Occupy movement? First I've heard that it's Republican.

Don't laugh too loud---a decent way to describe the Tea Party is as Occupy's nasty, paranoid uncle everyone dreads seeing at Thanksgiving dinner, who ran in the GOP primary and somehow got himself elected.

And yes, Uncle Tea Party is all for re-distribution and a lush welfare state---for himself, in the form of the mortgage tax credit, Social Security and Medicare---at the expense of the people he thinks got all the breaks in life: the banker who ripped him off on his mortgage and left him underwater; the wife who turned the children against him and walked off with half his assets; the Barack Obama clone who got promoted even though Uncle Tea Party thinks he worked twice as hard.

Meanwhile, while Occupy has its admirers in high places, their real political influence is nil. Most Occupiers will grow out of it. Uncle Tea Party, meanwhile, isn't going to change. We just have to pray we outlive him with global capitalism more or less intact.

(I haven't watched Colbert in years. Trust me, really very little digging will turn up plenty of people like this in the real conservative blogosphere. Go read Zerohedge, just for starters.)

I'm thinking it's less about what you watch than what you smoke.

I'm not sure he's that far off. The Tea Party isn't a political movement, it's a tribal movement reacting against progressive social values. Why do you think the Muslim birther stuff remains so prominent? It's pure identity politics, social security and medicare aren't targets because they're seen as serving stereotypical old white Americans.

Big business, healthcare, taxes, none of those are social issues and there's many Tea Partiers who would eagerly embrace the ACA or even public healthcare if it somehow became a Tea Party thing.

The thing with big business, banks, and CEOs is they aren't part of the Tea Party tribe, the big money is smart enough to try and keep the Tea Party as allies but the Tea Party will always see them as outsiders. Given the right circumstances the Tea Party can turn on banks and big business very quickly.

And to think that it was obvious the party line was shifting before reading this passage, sourced at calculated risk - 'House Republicans, facing the ninth day of a government shutdown, appeared increasingly isolated on Wednesday from even their strongest backers, with business groups demanding the immediate reopening of the government and benefactors such as Koch Industries publicly distancing themselves from the shutdown fight.'

And this, also noted by calculated risk, would appear to be a source of rejoicing for libertarians who don't care about the tactical wisdom of either major party - '[T]he Republican Party is now viewed favorably by 28% of Americans, down from 38% in September. This is the lowest favorable rating measured for either party since Gallup began asking this question in 1992.
More than six in 10 Americans (62%) now view the GOP unfavorably, a record high.'

And for anyone interested in reading what truly non-partisan, much less faux libertarian, analysis looks like, the following is a fine link - http://www.calculatedriskblog.com/2013/10/comment-politics-policy-deadbeats-and.html

I read the US did default briefly in 1979, during the crisis in NYC. The US failed to pay interest on certain US treasuries. It was on the internet (so it must be true) but i can't be bothered to find it. But it happened, and there was wrangling for a few months about the missing interest payments says the author, but the US gov't finally paid. I think it was the US Treasury not the city of NY, that's what made this story unusual.

There was a 24 or 48 hour delay in fund transfers due to Treasury/NY Fed not implementing the action of Congress in time.

Lawsuits were filed, which were resisted based on you can't sue the government, but were made moot by Congress passing a bill to pay the extra one-two day interest.

I hope the House doesn't vote to raise the debt ceiling.

It would be interesting to see what really would happen and if the Treasury Dept. could actually prioritize payments.

If it can't, then it's further proof that the Feds should not be trusted to run anything, ever.

They spend $100 billion a day... and they can't control any of it? It's just a hundred-billion-dollar firehose, spewing taxpayer money 24/7?

That dog's not so shaggy!!!

I don't wish to see our government turn another sneeze into another depression.

However I do see this as further evidence of my theory of the political dynamic. The Republicans don't care about the government spending because they derive no benefits from it. All they care about is the price tag. But it's hard to change the tax code when costs are marketed as benefits to the envious. So, the damage the Republicans are willing to threaten with is remarkably low compared to what they aren't getting from the government today.

'The Republicans don’t care about the government spending because they derive no benefits from it.'

I'm quite curious - what party do you think the highest management of companies like ExxonMobil or Lockheed Martin vote for? Or for that matter, the membership of the various Chambers of Commerce?

So again, let us quote a Republican with actual experience the last time the government was shutdown by Republicans attempting to make a point - 'Although the ardently conservative Coburn sympathizes with the more junior lawmakers’ strong opposition to the health-care law, he says their shutdown strategy will end badly for Republicans.

“What they’re going to do, they’re going to dig in harder until the pain becomes so bad they yell uncle,” he said. “And it isn’t going to be pain from the president, it’s going to be pain from their own constituents.”' http://articles.washingtonpost.com/2013-10-01/politics/42551484_1_house-republicans-gop-house-shutdown

And which constituents do you think those Republican members of Congress will be hearing from - those who ensure that the revolving door greases everyone that goes through it without squeaking, or the minority of Americans who actually support this idiotic posturing - such as every single person involved in the House creating the shutdown also voting, without a single exception, to pay federal workers for nnot working?

Echo chamber politics reward those with the loudest voices. In the real world where money talks, and nobody has patience for tantrums that impact the bottom line, such stupidity comes at a real cost.

I'm sure there is a free market think tank or two more than willing to explain this to anyone caring to listen. It is one thing to manipulate morons - it is something entirely different to let them have a say in matters involving real money.

"The Republicans don’t care about the government spending because they derive no benefits from it. All they care about is the price tag..."

How do you explain the explosion in debt and deficit from 2001 to 2006 when Republicans had far more control over the budget than they have had since?

How do you explain the unfunded Medicare Drug benefit to those over 65 who were voting almost 60% Republican and the prohibition on any effort to cap profits of drug and insurance corporations by employing VA global drug contract pricing?

Republicans took a budget that had an actual operating surplus of only $5B in CY 2000 (the excess FICA and other trust fund revenue was continuing to increase the debt in every other year since 1969 but in FY1997 to 2001 was reducing the T-bill debt by converting it to internal debt) to about a $400 billion operating deficit in three years, so Republicans seem to be happy to spend if they are going to benefit politically from the spending.

On the other hand, they seek to cut spending when they need to harm Democrats by causing widespread pain because they see that as their way back to power. In particular, Republicans want Democrats to take the blame for entitlement cuts so Republicans can explode the debt and deficit with tax cuts and pork for their corporate backers.

A faction circa 1992 associated with the Republican party was concerned about the debt and deficit, but Ross Perot was a Democrat tax and spending, just not willing to compromise with Reagan deficits and debt don't matter Republicans. His view was you controlled government spending by making everyone pay taxes for it. Democrats pay for spending with taxes because they don't want to fight over debt limits. The biggest sin of Obamacare are the taxes to pay for it in the eye of the Tea Party.

Bottom line: you can not show any evidence Republicans actually "care about spending" unless you mean Republicans care about shoveling pork to their supporters.

What will happen? A big party since swiss franc would rise like in 2011



Sad thing is that this is not happening (yet) on 2013.

The President should consider selling gold. It is probably one of the easiest Government assets to turn into cash. It does nothing for us, now that we are no longer on the gold standard. And it would be a painful psychological, and possibly financial, blow to the “pro-default” Republicans. It would be an especially appropriate punishment, if they had been increasing their gold holdings in anticipation of the economic uncertainty that they are now causing.

“We’ll keep selling, as needed, until the debt ceiling is extended, or we run out of gold.”

Dinosaurs eat man, woman inherits the earth.

A drug store owner in Oklahoma called into a radio show to say that she fills prescriptions for military related personnel which are authorized by the Federal benefit system of some name, but she has been informed that payments to her small business for these authorized dispensing and billing of the Federal government will not be paid until Congress authorizes spending.

I guess by the logic of Republicans, I can take stuff from a small business and promise payment when my spouse authorizes payment, without that being consider debt, or theft.

Pretty much sums it up IMO. http://www.youtube.com/watch?v=JmzuRXLzqKk

Well, I thought this was very well written and frighteningly plausible.

So why does the US have a triple A rating at 2 of the 3 ratings agencies?

Good question. I expect that will be changing soon.

Can you help me understand? I've read Krugman's post, and I don't interpret what he's saying to mean "an attack of the bond market vigilantes would be good for the economy". Rather, if the bond vigilantes attack, they wouldn't be able to do bad for the economy because of the Fed's power to step in. This is an important but subtle difference.

Krugman points out that a U.S. default would not cause a market crash resulting from capital flight from long-term bonds and short-term securities to foreign assets. Why? Because "the Fed retains control over the money supply and of short-term interest rates"--in other words, the Fed can step in and buy bonds and short-term securities if no one else will. You seem to dismiss this when you say "The Fed tries everything possible, but even with a flood of monetary liquidity, T-Bills are 'not what they used to be' and no flow of reserves can make up for this." But I don't understand the logic behind this assertion--can't the Fed buy a theoretically infinite amount of T-bills?

Sorry if my questions are overly simplistic or naive--I was an English major.

No, it's not plausible Tyler.

Remember, expectations uber alles. This is like when a large company suffers an adverse legal judgment -- if the judgement isn't large compared to the future profit stream, the stock price doesn't move much.

There is still zero risk of real defaults, plus everyone knows Fed will intervene if it has to, so interest rates won't move -- an "accident" like that described would be interpreted like a clerical or clearinghouse error, not a death knell for US bonds. The stream of tax revenue is enormous relative to the payments.

Basically, it doesn't create any new information.

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