Back to Quack Off
Now, or Suffer a More Expensive Crisis Later
by Rep Ron Paul
Washington, DC -- Debate over the debt ceiling has reached a fever pitch in
recent weeks, with each side trying to outdo the other in a game of
political chicken. If you believe some of the things that are being written,
the world will come to an end if the U.S. defaults on even the tiniest
portion of its debt.
In strict terms, the default being discussed will
occur if the U.S. fails to meet its debt obligations, through failure to pay
either interest or principal due a bondholder. Proponents of raising the
debt ceiling claim that a default on Aug. 2 is unprecedented and will result
in calamity (never mind that this is simply an arbitrary date, easily
changed, marking a congressional recess). My expectations of such a scenario
are more sanguine.
The U.S. government defaulted at least three times on
its obligations during the 20th century.
-- In 1934, the government banned ownership of gold
and eliminated the right to exchange gold certificates for gold coins. It
then immediately revalued gold from $20.67 per troy ounce to $35, thus
devaluing the dollar holdings of all Americans by 40 percent.
-- From 1934 to 1968, the federal government continued
to issue and redeem silver certificates, notes that circulated as legal
tender that could be redeemed for silver coins or silver bars. In 1968,
Congress unilaterally reneged on this obligation, too.
-- From 1934 to 1971,
foreign governments were permitted by the U.S. government to exchange their
dollars for gold through the gold window. In 1971, President Richard Nixon
severed this final link between the dollar and gold by closing the gold
window, thus in effect defaulting once again on a debt obligation of the
No longer constrained by any sort of commodity
backing, the federal government was now free to engage in almost unlimited
fiscal profligacy, the only check on its spending being the marketís
appetite for Treasury debt. Despite the defaults in 1934, 1968 and 1971,
world markets have been only too willing to purchase Treasury debt and
thereby fund the governmentís deficit spending. If these major defaults
didnít result in decreased investor appetite for U.S. obligations, I see no
reason why defaulting on a small amount of debt this August would cause any
The national debt now stands at just over $14
trillion, while net total liabilities are estimated at over $200 trillion.
The government is insolvent, as there is no way that this massive sum of
liabilities can ever be paid off. Successive Congresses and administrations
have shown absolutely no restraint when it comes to the budget process, and
the idea that either of the two parties is serious about getting our fiscal
house in order is laughable.
Boom and Bust
The Austrian Schoolís theory
of the business cycle describes how loose central bank monetary policy
causes booms and busts: It drives down interest rates below the market rate,
lowering the cost of borrowing; encourages malinvestment; and causes
economic miscalculation as resources are diverted from the highest value use
as reflected in true consumer preferences. Loose monetary policy caused the
dot-com bubble and the housing bubble, and now is causing the government
For far too long, the Federal Reserveís monetary
policy and quantitative easing have kept interest rates artificially low,
enabling the government to drastically increase its spending by funding its
profligacy through new debt whose service costs were lower than they
otherwise would have been.
Neither Republicans nor Democrats sought to end this
gravy train, with one party prioritizing war spending and the other
prioritizing welfare spending, and with both supporting both types of
spending. But now, with the end of the second round of quantitative easing,
the federal funds rate at the zero bound, and the debt limit maxed out,
Congress finds itself in a real quandary.
It isnít too late to return
to fiscal sanity. We could start by canceling out the debt held by the
Federal Reserve, which would clear $1.6 trillion under the debt ceiling. Or
we could cut trillions of dollars in spending by bringing our troops home
from overseas, making gradual reforms to Social Security and Medicare, and
bringing the federal government back within the limits envisioned by the
Constitution. Yet no one is willing to step up to the plate and make the
hard decisions that are necessary. Everyone wants to kick the can down the
road and believe that deficit spending can continue unabated.
Unless major changes are made today, the U.S. will
default on its debt sooner or later, and it is certainly preferable that it
be sooner rather than later.
If the government defaults on its debt now, the
consequences undoubtedly will be painful in the short term. The loss of its
AAA rating will raise the cost of issuing new debt, but this is not
altogether a bad thing. Higher borrowing costs will ensure that the
government cannot continue the same old spending policies. Budgets will have
to be brought into balance (as the cost of servicing debt will be so
expensive as to preclude future debt financing of government operations), so
hopefully, in the long term, the government will return to sound financial
Raising the Ceiling
The alternative to defaulting now is to keep
increasing the debt ceiling, keep spending like a drunken sailor, and hope
that the default comes after we die. A future default wonít take the form of
a missed payment, but rather will come through hyperinflation. The already
incestuous relationship between the Federal Reserve and the Treasury will
grow even closer as the Fed begins to purchase debt directly from the
Treasury and monetizes debt on a scale that makes QE2 look like a drop in
the bucket. Imagine the societal breakdown of Weimar Germany, but in a
country five times as large. That is what we face if we do not come to terms
with our debt problem immediately.
Default will be painful, but it is all but inevitable
for a country as heavily indebted as the U.S. Just as pumping money into the
system to combat a recession only ensures an unsustainable economic boom and
a future recession worse than the first, so too does continuously raising
the debt ceiling only forestall the day of reckoning and ensure that, when
it comes, it will be cataclysmic.
We have a choice: default now and take our medicine,
or put it off as long as possible, when the effects will be much worse.
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