The financial system is rooted in illusion; the concept of default is no exception. by Gene DeNardo
(libertarian)
Wednesday, July 27, 2011
As the date of August 2nd approaches, supposedly the date that the US government will exceed its debt limit if legislation to increase that limit is not enacted, the idea of default appears to be morphing from possibility to probability. What is most interesting about the default issue is that it is entirely illusionary. A real debt limit within a fiat economy is an imaginary concept!
To default is to fail to fulfill one’s obligations to another, whether individual or group. What one is obliged to do depends entirely on what one has “promised” to do in the past. Defaulting always occurs in the present based on past promises. Both sides have to “agree” on the same terms in order to have a “binding” contract; without a binding contract, default cannot occur.
The debt limit is based on agreements that are primarily known as government securities. Within these securities is the promise of the United States government to repay its creditors {those who own the securities} a certain amount of interest and principle at a certain point in time.
And, that is really all they say. They state that the United States government will repay whoever holds title to these securities in United States dollars on a specified date.
Now, the problem that has been publicized is that on August 2nd or so, the United States will have reached its “debt” limit. That is, the United States will have issued an amount of securities that legally exceeds the principle and interest amounts that it has allotted itself to issue. The debt that it has incurred will after August 2nd become greater than the debt that theUnited States legally allows itself.
But, that debt limit itself is an agreement. It is an “agreement” created by the Congress that attempts to limit amount of securities the Treasury issues. It is an agreement based on force. The Treasury does not necessarily “consent” to the agreement; it is enforced by the ability of the Congress to enact binding legislation or law that requires action or inaction by others without their consent.
We could go on and on with this, but the important point is that one party to these securities, the United States, has all the power and ability to repay its creditors and fulfill its obligations and avoid default simply by continuing to issue more securities. Its does not run out of that power until it runs out of creditors; people willing to buy those little official looking pieces of paper. Fiat currency by its nature is endless.
Even if the point is reached where creditors hesitate to buy US paper, the US can raise the rate of interest until it finds customers. Real default in a fiat monetary system is impossible. The Fed can always issue new currency to repay its creditors. It has fulfilled the extent of its obligation; to repay its debts with US dollars. Default within a fiat economy can only be a self inflicted wound.
The term “default” has been used erroneously and blatantly to continue and fortify the illusion that Treasury securities actually have real concrete value. And to be fair, they do have value. They are based on knowledge that the people of the United States will continue to go to work and allow the fruits of their labor to be used coercively to back the Treasury paper. This is known as the “full faith and credit” of theUnited States, although it could be better described as the "full sweat and toil of its citizens".
This, of course, is one of those “agreements” in which one party was never ask whether or not they desired to be a party to the agreement. We were never ask if we wished to have our labor tithed in order to allow our government to enrich those it chooses to be beneficiaries of its hijacked generosity.
That would make our little agreement “non-binding”; would it not?
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Posted By: Bill Gee
Date: July 27, 2011 11:13:36 AM
You are absolutely correct, which is why the bond market has failed to react to the notion of even a remote possiblity of an actual default on US Treasury debt. Interest payments will be made on time, Social Security and Medicare checks will be mailed, the US military will continue to fight their wars.
The real danger here is the downgrade of US debt by the three major rating agencies, S&P, Moody's and Fitch. What they are not questioning is whether the US can pay the interest on its debt. What they are questioning is to what extent can we trust the "Full Faith & Credit" of the debt. In other words, what they're worried about is if the US Government cannot get its financial house in order, or if they cut too much out of the government's ability to enforce law and order, or they lose the ability to regulate and ensure the free flow of commerce, what will that do to the average American worker's ability to do their job, pay taxes and thus ensure that the debt obligations of the Government can be paid. This is why S&P has indicated that even if Democrats & Republicans manage to hammer out a compromise in the last minute, they are still likely to downgrade the debt.
The immediate effect of a ratings downgrade will turn the bond market on its head. Not because US Treasuries will suddenly stop paying interest, but because there are several laws that require that institutional investors MUST carry a certain percentage of AAA rated securities in their portfolios. Institutional investors make up the lion's share of the investing public, so there is likely to be a sudden tsunami of US Treasuries being bought and sold. Simply due to the principle of supply and demand, the market value of these securities is likely to dip well below their stated Book Values. That means that companies will be realizing millions, if not billions, in realized investment losses, and it is very likely that many of those investors will become insolvent, which will result in even higher unemployment rates. The irony is that with increased unemployment, there will be even less tax revenue generated, which will likely result in an even further credit downgrade.
The cruel irony is that all the while, investors will continue to get their interest payments on time and the government's bills will continue to be paid. Only by then we'll be right in the middle of a Second Great Depression that will make the first one look like a minor hiccup.
Posted By: Bentree
Date: July 30, 2011 05:34:53 PM
Ask and you shall receive.
So what you are saying is that after tarp, QE1 & 2, we will still have to go through what TQ&2 were supposed inoculate us from. So here we are faced with a potential ruinous situation with less money and fewer assets and more responsibilities, all because the masters were spending and acquiring our assets all the while we were scrambling to make the mortgage, keep the power on and food on the table. Those shovel reading projects turned out to be a hole that they just kept digging deeper with the shovels/rope that we will be hung with, and we paid for it. Ironic? Oh! Yeah!
