NCPA - National Center for Policy Analysis

Some Possible Consequences of a U.S. Government Default

January 27, 2012

Few now doubt that the U.S. government is rushing headlong toward a major fiscal crisis.  Promised future outlays, mainly for Social Security, Medicare and Medicaid, far exceed projected future revenue, and the total federal debt continues to grow beyond previous boundaries, says Jeffrey Rogers Hummel, an associate economics professor at San Jose State University.

  • The latest estimate by Laurence J. Kotlikoff puts the gap's present value at the bone-crushing level of $211 trillion, while a more modest estimate from Jagadeesh Gokhale and Kent A. Smetters estimates the gap as of 2010 at $79.4 trillion.
  • The Congressional Budget Office's most recent long-term outlook has federal expenditures (without interest payments) accounting for 35 percent of gross domestic product (GDP), while revenues account for only 20 percent.
  • Marc Joffe, a former employee of Moody's Analytics, projects that by 2040 the national debt will have already reached more than 180 percent of GDP.

Critics are quick to point out that these projections are just that, and ignore the possibility of changes in public policy that would avert such drastic fiscal scenarios.  However, these critics place too much trust in the agents of political change.

  • As many researchers have acknowledged, federal tax revenue will never consistently rise much above 20 percent of GDP.
  • Politicians have little personal incentive to come up with the requisite expenditure cuts in time.
  • Monetary expansion and its accompanying inflation will prove ineffective at closing the gap.

It is in this situation that a real discussion needs to take place about the costs and benefits of a U.S. government debt default, as such a situation is likely to occur within the next two decades.  In the short run, the costs will likely be substantial as there would be an enormous loss of wealth within the United States.

  • Of the $10,127,031 million held by the public, approximately 40 percent is held domestically.
  • If a total repudiation took place today, initial direct losses to the U.S. private sector would total about $4 trillion -- roughly equivalent to the fall in real estate value between 2007 and 2009.
  • Secondary effects will also be numerous as the default reverberates throughout credit markets.

However, in the long run, a default could have benefits.  It would likely encourage greater fiscal discipline among politicians, and would also alleviate burdensome taxes for maintaining a high debt level.  The United States would also benefit from the elimination of liabilities to foreign lenders.

Source: Jeffrey Rogers Hummel, "Some Possible Consequences of a U.S. Government Default," Econ Journal Watch, January 2012.

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