Sunday, September 21, 2008

It could get much worse

Exerpt from,0,1400702.story By Rolfe Winkler – The Baltimore Sun


If the U.S. financial system relies on government funding to borrow, what will happen if the federal government's creditors take a walk? Consider Argentina, which in 2002 devalued its currency to pay off a crushing debt burden. Foreign capital fled the country, the banking system collapsed, inflation hit 80 percent and unemployment reached 25 percent as the economy sank into a depression.


That could never happen here, argue some. The $10 trillion national debt is "only" 70 percent of GDP, leaving the government plenty of borrowing capacity. But that ignores $60 trillion of projected liabilities for Medicare and Social Security, according to economist John Williams.


What's true of companies is true of countries: The more they borrow, the more they operate at the mercy of creditors. The more they borrow, the more violent their inevitable failure.


Under no scenario can Uncle Sam raise the trillions it needs to meet all these obligations. No tax rate is high enough, no discretionary spending cuts draconian enough. And there is no creditor of last resort for the U.S. Treasury. If default implies an Argentina-like scenario, that would leave us with only two options. The first is to print money; Mr. Williams says this would lead to "hyperinflation on the order of 1920s Germany." The other option is to eliminate Medicare and Social Security.



1 comment:

Math said...

Great job on the blog!

Regarding this article from the Baltimore Sun, I think it is important to remember that the Argentine peso was originally fixed to the U.S. dollar 1:1...which made the debt much harder to pay once the credit rating agencies determined it was virtually impossible to repay the debt. So, yes, Argentina eventually made the rate variable, but imposed a withdrawal limit on all citizens (protests on banks)...and overnight, everyone's bank account became worth much less when 1 dollar was worth over 3 pesos. The U.S. is a little different because it did not fix its currency...however, there are many other countries in the world that fix themselves (including some commodities) to the U.S. dollar. Interesting and scary stuff.