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David Paul

David Paul

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Default Is Not in Our Future

Posted: 05/10/11 08:40 AM ET

The notion of a default by the U.S. Government on outstanding Treasury securities is nonsense. This is not to say that Congress will act to raise the debt ceiling. Who knows what Congress, in its infinite wisdom, will do; but the notion that a failure to raise the debt ceiling will lead to a default by the U.S. Government on outstanding Treasury securities is nonsense.

Debt and deficits and default are thrown around loosely these days. Deficits are what we have when our budgeted revenues are less than our budgeted expenditures. Debt is what we issue from time to time to fund those deficits that result from our wanting more things from the government -- services, wars, transfer payments -- than we are willing to pay for in taxes.

And we also print currency.

Actually, printing currency is a concept that has largely been rendered quaint, but the concept of printing currency continues to hold a place in the public imagination for those times when the Federal Reserve funds some purchase or expenditure with money that it creates for that purpose, and is provided to the recipient through electronic transfer. There is no printing involved, and no currency either, at least in the Wikipedia definition of "physical objects generally accepted as a medium of exchange."

In the case of the current battles over the federal budget and the raising of the debt ceiling, increasing the debt ceiling may be necessary for the issuance of new Treasury securities -- which once legally issued carry the full faith and credit of the United States of America -- as presumably such bonds cannot be legally issued if the debt ceiling has been reached. Therefore, failure to raise the debt ceiling would presumably constrain the ability of the Federal government to "spend beyond its means," meaning spending in excess of current revenues within a budget year. In the absence of debt capacity under the debt ceiling, federal spending would have to be held in check, and constrained to the amount of available revenues within a budget year.

But a failure to lift the debt ceiling should have no impact on the ability -- and obligation -- of the Fed to pay the interest and maturing principal owed on Treasury securities. Such payments will be paid by the Fed through an electronic transfer of funds that for all intents and purposes are created at the moment of transfer, without regard to any budgetary action by the Congress or the availability of revenues in the Treasury. No budgetary action or further appropriation is required for the simple reason that any Treasury debt currently outstanding was legally issued under the debt ceiling at the time it was issued, and the full faith and credit pledge of the Government is pledged to its repayment.

And this is true of the general obligation indebtedness of any state government as well. Or Greece, for that matter.

The difference of course is the printing press. California can default on its general obligation bonds -- if its politicians continue to play the games that are becoming all too easy and routine -- because it must have money in the bank to pay its bonds when they come due. There does not need to be an appropriation in the budget -- though there always is -- but there does need to be money in the bank. Because unlike the U.S. Government, California does not have the ability to create currency to pay the debts that it has legally incurred and to which it has pledged its full faith and credit.

But the U.S. Government does have that ability. And it does have that obligation. And the Fed would act on that obligation regardless of what games Congress and the President might continue to play -- whatever posturing they might find to be in their partisan interests as this charade plays out.

The fact is that U.S. Government will not default on its duly and legally authorized Treasury securities. And anyone who is paying attention understands this. Like the bondholders. Today, the yield on three-month Treasury bonds was one basis point. That is one one-hundredth of one percent. Or 0.01%. This rate has not changed in the past month. The three year rate is still below 1.00%, and the benchmark 10-year rate is 3.15%, or more than forty basis points less than one month ago.

So Democrats and Republicans can yell about debt and deficits, and manipulate as much as they like the simple fact that for decades now none of them have cared one whit about it, except for those moments that come along when it serves some partisan interest, and they can whip voters -- who should be ashamed of themselves for going along with all of this -- into a frenzy. But the markets have not blinked.

Because for all the debt, and for all the deficits, a default is not in our future. Because we own the printing press.

Whatever that means.