THE US FEDERAL DEFICITS AND DEBT: What Does a US Debt Default Look Like?

Article #6 Purple Wayz: Navigating to the Center

How bad is ‘Bad’? How many articles do you read about what will happen if we don’t solve the debt problem? Yeah, me too. We all know it’ll be ‘bad’. But we don’t know how bad – and that makes it all kinda vague. So people write about the past and the short term future. We need a lot more serious thought and research on this. But I’m here to tell you today - no one knows exactly how it’ll roll out. BUT IT WILL ABSOLUTELY SUCK!

A default on the debt would cause a deep recession or a series of rolling recessions. There are two key things that would make it different, and worse, compared to prior US recessions that many of us have experienced:

1) In a default driven recession, the US will need to deleverage down below 175% Debt/GDP. As you saw in the prior articles, the US has grown accustomed to getting out of recessions by leveraging up. Look at 2008 and 2020: from Jan 2008 to Jan 2011 the Debt/GDP jumped from 36.2% to 62.9%. From Jan 2020 to Jan 2022 the ratio jumped from 79.3% to 94.8%. If you can’t spend your way out of trouble, it’s a MASSIVE difference.

2) After the shock of a debt-driven crisis, the US will have to stay disciplined to reduce its Debt/GDP. This means the government can’t be on ‘perma-stimulus’ like it has been since 2000. Markets won’t allow it.

We’re like all these condo associations around me who don’t fix their roofs, siding or windows for years. All is well! The HOA Fees are low! Then gradually, leaks start. Then you get a couple cave-ins. And suddenly, you need a huge renovation project. Everyone is pissed off – who let this happen? Before blaming the property manager, though, take a look in the mirror.

Wait–it just got worse! As I write this today, the headlines on the deficits just worsened: In yesterday’s news, October and November 2024 showed a deficit of $624 Billion, up 64% from 2023. This is a staggering 12% of run rate GDP ($30T) and includes NO COVID EFFECTS. We’re spending hard, folks. And while Musk and Ramaswamy will be looking at discretionary spending, the Republicans are planning another tax revenue reduction that will dwarf any spending improvements. So bottom line, this problem is likely to get even worse than my prior articles indicated. Ouch. Just ouch.

A Parade of Lousiness. Below is a list of things that WILL happen if we don’t change course in the next 10 years. In what order, exactly how and when, no one knows.

• Depression, a Deep/Long Recession, or Rolling Recessions: When financial markets agree that a tipping point has been reached, there will be a crisis which will lead to a large recession or depression. There are a variety of factors causing this, but the main one is confidence. If the millions of decision makers in our economy believe the US government is perhaps not going to stand by its explicit and implicit promises, uncertainty will rule the day. So people will pull in their horns. This collective action will result in unemployment rates in the high single or low double digits, which we haven’t experienced in a while. If the US can be disciplined afterwards, it’s a lost 8-12 years. If it can’t, it goes on–similar to where Greece is (see prior article).

• Ineffective Federal Government reactions. The federal government will try to step in to fill the gap in national income by spending, as in 2008 and 2020. The Fed will flood us with liquidity, and try to drop real interest rates below zero. However, this traditional playbook won’t work well at 175% debt/gdp, as neither the Federal Government nor the Fed will have credibility. So the markets will react to these actions with higher interest rates, currency devaluation, and inflation. Once the cred is gone, the alternatives are all bad. It takes a while.

• Deleveraging. To recover, the federal government will have to show markets a doable deleveraging plan. This won’t be easy because during the downturn, the government feels the need to spend aggressively to fight the depression. But deleveraging has to happen.

• Interest payments will take a much larger share of the national budget, crowding out needed expenses in all budget categories including social, military, climate and industrial spending. The US MUST MEET all its obligations. No write offs. For the first time in a long time, US debt gains a ‘risk premium’.

• Net worth plunges. As the idea of a ‘risk free’ rate of interest based on US Treasury Bills goes away, valuations of everything from real estate to stocks to bonds dive. No safe havens. (Bitcoin?) Cash will be king, but even cash will lose value with inflation and devaluation.

• Tax increases. As in all major deleveragings, there will be a need for a tax increase, as taxable income will shrink with the economy and net worth. Tax increases tend to slow future growth and provide reduced incentives for new investments. These negatives contribute to the 8-12 year deleveraging cycle. This along with asset devaluation ironically reduces wealth inequality, but that is NOT the way you want that to happen.

• Spending cuts. Discretionary expenses will definitely be cut. And yes, finally mandatory expenses will be cut too (Medicare, Social Security, Veterans benefits, etc). Americans will finally experience what Europeans have been experiencing off and on for years: Austerity.

• Efficiency and compensation in government will become a big issue. ‘Why do they have such cushy jobs and pensions when I’m scraping by?’

• No longer able to police the world. Nations will recognize that the US can no longer fund a military that could fight multiple wars simultaneously. The lack of credibility causes unchecked outbreaks of violence in the Middle East and elsewhere.

• Potential Loss of Reserve Currency status. In the 60s, French Finance Minister Valery Giscard D’Estaing called the dollar’s status as the leading reserve currency as the ‘exorbitant privilege’ of the US. The benefits include lower cost of debt, prestige, the need for all nations to hold most of their reserves in dollars, etc. It’s hard to enumerate what the loss of this status would mean, but most acknowledge it would be substantial.

• Dollar crisis. Along with the punch of reserve currency loss, we would likely be hit by a devaluation of the dollar. While that might help some of our manufactured products to seem cheaper to the rest of the world, it would take a massive toll on consumer balance sheets and contribute to inflation as international goods become more expensive.

• Stagflation. The combination of inflation and depression is brutal. We would likely experience some form of this. As we saw in the 1970s and from 2022-24, the poorest ⅓ of the US society takes inflation very hard.

• Lowered ability to respond to future crises. After a crisis of our own making, it will take a long time for the world (and ourselves) to regain faith in Congress, the Presidency, the Treasury, the Fed and the Dollar. And, yes, the US Voting Public. We’re the ones who put the can-kickers in there in the first place.

• Unrest. The US is not great at sharing the pain, but we’ll have no choice. Young Americans will finally know what they’ve suspected all along – that they will not be receiving the same Social Security and Medicare that their grandparents did. Conflict will be high.

• Strong leadership will be key. Who will Americans vote to be their leaders during a time like this? This is a major risk, and could compound the situation. In 2015 in Greece, for example, voters elected the Syriza anti-austerity party to run the government. This put the country on a crash course with its lenders. This story is still playing out, as mentioned earlier.

Other Potential Scenarios? At this point, you’re ABSOLUTELY calling me a doom and gloomer. And you’d be right in saying that no one really knows the impact of US debt that reaches 175-200% of GDP. We’re in uncharted waters. For example, one other possibility is a slow growth, extended cycle (~30-50 years). We never deleverage, and we continue to lose ground slowly. Debt mounts, and we have a zombie economy.

One thing is certain, though: NONE of the potential scenarios include zero or light impact. The 175% debt/GDP problem is a bear. And I have a pointed question for you all:

ARE YOU REALLY WILLING TO RISK THIS?

The Free Rider problem in Democracy. You’re starting to see that the issue is the short termism of our current democracy. Hope and planning are battling each other, and hope is winning. Voters and representatives are exhibiting a ‘free rider’ problem. Just like the condo owners: “I’m not going to take the pain involved in dealing with this now; let the next guys deal with it.” It’s really hard for leaders to tell people that the nation’s long term health is at serious risk, especially when past spending binges haven’t caused any problems. Recency bias is at work. Proposing tough solutions to citizens gets politicians voted out of office. It’s so much easier to ‘give’ than to take away.

I’m mainly saddened by the fact that this is PREVENTABLE. I can’t stand that my kids’ and grandkids’ generations are likely to suffer through a very tough time in the primes of their lives due to the prior generations’ inability to deal with problems of their own making.

MMT’ers Can Leave now. OK. If you don’t believe that we have a big issue by now, you are a Modern Monetary Theorist (MMT’er). It means you believe that deficits don’t matter. Nearly the entire Economics field has debunked your theory. But you would absolutely be right in saying that nearly the entire Economics field has been wrong a ton, too. About a lot of things!! Anyway, I’m about to go into ‘The Fix’. Since MMT’ers don’t think a fix is needed, it may be your time would be better spent elsewhere. (Apologies for the passive aggressiveness – MMT is a very very frustrating thing to me).

To understand ‘The Fix’, you need to understand the components of the Federal Budget. Stay tuned.