[T]hreatening to default should not be a partisan issue. In view of all the hazards it entails, one wonders why any responsible person would even flirt with the idea.
-- Alan S. Blinder, Princeton professor of economics, former vice chairman of the Federal Reserve
A game of Russian roulette is being played with the national debt ceiling. Fire the wrong chamber of the gun, and the result could be the second Great Depression.
The first Great Depression led to totalitarian dictatorships, war to consolidate power, and concentrations of capital in the hands of a financial elite. The trigger was a default on the global reserve currency, in that case the pound sterling. The U.S. dollar is now the global reserve currency. The concern is that default could create the same sort of global panic today. Dark visions are evoked of the President declaring a national emergency, FEMA plans locking into place, camps being readied for protesters, and the secret government taking over . . . .
This may all just be political theater, but do we really want to get close enough to the economic precipice to find out? The conservative ideologues toying with the debt ceiling are doing it to force cuts in the budget, a budget that was already approved by Congress. Congress is being held hostage by a radical minority pushing a risky agenda, one that is based on an economic model that is obsolete.
On May 16, the Wall Street Journal published an opinion piece titled "The Armaggedon Lobby," which claimed that a "technical default" on the federal debt was just "political melodrama" and not really a big deal:
[B]o nd markets can figure out the difference between a genuine default when a country can't pay its bills and a technical default of a few days if it serves the purpose of fixing America's fiscal mess.
Not so, said Saudi Prince Alwaleed bin Talal in a May 20 interview on CNBC. "That's gambling. This is the United States. You're leading the whole world. You cannot play games with that."
It is not just that the government could be brought to a standstill, with a third of its bills now being paid by borrowing; or that interest rates would shoot up, forcing thousands of homeowners into foreclosure. F ailure to pay on the national debt could trigger a default on the global reserve currency. As one commentator described what could go wrong:
[T]he consequences of a US default could spark yet another global financial crisis. The US could lose its triple-A rating, which could cause a sell-off in Treasury notes by institutional and foreign investors. This sell-off could lead to higher interest rates, and banks' balance sheets might be decimated by the decline in their bond portfolios. Thus, global banking and financial market liquidity could dry up. Lending between institutions and people or businesses could possibly cease altogether or become cost prohibitive.
A Rerun of 1931?
The sort of chaos that could ensue was seen when Great Britain reneged on its deal to redeem pound sterling banknotes in gold in 1931. The result was the worst global depression in history.
When the pound went off the gold standard, markets panicked. People rushed to exchange their paper money for gold, in any currencies in which that was still possible. The gold wound up hidden under mattresses and in safety deposit boxes, unspent; and the banks from which it was pulled, having no reserves to back their loans, quit lending or closed their doors. Credit froze; business ground to a halt.
As other countries ran short of gold, they too were forced to take their currencies off the gold standard. The last holdouts suffered the most, including the United States, which kept its gold window open until 1933.
The 19th century had been plagued by bank runs, caused by banks having too little gold to back their outstanding loans. The Federal Reserve was instituted in 1913 ostensibly to prevent those runs, but its levee did not hold back the run of the 1930s. In 1933, the country suffered a massive banking collapse, forcing President Roosevelt to declare a banking holiday and take the U.S. dollar, too, off the gold standard.