To Default or Not to Default? (July 2011)

We find ourselves within hours of a possible default by the US Government. A default simply means that the government will be unable to pay some of the bills and IOU's that come due, because the limit on its credit card will not have been increased. Catastrophic, right? Maybe, maybe not.

I don't fear the consequences of a default as much as I fear the continuous habit of reckless, increased spending while simultaneously cutting taxes. Imagine if you, as an individual, increased your spending enormously while cutting your income; and if this were not bad enough, you began or continued with two wars-where real people were being killed and maimed and the daily monetary toll was exorbitant. It would be crazy, wouldn't it? Well, that's what we have been doing for far too long. We have to stop this financial madness, and if a default now is the price, so be it. However, if the default is avoided at the last moment, and the irresponsible deficit spending continuous, it will eventually lead to a new default crisis. So, why postpone the inevitable?

How will a default or a budget compromise affect investments?

To achieve good investment performance, we need sustained economic growth, low inflation and full employment. To achieve these goals, we need a balanced budget and reasonable tax rates, which are the core issues in dispute in Washington right now. So, to improve the investment climate, we have got to get our financial house in order. We have to start living within our means, continuously, and not just every now and then.

My personal view is that a default is unthinkable, irresponsible and totally unacceptable. You honor your commitments. But let's be practical too. We just allowed millions of Americans to default on their mortgage loans and suffer no real consequences. We no longer have debtor prisons, and it is all too common for individuals and corporations to file for bankruptcy and wipe away their debt. So why can't the government act as irresponsible as so many of its citizens?

Who will lose if a default occurs? Clearly, those that are selling products and services to the government, and those that receive benefits. For example, military contractors, welfare recipients, etc. They will lose because the government will be forced to cut spending.

Who will win if a default occurs? Those that pay taxes, because otherwise tax rates would need to go up a lot in order to raise the revenue needed to continue supporting the prolific spending emanating out of Washington.

In sum, I would prefer that the parties in Washington reach an agreement. We need to cut spending-no question about that. But we cannot force a massive reduction in spending all of a sudden. It would be too traumatic, and it would have unforeseen negative consequences. Raising taxes alone is not the answer either, because it will eventually lead to more spending and will put us in the same position we are in now, perhaps an even worse one. The solution? Find the right balance between a reduction in spending and new taxes, combined with a commitment to live with balanced budgets that promote full employment, economic growth and low inflation.

I am in Argentina on a working vacation. This country has lots of experience in living with massive government deficits that have been financed with ever accumulating debt, just like we are experiencing in the US. The result of this financial recklessness? Incredible poverty, poor education levels, rampant and widespread corruption benefiting those with connections rather than those with merit, every day chaos, poor justice, extremely high interest rates and very little credit. We don't want to end up like Argentina, so I hope our leaders will reach a wise compromise.