Memewatch: Krugman explains “default!”

FRIDAY, OCTOBER 11, 2013

How well did he do: Some things never get explained, although they get repeated incessantly.

Case in point: the following letter appears in today’s New York Times:

LETTER TO THE NEW YORK TIMES (10/11/13): The stance of some Republican members of Congress and others is not surprising, coming from the party that denies the human impact on global warming, is home to so many creationists and “birthers,” and cuts spending for research and education.

Gut feelings and denial of inconvenient facts are more important to them than rational analysis. Since 1968 I have worked for three Republican members of Congress and have covered the Hill for a major news agency, and this is the worst Congress I’ve seen.

It is a disgrace that the country is being ruined by some 20-plus know-nothing members who have little or no previous government experience, and by a “leadership” that is not willing to stand up to them and their well-financed ideological groups.

To this day, we have no idea how “20-plus know-nothing members” of the House are supposed to be running, even ruining, the country. You hear the claim made all the time. But how is that supposed to work?

At present, there are 432 members of the House (three vacancies). 232 are Republicans. How could 20-something junior members be screwing everything up?

We’re just saying! Our culture runs on familiar claims, not on clear explanations. A second case in point:

This morning, the analysts cheered at the start of Paul Krugman’s column. What will happen if we don’t raise the debt limit? Krugman said he’d explain:

KRUGMAN (10/11/13): So what are the choices if we do hit the ceiling? As you might guess, they’re all bad, so the question is which bad choice would do the least harm.

Now, the administration insists that there are no choices, that if we hit the debt limit the U.S. government will go into general default. Many people, even those sympathetic to the administration, suspect that this is simply what officials have to say at this point, that they can’t give Republicans any excuse to downplay the seriousness of what they’re doing. But suppose that it’s true. What would a general default look like?

“What would a general default look like?”

For ourselves, we weren’t sure what a “general default” even is. But it sounded like we were about to get a good solid clear explanation.

To some extent, we did. According to Krugman, this is what a “general default” would be like:

KRUGMAN (continuing directly): A report last year from the Treasury Department suggested that hitting the debt ceiling would lead to a “delayed payment regime”: bills, including bills for interest due on federal debt, would be paid in the order received, as cash became available. Since the bills coming in each day would exceed cash receipts, this would mean falling further and further behind. And this could create an immediate financial crisis, because U.S. debt—heretofore considered the ultimate safe asset—would be reclassified as an asset in default, possibly forcing financial institutions to sell off their U.S. bonds and seek other forms of collateral.

In a general default, payment of all bills would be delayed, “including bills for interest due on federal debt.” As a result, financial institutions might “sell off their U.S. bonds and seek other forms of collateral.”

How many readers fully understand what that means? At any rate, if that happened, that could or would “create an immediate financial crisis.”

We’ll guess that a very large chunk of Krugman’s readers couldn’t really explain that part of his column. Whatever! As he continued, Krugman explained what would happen if we “prioritize”—if the Treasury Department “pays off bonds in full, so that the whole burden of the cash shortage fell on other things.”

What would happen if we did that? It wouldn’t be great, Krugman says. He goes on to explain his claim, but chunks of this are fuzzy:

KRUGMAN: Some advocates of prioritization seem to believe that everything will be O.K. as long as we keep making our interest payments. Let me give four reasons they’re wrong.

First, the U.S. government would still be going into default, failing to meet its legal obligations to pay. You may say that things like Social Security checks aren’t the same as interest due on bonds because Congress can’t repudiate debt, but it can, if it chooses, pass a law reducing benefits. But Congress hasn’t passed such a law, and until or unless it does, Social Security benefits have the same inviolable legal status as payments to investors.

Second, prioritizing interest payments would reinforce the terrible precedent we set after the 2008 crisis, when Wall Street was bailed out but distressed workers and homeowners got little or nothing. We would, once again, be signaling that the financial industry gets special treatment because it can threaten to shut down the economy if it doesn’t.

Third, the spending cuts would create great hardship if they go on for any length of time. Think Medicare recipients turned away from hospitals because the government isn’t paying claims.

Finally, while prioritizing might avoid an immediate financial crisis, it would still have devastating economic effects. We’d be looking at an immediate spending cut roughly comparable to the plunge in housing investment after the bubble burst, a plunge that was the most important cause of the Great Recession of 2007-9. That by itself would surely be enough to push us into recession.

In his third and fourth points, Krugman notes that the government would have to cut or delay all kinds of other payments if we prioritized interest payments. This would create a giant mess, including a quick recession.

That seems fairly straightforward. But how well do you understand the business about “default” in Krugman’s first point?

Here’s the good news: Krugman says that prioritizing—“paying off bonds in full”—“might avoid an immediate financial crisis.” But in his first point, he says “the U.S. government would still be going into default, failing to meet its legal obligations to pay.”

Do you understand what that means? More specifically, do you understand why that is supposed to matter? If we avoid that “immediate financial crisis,” why are we supposed to care if someone can still say that we are “in default?”

In points three and four, Krugman explains the obvious—absent the ability to borrow money, a lot of bills will go unpaid. But for our money, even this piece, by our sharpest columnist, remains rather unclear about the whole notion of “default.”

In this column, Krugman uses a lot of technical terms which may not strike him as technical. For people who aren't well versed in finance, the air of confusion grows.

Our general view of this matter is this: We simply aren’t a highly skilled people. Many things simply won’t be explained, even by our brightest, most valuable writers.

As a people, we’re remarkably limited. It’s amazing how good our technology is, given our weak verbal skills.

A very basic question: Here’s a very basic question drawn right out of this column:

If “financial institutions sell off their U.S. bonds and seek other forms of collateral,” in what way would that create “an immediate financial crisis?”

Just a guess: Most of Krugman’s readers couldn’t really answer that question. As a highly knowledgeable expert, Krugman didn’t see the need to break it down more than he did.