No Need to Ever Fear Default, Only Inflation


There is so much concern about the level of our federal government debt and how will we ever repay it. That is one thing to never have to lose sleep over. The United States uses a currency (the dollar) that only it can produce, has no obligation to back its currency with anything other than its commitment to accept it to pay taxes that are owed, no fixed exchange rate regime in which it operates, and has virtually no debt denominated in foreign currency.

Salt Lake Tribune March 28, 1937 By Mark Sullivan

Salt Lake Tribune March 28, 1937
By Mark Sullivan

All of these conditions result in the dollar being a flat currency, backed by nothing, with the unrestricted ability to create more of it by printing more dollars or, much more common, crediting bank accounts via keystrokes of a computer. Given this, the only way the United States can default on repaying its debt is if it makes a political decision to do so. It is in no way revenue constrained because it can create all of the dollars it wants to pay any and all debt that comes due.

The one major constraint it is under, however, and is mentioned in the excerpt above from 1937, is inflation. Given the very weak labor market, sluggish business investment climate, and continued need for households to build and rebuild their savings, I don’t expect inflation to be an issue for awhile. The Cleveland Fed seems to think the same as its long-term inflation model shows very moderate inflation expectations for the long term as the following chart shows:

Ten Year Expected Inflation and Real and Nominal Risk Premia

Default vs. Inflation – 2016 Update

[September 1, 2016 – Update] When this blog was published in April 2013 the economy was still recovering from the Recession of 2008. Looking back over this article today, during a time when we are close to full employment and the markets are strong, many of you would see this from a more positive perspective than most had in mid-2013.

Cleveland Fed 10 Year Expected Inflation

As the updated Cleveland Fed chart shows the 10 Year expected inflation is 1.63%.

[NOTE] Based on a comment I received I’d like to clarify that default should only be the result of a political decision and has nothing to do with the¬†ability to pay, just willingness to pay.

Over to You:

As you re-read this blog, given the positive economic climate we are in now – 2016 – does it change your perspective or your interpretation? There will always be global upheaval and political strife that affect the world economy. Do you agree that the economic climate affects your interpretation of the blog? I’d welcome your thoughts, especially if you commented on the blog when it originally was published in 2013!

12 comments on “No Need to Ever Fear Default, Only Inflation
  1. Ramanan says:

    Before you hit the submit button with such slogans “No Need to Ever Fear Default”, consider cases such as the debt ceiling.

    I know you will change the argument to “politicians are silly” but realize the falsehood of your title.

    • Gary Carmell says:

      Your point is well taken in that default should only be the result of a political decision and has nothing to do with ability to pay, just willingness to pay.

      • Gary Carmell says:

        From my reading of your well written link, your scenarios peg the pound to required convertibility regimes or have the U.K. borrow in foreign currency which then can introduce externally driven default catalysts versus solely political ones.

        • LVG says:

          Not all countries are like the USA. Many don’t have the choice not to peg their currency or borrow foreign debts. The MMT concept that anyone can remain sovereign is true, but not to the advantage of all countries at all times. For instance, MMT would probably say that China and Switzerland are not “sovereign” because they have had pegs of some sort at times during the last 10 years. But that’s only because it was advantageous for them to do so. It’s a choice to peg one’s currency, but sometimes it’s a very bad choice not to peg one’s currency.

  2. Sam Foster says:

    Great summary of the main reasons why fears of default are silly. However, I would also argue that fears over inflation are also misplaced. What we have to fear is not inflation per se, but hyperinflation and/or price inflation without corresponding wage inflation. Inflation, in and of itself, as long as it’s not hyper and as long as wages also grow at near the inflation rate, are vital aspects to any capitalist system. Since capitalism is based on the pursuit of profit and financial capitalism is heavily reliant on credit creation, capitalism simply cannot exist without some degree of inflation. As for hyperinflation, we have nothing to fear. As far as wage inflation, that is surely the biggest problem we face. Basic living costs, such as healthcare and education, have been and continue to rise at a much faster pace than wage increases. This, not some default bogeyman, is the main economic problem facing the US.

    • Gary Carmell says:

      The statistics would bear out your concern about very weak real wage growth for much of the population growth over the last 30 years or so in the face of higher costs for many of the necessities such as healthcare, food, housing, etc. Productivity and corporate profits have grown tremendously during this era of “financialization” while the share of the pie allocated to labor has dropped quite significantly. This link is a good pictoral of the diverging trends between productivity and real median incomes:

      I don’t share any meaningful concerns about hyperinflation such that it would have me change any of my investment strategies or how I live my life day to day. It usually manifests itself in non-fiat currency regimes in conjunction with some set of terrible economic or social conditions or disastrous political decisions. I have been very impressed by Cullen Roche’s writings about this subject at Pragmatic Capitalism. This is a good starting point to read more about how he views it:

      Thank you for your thoughtful post.

  3. Nice article, Gary. Repeat your points a thousand times and the message might eventually get thru to the idiots in power, and numerous idiots like Rogoff in university economics departments.

    • Gary Carmell says:

      “A man sees what he wants to see and disregards the rest.” – Paul Simon

      No reason to let the facts or truth get in the way of a good story. Thank you for your kind words.

  4. John Hobgood says:

    Well done, Gary!

    I’d love to see an article on the history of inflation in the U.S., what type of inflation it was and what the response was vs. your prescription.

  5. RhinoTroy says:

    Gary, how is “inflation risk premium” defined here? If it is “the amount you would be willing to give up to protect yourself from unexpected inflation” then 0.3% to 0.4% pa seems like a large amount to pay for such protection in a low yield world?

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