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it was all just a bad dream...

Josh Marshall rightly extrapolates from the utterly insane and terrifying comments of Ted Yoho (R-Airstrip One) that we should all be very, very afraid. He’s not wrong, exactly (I just said he was “rightly,” after all) but I don’t think we’re going to default on the national debt. Here’s why:

40-50%: Debt limit compromise on process. Not enough, methinks, has been made of this report from Greg Sargent:

The principle articulated internally is simple. Never mind delaying or defunding Obamacare — there will be no policy concessions in exchange for a debt limit that would damage Dem priorities. Republicans must refocus on legitimate legislative means, i.e., the legislative process’ normal give and take. In exchange for the debt limit hike, there will be no medical device tax repeal. No Keystone pipeline. Obama administration officials are open to the possibility of face saving moves by Republicans being part of the endgame, but only ones involving process — not policy concessions — such as the McConnell provision, a device floated last year that would have largely transferred debt limit authority to the president.

This strikes me as being both politically and policy-wise the best solution. The Democrats and the President maintain that they did not offer policy concessions for ransom, the Republicans get to claim that they won something, and the potential of future debt ceiling crises is permanently defused in a wholly-legitimized manner. The main goal the President is trying to accomplish (and that the whole world should be behind) is that a faction of Congress cannot threaten massive catastrophe in exchange for unilateral policy concessions, and even a completely clean debt ceiling hike doesn’t wholly remove that possibility from the table in the future, though it would make it far less likely.

20-30%: Clean debt ceiling hike, AKA, the GOP caves. Who knows what lives in the addled mind of John Boehner? Of which GOPers are truly mad and which are eyeing the emergency exits on the crazy train? Certainly, though, it seems that if the Senate were to pass a clean hike soon, the pressure on the House to do the same on Oct 16-17 would be enormous, and it seems that wouldn’t be a too-unlikely scenario. This is certainly what the President wants, and it would hopefully defuse future crises of this nature, but of course, nothing is guaranteed.

20-30%: The financial crisis is substituted with a wholly political one. In this scenario, the President would emerge when the first payment is due beyond what is in Treasury’s coffers and above the legal borrowing limit and, legal memo in hand, declare the debt ceiling unconstitutional and order his administration to proceed as if it did not exist. (I don’t think the platinum coin, awesome though it is, has a snowball’s chance in hell of happening). What would happen then is – the government and debt markets proceed as normal, forever. The GOP would epically flip out, the House would pass a bill/resolution ordering the POTUS to respect the debt ceiling, but a) it wouldn’t pass the Senate and b) the POTUS/WH would simply lump that in with “unconstitutional threats to the credit of the US” and move along. The House would then impeach the President on a purely party-line basis, the Senate would acquit, and there it would lie. Certainly nothing would move forward in Congress through the rest of Obama’s second term, but it’s not like anything would anyway! Whether the POTUS’s decision was correct legally would be debated, but morally, pragmatically, and governance-ally the consensus would be sympathetic to him. This would have the effect of burying the debt ceiling as an issue forever, since it’s unlikely that the GOP would believe so strongly in this that, in 2017, a President Christie/Jindal/Cruz/Paul/Palin/whomever would take the oath of office and immediately order a cessation of payments on the national debt. It would also have the odd effect of making any US default ever, for any reason, untenable legally, and thus prevent the US from any kind of Argentina/Greece kind of debt restructuring/selective defaulting down the line, meaning an actual US debt crisis (as opposed to the political crisis nominally centered around the issue of the national debt) would have to be resolved through a combination of austerity and inflation.

…and that’s it. I truly do not believe that Obama and his administration has any incentive to elect to actually catastrophically default over taking the legal out above, and I think they would elect for that knowing full well it would result in impeachment.

But of course, they can’t say they’re going to do that, or even hint that they would, because that would eliminate all incentive for the GOP to cooperate in advancing either of the two other scenarios above. The GOP would love to paint Obama as a lawless debt-addicted tyrant and has been all-but-openly itching for a reason to impeach him since Jan 20 2009, so Obama in fact has to act like Option C is off the table even if he’s completely convinced that it’s the only alternative.

It’s going to be an interesting couple of weeks, folks.

I was listening to The Economist’s podcast summarizing their special report on Germany and and when I got to the equivalent of this line:

It is the largest creditor country in the euro zone, and as chief paymaster it has the biggest clout in determining the single currency’s future.

And I guffawed. And it’s worth explaining why.

When a creditor loans money to a debtor, there is the potential for everyone to be better off – the debtor can make an investment they could otherwise not afford, and the creditor receives some interest in return. However, there is a large potential opportunity for the debtor to rip off the creditor and never pay back their money, thus getting free money. Therefore, creditors have traditionally tried to employ both the power of the state and extra-legal threats to ensure compliance. There is a long history of violence and threats of violence in this regard, from Mafia kneebreaking on the black-market side to the Venezuelan blockade on the macro-side. The reason the Iron Bank of Braavos* gets paid back is because they have proven their willingness in the past to depose and assassinate kings to collect.

But modern norms have changed that. Sure, you can still be imprisoned for debt in certain parts of the United States, but remember that the entire state of Georgia was originally envisioned as a debtor’s colony. And on an international scale, while you will suffer for sovereign default, you won’t be invaded and expropriated, and note that countries like Argentina have done surprisingly OK after even a spectacular sovereign default. Not that being shut out of most financial markets, both as an individual and a nation, is without consequences, but it’s a lot better than being behind bars or under the gun.

What’s the point? The key is the huge power of social and cultural norms, and how many can persist even as related ones change. For example, our increased unwillingness to use violence and imprisonment to punish debtors would seem to encourage double-dealing by borrowers and recalcitrance by lenders; yet our powerful social norm in favor of paying back debts and in viewing creditors as virtuous (“savers” “investors”) and debtors, especially debtors who fail or struggle to repay, as sinners (“deadbeats” “spendthrift” “profligate”) then debtors will largely continue to pay and creditors will largely continue to lend even though debtors, not creditors, are gaining in leverage and material power. They have your money! Germany isn’t invading Greece or Italy or Spain or Portugal or Ireland! But debtors don’t have anyone’s respect and that matters tremendouslyAnd economic models (and economic commentators) fail to account for it.

*You seriously thought I was going to go all day on this blog without a reference to “A Song of Ice and Fire?” Ha! Ha, I say, ha!

Tyler Cowen poses this question:

Why is there still inflation in Greece?

He thinks this puzzle is hard, but it is in fact easy. Let’s model this more simply:

There are three countries in the world, Productoland, Moderatia, and Dysfunctiony. In this model there are a few rules:

· All money is gold.

· All goods and money can be teleported and traded freely across national borders.

· There is a universal legal prohibition from a resident of any country from relocating to any other country for non-leisure purposes.

· Wages are sticky.

· The equation of exchange accurately describes these economies.

In the initial state all three economies are performing well, even though “fundamentals” (mainly institutions) are much stronger in Productoland and significantly stronger in Moderatia. However, after some unexpected shock (say, a surprising report about the economic state of Dysfunctiony), there is a “panic” about the economy of Dysfunctiony. Very rapidly money, ie gold, begins to flee Dysfunctiony.

What would we expect to see happen? Primarily, we would expect to see a substantial negative shock to AD in Dysfunctiony. Wages are sticky; and more importantly, the law of one price means that prices of all goods (since there are zero transaction costs in this model) must remain equal in all three nations. Therefore, the decrease in MV would result in a reduction in QP; but because both Plabor and Pgoods are sticky, we would expect to see most of the commensurate decline occur in Q. We would expect to see some slowdown in Productoland and Moderatia, since presumably the market for imports in Dysfunctiony is slower, and overall global NGDP would probably fall, but if labor markets remained relatively tight in Productoland and Moderatia, we may in fact see the increase in MV in those countries (due to the influx of gold, ie money) lead to an increase in P, since Q is probably nearing its upper-bound; and an increase in P in those countries would of course result in a further increase in P in Dysfunctiony to the extent it affected teleportable goods. This would of course result in a further commensurate decline in Q, which would cause MV to further flee.

Basically, if transaction costs and barriers to trade are low, we should expect to see consumer prices move in unison within a currency union, and we should expect monetary shocks to result in severe real declines in output but continued price stability. This, I believe, sufficiently explains why Greece saw massive unemployment even as prices continued along the ECB’s chosen path, for the same reason Nevada saw unemployment increase from 4.2% to 14% over the course of the Great Recession even as there is no evidence that consumer prices diverged wildly in Nevada from other parts of the United States.

did ya miss me?

Thinking about the Wolfson Prize whilst walking about DC this evening, a notion struck me:

There are three futures for Europe. The first is total federation and integration. This seems, at the moment, unlikely. The second is constant crisis and panic with long periods of recession and tepid growth in-between, similar to the United States between the Civil War and the Great Depression. That choice is woefully undesirable. Barring either of those, it seems as thought the Eurozone may have to be, if not unwound, reduced in scope.

But how do you leave the Eurozone? Specifically in the current crisis, forgetting the logistical nightmare of endless private contracts denominated in euros, the sovereign debt is also denominated in euros; to leave the euro and refuse to pay back creditors in euro is default, the outcome everyone is trying so hard to avoid. So how can you leave the euro?

Well, I had one idea. Let’s say this – Greece leaves the Euro and re-institutes the drachma as the national currency at an initial 1:1 exchange rate. Obviously this rate will not last, and the drachma will plummet in value, leaving Greece poorer in the sane, proper way that independent nations do so – monetary devaluation. Yet Greece now has to pay its debts. How can they do this?

What if the European Central Bank offered Greece a special privilege – the Greek treasury can, up to a certain limit, exchange drachmas for euros at a 1:1 rate with the ECB. Greece can then turn around and use those euros to pay its pre-drachma debts.

Now clearly, the ECB will be taking a loss here. However, it won’t be a bailout – as far as Greece is concerned they are paying their debts fair and square with tax revenues. So there is no (or at least much less) moral hazard. Also, this avoids the dread specter of inflation that has so gripped the ECB. So even though they take a loss, it’s an outcome where a) Greece still pays 100%, b) the creditors are paid back in full in Euros, and c) there is no default, bailout, or inflation.

This still leaves the question of private debts; I’m not sure a program like this could work for every contract denominated in euros between a Greek and a non-Greek party. You wouldn’t want to allow anyone other than the Greek treasury to exchange drachmas for euros at a fixed, favorable rate, since you’d have a mad dash to dump the drachma in anticipation of devaluation. But if you could at least solve the sovereign debt problem perhaps the magic of the market could work out private debts on a case-by-case directly negotiated basis.

Anyway, just an evening thought on the issue d’jour.

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