Arnold Kling  

Will the United States Default?

Correction on Krugman... More Thoughts on the Great Rec...

Someone asked for my comments on the Jeffrey Rogers Hummel piece.

I think that the U.S. government would enact a wealth tax rather than default on its debt.

Other countries that have defaulted have not had the option of enacting wealth taxes. When you are in a banana republic with shaky government finances and you have a lot of wealth, you send that wealth over to the United States, where your government cannot get to it. That "safe haven" motive is what keeps the dollar so strong. Anyway, by the time the banana republic gets around to enacting a wealth tax, all the wealth has fled the country and there is nothing left to tax. So the banana republic defaults.

As the U.S. government's finances deteriorate, it will strengthen its hold on its citizens' wealth. My guess is that you will see tighter laws that restrict your ability to hide wealth overseas and much more enforcement of those laws.

Basically, if a banana republic says to us, "Help us keep the wealth of our citizens," we can say no. On the other hand, if we tell another country, "Help us keep the wealth of our citizens," that country will co-operate. This asymmetry reflects the distribution of military power.

So what I am saying is that the ultimate guarantor against a U.S. government default is the U.S. Navy. Because of the navy, the U.S. government can control the policies of other governments. Because it can control the policies of other governments, the U.S. government is in a position to dictate whose wealth can flee where. Because the U.S. government can stop our wealth from fleeing, the U.S. could enact a wealth tax. Because it could enact a wealth tax, the U.S. is unlikely to default on its debt.

Have a nice day.

Comments and Sharing

COMMENTS (15 to date)
Niccolo writes:

The slightly less evil empire strikes again!

Sean O. writes:

On the Korea scale we are becoming more like North and less like South every day. But like frogs in a pot, we'll all be doomed before we know to jump out.

The Capitalist writes:

How large of a wealth tax can be put into place? It won't matter anyway... If such a tax were put into place, the reaction will be obvious... businesses, individuals, and entrepreneurs will want out and leave the country with their assets. Taxation has a prohibitive effect and a black market will be created... especially if a VAT is put into place. Violence, organized crime, and government corruption goes up because some police will be bribed to look the other way. Will the U.S. Government default? No, because I believe that the U.S. Government is already starting an "anti-deflation plan" AKA a huge inflation plan to pay off the debts and interest. The U.S. Government is made of the worst minds in the country, I expect to see the worst ideas put into place.

LLAC writes:

@ The Capitalist

US citizens may want to leave with their wealth, but that really doesn't matter. The US (uniquely) taxes the worldwide income of its citizens (and their worldwide wealth too, under the estate tax), regardless of whether you live in the US or abroad.

And it won't do to renounce your citizenship and move away. I believe the rule (too lazy to look it up) is that for 10 years after such renunciation you are still subject to US tax. In addition (or separately?), they is a high legal burden of proof on the taxpayer to show that the renunciation of citizenship was not tax-motivated. Even if you've jumped all those hurdles, you've basically rejected ever living in the US (and all that that entails) again.

That ties back into Arnold's point. The US can tax your worldwide wealth and income because of our global influence. This is playing out specifically in the UBS/Swiss dispute with the IRS (which the IRS mostly seems to be getting its way). The US is using its sway to force the Swiss to ignore their banking secrecy laws to give up the names of US account holders.

Fenn writes:

Serious question:

Is it better for the country's future to default rather than impose a wealth tax?

Akshay writes:

It's useful to remember that the US has already defaulted on its debt once-- when it devalued the dollar

Here, from,
In 1933, through a series of gold-related acts, culminating in the Gold Reserve Act of 1934, America realized a dollar devaluation of 41% when the price of gold was adjusted from $20.67 per ounce of gold to $35 per ounce. America, like the others before, had its economy bottom and recover as a result. Of the larger economies, only the French and Italians continued to adhere to the gold standard, and their economies remained depressed until finally, in 1936, they allowed their currencies to devalue, and their economies then recovered.

There could be a situation where the US refuses to pay interest on its treasuries, or something of the sort.

Jeff writes:

I certainly think this will be attempted prior to default; however, it seems unlikely that there's enough non-working wealth (i.e., not already locked into investment vehicles) in the US that is "capturable" in this way to stave off either default or hyperinflation. With deflation-warrior Bernanke ("drop money from helicopters") at the helm, coupled with continued egregious and unsustainable deficit spending and entitlement-creation, the logical progression would seem to be: wealth taxes, hyperinflation, eventual default.


8 writes:

Similar to a controlled devaluation, a tax will be swift and limited in time. You will wake up one morning to find XX% of various assets have been taxed away. Or you might wake up to find your $$$ are worth 50% less. There will be no escape because there will be no warning, and the protest will be muted because of this. Higher taxes spur people to leave, but if the tax is finished and the losses are over, what's the point?

It's like you're living on the side of Vesuvius. Once it blows, you're out of options.

winterspeak writes:

ARNOLD: I made this point in the original post, and I will make it here again.

Given that the US$ is a fiat, non-convertible, floating-fx currency, there is no reason the US need EVER default.

It would be like American Airlines running out of frequent flier points, or a basketball game running out of "score" to give to players when they make baskets. Similarly, the US is absolutely unconstrained in it's ability to create US$.

You seem to think we are on a gold standard of some sort where the regime needs to tax in order to have money to spend. This is exactly opposite to reality.

The US may inflate. The US may have higher tax rates. The US may alter domestic re-distribution in a myriad of ways. But it need never never NEVER default.

I offered to make a bet with Hummel. I'll make a bet with you.

David writes:

We've already seen the US' treatment of UBS and the money its citizens had been keeping with it. I wouldn't be surprised if we do end up with a wealth tax of some sort in the future.

Anonymous writes:

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Tim Nutt writes:

Arnold, the one place in the world that might be willing to tell the United States Navy "NO" would be China. I have read a few people who suggest that for this reason China might become the preferred destination for flight capital. Whether you are better off taking your chances with the Chinese government is a separate question, but that it is even in question is a pretty strong statement on how far we have come.

Jeremy, Alabama writes:

Unintended Consequence Watch:

You don't have to be a Star Wars fan to know "the more you tighten your grip, the more will slip through your fingers."

The British liberated more wealth in India, through reasonable returns and enforcement of contract, than the local princes could extort through extreme violence (iirc from "Wealth And Poverty Of Nations", David Landes).

The IRS shakedown of UBS is being hailed as a victory, but what are the unintended consequences?

The truly wealthy:
- are far more vigorous in protecting their wealth
- have far more options in its deployment
- have far more options in choosing where to live

The US can strong-arm Switzerland, but can it strong-arm Belarus and discover the $15k apartment someone just bought there? If the US strong-arms its friends, it necessarily improves the investment environment of its enemies.

If the US is contemplating a wealth tax, does this increase or decrease capital flight from the US? If the US is contemplating hyperinflation, does this increase or decrease capital flight?

Since the facts of life are conservative, conservatives will always be OK. But they may be somewhere other than the US. The US's big mistake is pretending it will always be the greatest beacon of freedom and wealth creation in the world, while ramping up the invasiveness, arbitrariness and sheer scale of its tax take. Those who create wealth are beginning to have better options.

Marty writes:

I think default is maybe not the right question. I would be more concerned about the rest of the world deciding the dollar is no longer acceptable as payment; essentially, no longer the reserve currency. This is already in the air and if it happens, would happen quite suddenly. As the only thing that sustains the dollar is confidence the Fed and Treasury will manage it well, you could see a crisis of confidence not unlike a bank run, think Bear Stearns or Lehman. Some volaitility and uneasiness in the markets, then a major player or 2 says "no" and everyone heads for the exits in a period of a few days.

I think the above commenter who said a default is illogical because the govt can always just make up more dollars is correct, as long as dollars are accepted. But what happens when they aren't acceptable at any reasonable price and the Treasury has to roll a $100B a month? Is there any level of interest rate that would be a stopping point, esp given that higher interest rates will increase the deficit and future debt burden?

Graeme Bird writes:

Of course the United States will default. Either by galloping inflation or by simply defaulting. Does anyone imagine that all the public servants are going to put up with losing their jobs just because the Chinese need to be paid back. Silly question. Since the answer is not the least bit in doubt. Its like asking whether Bernie Madoff would eventually default. You'll default just as soon as you cannot find anymore suckers. And not any later than that.

Imagine Obama suddenly showing up and saying that he was wrong. He's no longer a socialist. And he's closing down government departments by the bakers dozen daily until such time as he can what?........ fix medicaire?..... See to it that the Social Security is cashed up for all the baby boomers for decades to come????

No none of the above. Rather says Obama, while former taxeaters are rioting and demanding that he show his papers, the medicare can wait, and the social security. Because the Chinese, Japanese Dutch and Germans must be paid back. There is no mystery to this. You are bankrupt and you are unlikely to stay together in one piece. The last thing you are going to do is pay non-voters the money you owe them out of money that has not been ultimately borrowed or printed. You will not be paying anyone back out of tax receipts.

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