Summary: Hard times might lie ahead, forcing difficult choices. We must clearly understand our alternatives, and their history. IMO only clarity of thought and resolute wills will see us through the next decade. How to manage public finances might be our greatest challenge.
Why do we continue down a path which almost certainly ends badly? Since President Reagan we — citizens, voters — have indulged in an orgy of deficit spending — plus writing ourselves promises of vast future benefits. The reasons are complex and many. One is a belief that governments are reliable. Governments — real governments, of developed nation — do not default. Or so we believe.
Even implying that governments like ours might default earns scorn from most experts and major institutions. Yet governments do default, in many ways, frequently, when the time comes to pay high debt loads. And then life goes on. Default is not the end of a people, or even a nation. Like wars, often what happens afterwards has equal impact as what came before.
For a brief review of sovereign defaults see “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises“, Carmen M. Reinhart and Kenneth S. Rogoff, April 2008. Even superpowers default, as described in “The Sustainable Debts of Philip II: A Reconstruction of Spain’s Fiscal Position“, 1560-1598″, Mauricio Drelichman and Hans-Joachim Voth, 6 November 2007.
But there is no need to look at foreigners, we have our own history of defaulting. The United States has twice done soft defaults. First on 3 June 1933 with the wonderfully titled congressional resolution “To assure uniform value to the coins and currencies of the United States” (text here). And again in 1971, when President Nixon ended convertibility of the US dollar into gold by governments (see Wikipedia).
Other examples are the mini-soverign sub-units of the United States. The 11th Amendment to the Constitution prevents citizens from using the Federal Courts to compel States to honor their contracts. Only State constitutions and laws can do so, and they often allow flexibility to their governments. States have defaulted 17 times (perhaps more), in many ways.
- Eight States defaulted during the 1840’s. Four outright repudiations: Arkansas, Florida, Michigan, and Mississippi. Adjustments in Pennsylvania, Maryland, Illinois, Indiana, and Louisiana.
- Eight States defaulted to varying degrees during the 1870’s and 1880’s: Alabama, Arkansas, Florida, Georgia, Louisiana, North Carolina, South Carolina, Tennessee, and West Virginia.
- Arkansas defaulted on its bonds in 1933; but eventually paid all creditors in full.
Most of these were settled only after long battles in the State legislatures and courts (State and Federal), usually with partial payments (often long delayed). As a result there is a large body of case law on State defaults, which we might soon dust off and use.
Defaults of municipalities are governed by Chapter 9 of the Federal Bankruptcy Code. It too might get wide use during the next few decades.
For more information
The information about State defaults presented here comes from American State Debts by B. U. Ratchford, Asst Prof Economics at Duke (1941). For more detailed information I recommend The Repudiation of State Debts by William A. Scott, Asst Prof of Political Economy, U Wisconsin )1893) — available on Google Books.
Other useful reports:
- “The 2010-11 Budget: California’s Fiscal Outlook“, California Legislative Analyst’s Office, 18 November 2009 — Grim reading.
- “Nightmare scenarios haunt states“, Stateline, 14 December 2009
- ”California at the Brink of Financial Disaster“, Michael E. Genest (California Director of Finance), 13 January 2010
- “State of the States 2010: How the Recession Might Change States“, Pew Center on the States, 11 February 2010
- “The Trillion Dollar Gap: Underfunded State Retirement Systems and the Road to Reform“, Pew Center on the States, 18 February 2010
Originally published at Fabius Maximus and reproduced here with the author’s permission.