The Upside of Default

When the sub-prime loan crisis triggered a global financial meltdown, two issues became very clear.


The first was that America had a serious structural corruption problem with co-mingled interests among the financial sector, regulators and politicians.  The US had tilted its economy towards Wall Street and had undermined Main Street in the process.

The other issue was that America had become a nation whose growth flowed from over-consumption and the piling up of debt.  China, on the reverse side and quickly becoming a consequential economic heavyweight, was underconsuming and piling up cash reserves. 

'Global economic rebalancing' became the term of the times -- and Treasury Secretary Tim Geithner and others began talking in earnest about the importance to the global economy of China growing more through its own domestic consumption rather than through exports -- and of the US cutting debt and saving and investing more.

But addiction to consumption is hard to stop.  One way to quickly adjust consumption patterns in the US and to force a different behavior is to default on America's sovereign debt. 

There are huge and nasty consequences that lie ahead if the government does default.  Former National Economic Advisor to President Clinton, Laura Tyson, has estimated that just a 50 basis point rise in basic interest rates will result in about 600,000 Americans losing their jobs.  Some economists, on the far end of the scale, have said that default could trigger a 200 basis point rise in rates.

The key point is that a default will drive up rates and end America's role as a safe bedrock for the most conservative investments.  The US dollar will continue as the reserve currency, but other nations will build bigger hedges against the dollar.  The 'gravity switch' will be turned on -- and the financial sector will have less of a tilt in its benefit vs. the other real parts of the economy.

If default occurs, Americans will have to work harder to overcome the new hurdle put in front of them; they will have to invest more in the economy, will have to save more and grow the economy through a savings and investment strategy that we haven't seen in a long time.  The financial sector will be hit very hard, but America's export-oriented economy will get a boost as a cheaper dollar will put a tail wind behind the rest of the world buying less expensive American products.

I'm not endorsing a default.  I think it would be a terrible blow to American interests.  But there are some potential upsides if we do go into default that should be considered. 

As part of the sub-prime debacle, the US managed to export toxic financial products to the rest of the world -- and failed to protect the interests of its citizens as the financial sector blew up.  That was the point at which the rating agencies should have been moving to cut America's gold-plated investment rating. 

What we are seeing unfold in the debt ceiling crisis and the irresponsible actions of many  legislators is simply the second act of a play on America's decline that began some time ago.  The upside of America shredding its international reputation and responsibilities is that it ultimately will be forced to finally get its own domestic economic house in order.

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Steve Clemons is Washington editor at large for The Atlantic and editor of Atlantic Live. He writes frequently about politics and foreign affairs. More

Clemons is a senior fellow and the founder of the American Strategy Program at the New America Foundation, a centrist think tank in Washington, D.C., where he previously served as executive vice president. He writes and speaks frequently about the D.C. political scene, foreign policy, and national security issues, as well as domestic and global economic-policy challenges.

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