From reading and watching current events, the public at large has become quite alarmed at the national debt and possibilities of default. It’s certainly a big issue dominating the political conversation in the U.S, Europe and even around the world.
Last summer, the specter of a default came into focus as the Congress, President and other officials in Washington argued over raising the nation’s borrowing limit yet again. And just in the past two weeks, the debt limit was raised once again by way of the agreement brokered last August.
Opinions on what to do to address these problems vary far and wide.
One of those options (…well actually two) is to default. Each one has tremendous consequences but their impacts vary depending on which type of default is pursued.
An outright default – one where the government simply refuses to pay interest in the debt it currently holds – would be chaotic to say the least. Some say this is the path that should be taken but politically, it’s a non-starter.
Let’s take a look at these two types of default and what it all means in terms of real world consequences.
(1). Literal Default
As we briefly stated above, a literal default means refusing to pay interest to those who have purchased T-bills and bonds that fund the government. Money market funds would collapse since many of them are heavily invested in these instruments. The stock market would drop dramatically and there would have to massive cuts in government spending. T-bills and so forth would in effect, become worthless.
Besides these consequences for equity markets and government outlays, uncertainty would grip the nation. Businesses would hold off on new projects until things stabilized.
Politically, this situation is untenable since most politicians do not want to simply ride this default process out. It may be allowed to occur in the short term but long term is a different story.
(2). Inflationary Default
The more popular way, at least politically in the short term, is to print more money to keep making payments on the interest of outstanding debt. That’s the big difference between inflationary default and a literal default – inflationary default increases the money supply.
But rather than pull dollars into the U.S. from around the world to finance the deficits, the U.S. Government along with the Federal Reserve can print the money to pay the bills.
This is different than Greece for example. Since they are part of the Euro, they’re unable to print money to pay their bills. In other words, their only option is a literal default, which as we can see, is very chaotic.
Will inflationary default lead to hyperinflation?
According to our main source for this post over at Live Gold Prices, it really depends on how rapidly the government increases spending. Absent a catalyzing event like a world war, hyperinflation isn’t likely to occur.
However, the author does maintain that inflation will occur to some extent but like us, he’s very cautious about predicting the future. We are too so we want to be careful about giving our thoughts too.
Inflation is certainly occurring – both through deficit government financing and the central bank’s monetary easing efforts aimed at stimulating economic growth.
Gold and silver bullion offer a refuge from this chaos. In times of high inflation – like the 1970s – both metals did very well.
