US Government Debt Different - Finance Department - University of ...

160Burning the Furniture to Heat the House – The Potential Role of Asset Sales in Funding the Federal Government’s DeficitsOutright default or restructuring or attempting to implement capitalcontrols would generate a severe credit shock in the US and abroad.Investors in US securities across the risk spectrum would flee, provokinga severe credit contraction and sinking prices along with thedollar. Moreover, impairing recoveries on Treasury securities wouldreduce the value of a large proportion of the assets on balance sheetsof US financial and non-financial companies alike. Domestic providersof credit—banks, mortgage finance companies, life insurancecompanies—would all retrench, slowing economic activity. The capitalbuffers that US banks have built up since the crisis would likelybe eliminated, requiring government re-intervention to shore up thefinancial sector at the worst possible time. Moreover, it is unlikelythat the US could effectively implement capital controls to preventcapital flight, given how open its economy is today.Using inflation to reduce the US government’s real burden of debtservice would run directly contrary to one of the Federal Reserve’stwo core mandates. And if Congress proved desperate enough torevise the central bank’s charter to force it to abandon price stabilityas a target, markets would revolt. Inflation would reduce real returnsnot only on Treasury securities, but all US securities. The dollarwould again sink. And borrowing costs for the Federal Governmentwould skyrocket.That leaves budgetary austerity and asset sales. Political compromiseto reach agreement on serious long-term budgetary austerity is unlikelyin the near term for two reasons. First, the majority of seriousdebt reduction proposals call for both lower expenditures and taxincreases. 12 As Alexander explains, leading proposals reflect very differentif not irreconcilable political priorities, which make it difficultto achieve consensus on long-term reform. 13 For example, there are12 President Obama’s FY2013 Budget, the LaTourette-Cooper Plan modeled afterproposals from the Bowles-Simpson Commission and the Domenici-Rivlin TaskForce, and the Progressive Caucus proposed budget, all feature combinations oflower expenditures and tax increases. The Ryan Plan calls for lowering expendituresand taxes.13 Alexander, L., Near-Term Fiscal Challenges for the US, Nomura Policy Watch,Jun. 26, 2012 (comparing the Ryan plan, which would shrink federal transfer programswithout directly increasing aggregate tax revenues, with the Progressive Caucusplan, which increase the progressivity of the tax system to accommodate risinghealthcare costs).