Defaulting Our Way to Higher Employment

Posted: July 28, 2011 in Uncategorized

A post by Matt Levine too good to paraphrase, so here it is in full length.  Follow-up and commentary coming soon.

Some fairly unobjectionable premises:

1. The U.S. Treasury’s IR girl was in Asia this week telling our Chinese overlords that we’re probably not going to default on our debt but if we do it’s democracy in action and they should actually be impressed, not pissed.

2. When our government is not busy blowing itself up, it usually spends most of its time with the overlords asking them to let their currency appreciate, which should increase U.S. exports to China and create jobs here (not everyone agrees)

3. There is an ongoing debate in the econoblogosphere about whether a default on U.S. debt would actually have expansionary effects (Krugman: no, Cowen: maybe, DeLong: probably a wash).

4. There are some people who think that focusing on deficit-cutting rather than Keynesian expansion when 10-year rates are below 3% and unemployment is close to 10% is kind of foolish.

So …

Not a macroeconomist, but…got to thinking about a simple political/macro model for what could happen with the debt ceiling endgame:

1. The U.S. defaults and/or does whatever else it takes to convince people that we are not going to get our shit together any time soon.

2. China loses faith in U.S. Treasuries as its main store of foreign reserves (not happening yet).

3. China dumps USTs and has nowhere else to put its money since UST is by far the largest and most liquid place for anyone to put foreign currency reserves.

4. With nowhere to put its savings China is forced to reduce foreign currency reserves and spend on internal consumption.

5. The yuan appreciates versus the dollar (see CHF, JPY) and likely versus other currencies.

6. American export and wage competitiveness improves versus China (though consumers get hosed by rising prices of imports).

7. This creates jobs in the U.S., reducing unemployment and helping all the incumbents get re-elected in 2012.

And so we achieve what politicians should actually want (jobs) without anyone articulating reasons for it / voting for it / doing anything about it except screaming about the debt ceiling. Problem solved! Or, a problem solved. Or something.

There are only three potential flaws in this plan:

1. Global financial catastrophe

2. USTs remain extremely well bid and some think would be better bid on a default on mindless-flight-to-safety grounds, meaning that the Chinese might see no reason to play along

3. Aerial and/or nuclear warfare

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