A Government Default Doesn't Matter

This article is published with permission from InvestmentU.com.

When I tell investors that a U.S. government debt default doesn’t really matter, they look at me like I’m crazy.

After all, Uncle Sam is the world’s highest credit. The country has always paid its obligations. And a default could send serious shudders through the world financial system.

Yet, it still doesn’t really matter. Why? In part because this “financial crisis” is an entirely manufactured one.

Don’t get me wrong. Washington is playing a dangerous game. And markets abhor uncertainty. But the risks are less than many suppose and the long-term consequences will be minuscule. Here’s why.

It’s not uncommon to hear people lament that — thanks to our political system — the federal government today is contentious, fractured and slow to respond.

Indeed. That is exactly how the Founders envisioned it. They would have been horrified by the prospect of a speedy and efficient government. That’s how hasty decisions get made and rights get trampled.

So they carefully designed a system with multiple blocking mechanisms: three branches of government, a two-house legislature, vetoes, veto overrides, super majorities, judicial review and so on.

The unwillingness to compromise today is more than just the usual partisan wrangling and posturing, however. There is a real and important debate playing out right now.

Are we going to become more like Europe, where government entitlements play a big role in citizens’ lives from cradle to grave? (Or, as one Swede told me, “from erection to resurrection.”) Or are we going to remain a country based on individual initiative and personal responsibility?

The answer will have enormous consequences for decades to come.

Credit the Tea Party

Many Americans are blaming today’s political intransigence on Tea Party Republicans in the House. This is largely true and most Tea Party members would be proud to admit it.

For decades, Republicans claimed to be the party of limited government and fiscal responsibility. But while they were rhetorically conservative, they were operationally liberal.

For example, when George W. was in the White House with a Republican majority in both the House and Senate, we got huge new entitlement programs (including No Child Left Behind and the new Prescription Drug Benefit), an enormous increase in the size and scope of government (thanks, in part, to the ill-conceived Patriot Act), record budget deficits, record earmarks, and no reform of the infernal tax code or runaway entitlement spending.

If this is limited government, I’m Ward Cleaver.

Recall that the Tea Party sprang up not in reaction to Barack Obama but to George W. Bush.

Unfortunately, Democrats took Republican financial recklessness and doubled down. Never have we run mind-boggling deficits like these during peacetime.

And spending — not revenue — is the problem. Obama asked for and received a $650 billion tax increase in January. As a result, the Treasury will take in record revenue this year. Yet we will still run a $700 billion-plus deficit in 2013. Obama is already saying Republicans must accept new tax increases.

In addition to the national debt — which is rapidly approaching 100% of GDP — the current unfunded liabilities for Social Security, Medicare and Medicaid total more than $126 trillion. To put this in perspective, that’s more than $1.1 million per taxpayer. On top of this rickety scaffolding, we have thrown the financial time bomb known as Obamacare.

Both sides are talking past each other right now. Democrats insist the Affordable Care Act is about providing high quality health care for all Americans. Republicans insist it’s about fiscal responsibility.

And this time, Republicans say, they mean business.

A doomed plan

Too bad they’re not acting like it. Their primary tactic — defunding the program — is both politically unpopular and doomed. Democrats are not about to let Republicans undo their primary legislative accomplishment of the last four years.

How will all this end? Your guess is as good as mine, but I’d wager on an 11th-hour, face-saving compromise that allows both sides to claim some measure of victory. And even if this doesn’t come before a technical default, it still isn’t a big deal.

I’m not saying world equity markets won’t sell off at this development. They may. But this is political theater, not national bankruptcy (though we are headed down that road). For now, no one believes we don’t have the ability to make good on our debts or that U.S. government bondholders won’t receive every nickel of interest and principal due.

That’s why there hasn’t been a spasmodic sell-off in the financial markets so far. And, in my view, there isn’t likely to be one.

So fasten your seatbelt and enjoy the show. We have a long-term financial picture that is ominous, but there is still time for fiscal sanity along the lines of Simpson-Bowles.

As for the federal government being rancorous, slow moving and inefficient, take some consolation in this fact: That’s how the Founders intended it.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

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