My Latest Column: The Chinese ‘Solution’

by Reihan Salam

My latest column for The Daily is an extended discussion of Arnold Kling’s scenario for how a U.S. sovereign debt crisis might play out. The following is from Kling’s provocative new essay:

Let us consider how this would play out in the event of a loss of confidence in the ability of the U.S. to meet its obligations. Under such a scenario, the hole in the U.S. budget is likely to be too large to be filled by an IMF loan. Consequently, creditors will be in a weak negotiating position. If the U.S. government is deadlocked (for example, with different branches of government controlled by different parties and strong partisan divisions, as now, going into the 2012 election), it will be in a strong negotiating position. That is, an IMF proposal for austerity that is too severe may stand little chance of being enacted.

If creditors are in a weak position and the government is in a strong position, then it becomes likely that a negotiated agreement will include some form of debt restructuring. The IMF will force as much austerity on the U.S. fiscal system as the political realities will allow, and the rest of the fiscal gap will be closed by a negotiated default.

It would seem reasonable to suppose that the U.S. would give up some of its sovereignty in the event of default. That is, in order to be able to resume borrowing in international credit markets, the U.S. would have to agree to IMF conditions going forward. The content of those conditions would be determined by the key lending countries. So, for example, if China wanted the United States to reduce defense spending as a condition for continued lending, the IMF would require lower defense spending as part of the negotiated default agreement.

Indeed, much of global politics and economics would be altered by a negotiated default. United States Treasury securities would lose the status of a “safe haven” asset and the dollar would lose its status as a reserve currency. International investors would seek out some alternative. That might involve gold or real estate or the financial claims issued by other countries. It is difficult to forecast what such a world would be like, other than it would be quite different from the world we live in today. [Emphasis added]

At the risk of coming across as a fear-mongering reactionary, I’d like to draw your attention to the highlighted passage. This is what Indiana Gov. Mitch Daniels meant when he described mounting debt levels as a “survival-level threat to the America we’ve known.” 

Newt Gingrich’s rise is predicated on the belief that he will never compromise with his political enemies. Yet it is also hard to imagine Gingrich charming or cajoling his political enemies into moving in his direction. It is not difficult to imagine that Gingrich’s approach to governance will accelerate the timetable Kling describes.