What if the US Defaults Next Week?

Some pain, then a whole lot of gain.

This week the US Congress is bickering over trying to raise their debt limit so they can borrow more trillions. The usual suspects, of course, are panicking that it will end the world.

I’ve talked about debt default in general, but now we have the prospect in flesh and blood.

So what would it mean for Americans in general, and for Bitcoin specifically, if Congress does default?

First, why is this happening. The US has an odd system where Congress can vote to spend more than it collects, but it has to separately vote on the debt limit in order to borrow that new money. If they don’t raise the limit in time, in theory the government runs out of money.

Now, the reason for this odd arrangement is to put an extra barrier on irresponsible federal spending. Which hasn’t worked, so far anyway. But it does create these dramas, this being potentially the 4th time in the last 25 years – 1996, then 2011, then 2013.

Unfortunately, each time they goof around for awhile but end up raising the limit. And, of course, since politicians usually choose power over the people, each time they try to make it as painful as possible for regular Americans. They do this by closing down the most popular parts of government like national parks or by postponing pension checks, while leaving the 99% of spending that is unpopular garbage running in the background.

The tactic actually has a name: “Firemen First.” As in get rid of the firemen first. Also called the “Washington Monument Strategy” since they invariably close the most popular tourist attraction in Washington. Cities, incidentally, play the same game, and they do it worldwide — I guess it’s taught in Government 101 at this point. So, as exciting as it would be to supershrink the government, it’s probably going to be little more than an inconvenience.

Still, for giggles, what happens if the US does actually fail to raise the debt limit and runs out of money?

How Much Money Are We Talking?

First, what’s the scale here. In 2021 the US government plans to spend $6.8 trillion. Of which about half is borrowed -- $3 trillion. So if they can’t raise the ceiling, they’d have to cut that $3 trillion.

Mainstream media, naturally, claims this is the end of the world. CBS estimates it would cost 6 million jobs and $15 trillion in lost wealth — comparable to the 2008 crisis, which was also caused by the federal government. CNN, more colorfully, claims cascading job losses and “a near-freeze in credit markets.” They conclude, falsely, that “No one would be spared.”

Considering the source, we can guess these predictions are overblown. So what would happen?

Well, $3 trillion is a lot of money — roughly 15% of America’s GDP. But we have to remember where that $3 trillion came from. The government, after all, doesn’t actually create anything, every dollar it spends came out of somebody else’s pocket. Whose pocket? Part of the $3 trillion was bid away from private borrowers like businesses, and the rest was siphoned from peoples’ savings by the Federal Reserve creating new money.

This means that, yes, GDP would decline sharply. But wealth would actually grow, perhaps substantially. The businesses would be able to buy things they need, while the savers keep their money that was doing useful things like paying their retirement.

So GDP drops, wealth soars.

Now, there will be near-term pain, simply because the GDP drop comes before the private borrowing ramps up, while those retirement savings are no longer being siphoned to pay for parties at strip clubs or, say, another trillion for farting cows.

So, yes, it will be a sharp drop in GDP. But so long as government stays out of the way, choosing the prudent 1920 response of doing nothing, the recovery will be very rapid. Why would they do nothing? After all, governments don’t like staying out of the way these days. Because a government that suddenly loses half it’s budget is going to find a lot of things not worth doing. Given a choice between defunding government workers’ pensions or defunding economy-crushing Green New Deals, governments will choose their own.

So that’s short term: pain, but less than it seems. And that’s where the magic begins. Because ending deficits fundamentally reduces governments’ long-term ability to prey on the people’s wealth.

This is because debt and money printers are much less obvious than taxes, which are painful and make more enemies. So a default becomes a “back door” to move government back towards its traditional “parasite” role rather than the “predator” role it’s taken on since Nixon unleashed the money printers. Especially since Covid-19, when lockdowns were bought with fresh money and deficits. I wrote about this predatory evolution a few months ago, but the bottom line is government default is a tremendous investment in our future prosperity.

What Does This Mean for Bitcoin?

A federal default very elegantly achieves one of the main real-world benefits of Bitcoin: it shrinks the state. Now, of course, the Fed will still siphon savings, but instead of handing that stolen money to government, it will be handing it to subsidized private borrowers. So the hustle remains, meaning Bitcoin remains imperative for protecting the people, but at least the stolen money isn’t funding wars and totalitarian mandates against the public.

As for individual Bitcoiners, a default is probably enormously price-boosting for Bitcoin. Partly because it’s chaos, and hedges like Bitcoin or gold like chaos, but because the Fed would almost certainly try to step in and make up for that “lost” GDP.

I’d guess the Fed tries to compensate for the entire $3 trillion, plowing it into anything with a price tag — mortgage-backed securities, corporate bonds, even equities. So money printing would probably actually increase — perhaps doubling on present trends.

This could make for some headline-grabbing inflation numbers, and considering Bitcoin is so responsive to inflation — my favorite metaphor is a tsunami up a canyon — this could make Bitcoin go up enormously.

So, in sum, with one weird trick we restore $3 trillion to the private sector, shore up Americans’ retirement savings and safety nets, and permanently reduce government’s ability to hog the resources we need to maintain prosperity. Indeed, if the default lasts, on current trends we’d be looking at perhaps $100 trillion going to our grandchildren.

Sadly, keep in mind all these wonderful things almost certainly won’t come to pass next week. In fact, they may not even get around to laying off the firemen. Most likely, they’ll make threats, the other side will cave amid media’s doomtalk, and we all get to move on to the next crisis.

Still, it’s worth keeping in mind what’s at stake here, what a glorious gift to future generations it would be if the government, for once, sat down and shut up. To be sure, central banks would still siphon trillions. But we’d be well on our way to at least fiscal sustainability. Not as good as going all the way to full Bitcoin adoption, to be sure, but a fantastic start.

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See you next week!