US and debt default are we on the way to global economic meltdown MK2?

Under US law, the country's national debt may not exceed $14.3 trillion (£8.75tn). That figure was reached last month, forcing America to dip into two government pension schemes to service its debts. That, though, will only tide the US over until the start of August. President Obama has been locked in talks with members of Congress in recent days, in an attempt to reach agreement to raise the ceiling. The Republican party is demanding massive spending cuts in return, and the two sides have made little progress.

America risks losing its triple-A credit rating unless swift and significant progress is made over its debt ceiling, Moody's the credit rating agency has warned, piling fresh pressure on the US a few hours before crucial employment data is released this Friday. The ratings agency is concerned by the lack of progress made by the US Treasury and Congress over whether to allow the US national debt to increase.

It said that the risk of the US defaulting on its loans was "very small but rising", suggesting that the country might not deserve its AAA rating. http://www.guardian.co.uk/business/2011/jun/03/us-credit-rating-under-threat-moodys

It is not just that the government could be brought to a standstill, with a third of its bills now being paid by borrowing; or that interest rates would shoot up, forcing thousands of homeowners into foreclosure. Failure to pay on the national debt could trigger a default on the global reserve currency.

The consequences of a US default could spark yet another global financial crisis. The US could lose its triple-A rating, which could cause a sell-off in Treasury notes by institutional and overseas investors. This sell-off could lead to higher interest rates, and banks’ balance sheets might be decimated by the decline in their bond portfolios. Thus, global banking and financial market liquidity could dry up. Lending between institutions and people or businesses could possibly cease altogether or become cost prohibitive we could run out of cash.

The sort of chaos that could ensue was seen when Britain reneged on its deal to redeem pound sterling banknotes in gold in 1931. The result was the worst global depression in history. When the pound went off the gold standard, markets panicked. People rushed to exchange their paper money for gold, in any currencies in which that was still possible.

The gold wound up hidden under mattresses and in safety deposit boxes, unspent; and the banks from which it was pulled, having no reserves to back their loans, quit lending or closed their doors. Credit froze; business ground to a halt.

So a game of Russian roulette is being played by the Republicans with the US national debt ceiling. Fire the wrong chamber of the gun, and the result could be the second Great Depression.

We have been frightened into believing that government debt is a bad thing, but nearly all money today originates as debt. That is what our money system is. If there were no debts in our money system, there wouldn’t be any money under the current system. The public debt is the people’s money, and today the people are coming up short.

There is, however, a solution to this problem, and it was discovered by Japan. The government can spend, not by issuing bonds at interest to the public, but simply by creating an overdraft at the central bank. The Bank of Japan now holds an amount of public debt equal to the country’s GDP! As noted by the Center for Economic and Policy Research: http://www.cepr.net/index.php/blogs/beat-the-press/the-japanese-central-banks-holding-of-government-debt-also-reduces-its-interest-burden

Interest on [Japanese] debt held by the central bank is refunded back to the treasury, leaving no net cost to the government on this debt Japan continues to experience deflation, in spite of the fact that its central bank holds an amount of debt that is roughly equal to its GDP!

Shrinking the public debt means shrinking more than just the services the government is expected to provide. It means shrinking the money supply itself, along with the ability to provide the jobs, wages and purchasing power necessary for a thriving economy.