Will The United States Go Bankrupt?

In the decade or so that I've really been following stocks and finance, I've learned a few lessons that I think many people involved in markets still don't understand. I've learned that when a crisis is coming, be it an end to the tech bubble, a housing bubble, or problems in the mortgage market, most people will not acknowledge it until the market is well down that path. I've also learned that when these things happen, they have a tendency to collapse in on themselves and compound the initial trouble. So when I read this entry on the CFO blog about the possible bankruptcy of the U.S., I began to wonder if this will happen, and if so, what that means for me.

Now, the other side of all this is that dire predictions happen all the time that never come true. How many times have we been told that the world was coming to an end, that we are almost out of oil, or that Y2K was going to bring everything to a halt? The issue I struggle with is how to tell when the doom and gloom prophets are being reasonable (and seeing some data point the rest of us don't), and when they are being fearmongers.

One gauge I use to analyze issues like this is the various incentives of the people involved. Companies that offered solutions to Y2K issues benefited from predicting doom and gloom, so their predictions need to be discounted a bit for that. With respect to the issue of a bankrupt U.S. government, I don't initially see how a few economics or accounting professors benefit from such predictions. I assume they are being reasonably honest.

A second gauge I use is the structure of the overall situation, and whether it is possible for such an idea to get traction with the parties involved if it is true. Evolution is a great example here. Less than half of Americans accept it because it doesn't mesh well with the other things we want to believe. Our cultural and social systems prevent such an idea from becoming mainstream. So with respect to a bankrupt United States, if these predictions are true (and that is a big if), could the idea become mainstream enough to initiate any change? I think no, not until it happens. Populist politics will prevent it. No one will ever get elected who preaches sacrifice, savings, and fiscal discipline. The country will either need a vast cultural change, or we will have to directly experience the effects of a bankrupt U.S. to accept the policies that will get us out of that situation.

Incentives matter sooooo much when it comes to predictions and decision making, and I suspect that if this happens, it will occur only after many pundits are on national television explaining why it won't. These are, of course, the people who don't want it to happen and are often blinded by wishful thinking. But those "Dow 36,000" types are always out there before a crisis.

This isn't the first time I've heard the bankruptcy of the U.S. come up. I wonder if the people predicting this are the same people who, in 2003 and 2004, were the sparse voices talking about a housing bubble. I don't know enough about the issues involved to really make a good judgment, but I do know that historically, it has been very common for such fiscal mishaps to catch countries by surprise. Given the stupidity of the average politician, I think I'll err on the side of pessimism and protect my long-term downside risk.

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  1. Nick Huhn's Gravatar Comment by Nick Huhn on December 7th, 2007 at 6:21 am

    Taxpayers will go bankrupt long before the government does. No worries! ;)

  2. Andy Swan's Gravatar Comment by Andy Swan on December 7th, 2007 at 7:57 am

    Never forget to include political incentives. This is extremely likely when dealing with professors or think-tanks. Doom and gloom and sky-is-falling turns out the vote.

  3. Jay's Gravatar Comment by Jay on December 7th, 2007 at 9:34 am

    I’ve thought about this issue for decades. The bottom line is that “bankruptcy” of the government would mean massive inflation, probably a currency rejiggering, and when it is truly accepted what a problem we’ve dug, true changes to the budgetary roots of the problem. It’s less likely debt owed lenders to the government would be – why can’t I think of the word even with no kid crying a few feet away? – that is, creditors would not likely be stiffed per se. It’s just that inflating the currency accomplishes reducing the debt, but is a dangerous game. Which we’ve played enough before that perhaps it *won’t* become a factor, changing the scenario and possibly rendering it even worse.

    Guess I should go see what the link says…

  4. Richard's Gravatar Comment by Richard on December 7th, 2007 at 9:52 am

    Orange County, California recently went through bankruptcy. What was the effect?

  5. Jason Byrnes's Gravatar Comment by Jason Byrnes on December 10th, 2007 at 5:18 pm

    I cant realistically see the u.s. going bankrupt – please!! they will probably enter a reasonably bad recession, but a nation as powerful as the u.s. will not go bankrupt, its near impossible and foolhardy of those who believe it.

  6. Jason Byrnes's Gravatar Comment by Jason Byrnes on December 10th, 2007 at 5:21 pm

    Seems like a panic reaction to the downturn of the loans market to me, as a broker in the uk ( http://www.securedpersonalloansukonline.co.uk ) i have been expecting to see a huge downward spiral in the loans market for the last 12 months, so its no real surprise.

  7. Mike DeWitt's Gravatar Comment by Mike DeWitt on December 11th, 2007 at 9:23 am

    The article uses the term “bankruptcy” to mean that projected revenues won’t match projected expenditures. Does ANYONE think that Social Security and other entitlement programs won’t need to undergo massive overhauls in the next decade? That’s what we’re talking about, and that’s the issue that politicians hope they can forestall until THEY get out of the game. Under that definition, HELL YES the US will go bankrupt!

  8. Bo's Gravatar Comment by Bo on December 13th, 2007 at 2:52 pm

    The U.S. can never go bankrupt because we print money. Hyper-inflation can occur but not likely. I didn’t follow the link but if a writer at CFO is suggesting bankruptcy, he/she is using the term figuratively, inaccurately and downright ignorantly.

    Bankrupt U.S., Global Warming..we’re all headed to doomsday soon.


  9. Christine's Gravatar Comment by Christine on September 15th, 2008 at 2:04 pm

    Fact: The US dollar is steadily decreasing in value in comparison to the Euro, which is now the ONLY currency the OPEC nations will accept as payment for oil.
    Fact: The US has bankrupt itself by continuing to subsidize those on welfare who have not contributed one red cent to the economy, illegals who have infiltrated our country and continue to suck dry the somehow readily available aid given to them for being here ILLEGALLY when all they really deserve is deportation, AND by continuing to GIVE away TRILLIONS of dollars to foreign nations who will never repay their debt or have any interest in fair trade policies unless they are the sole beneficiary in the interest of kickbacks (politicians lining their own pockets).
    FACT: The government has caused this crisis by assisting corporations and businesses using cheap foreign labor and allowing them to continue to outsource Americans’ jobs.
    IF these are the people contributing to the so-called “BAD LOANS”, our government has noone to blame but themselves.

  10. Pondering's Gravatar Comment by Pondering on November 12th, 2010 at 5:25 pm

    The U.S. government can’t live within its means and neither can many private citizens. The country’s national debt is about equal to a year’s G.D.P. now. Does anyone out there think the U.S. can repay it or even has the intention of repaying it? At what point will it become not worthwhile for Chinese- and other creditors to keep financing America’s debt? Especially as the debt goes up the actual dollar value tends to decline? So the more the U.S. borrows the less able it is to repay it in more ways than one. I think the real question is at what point will China start decoupling its economy from the sinking American ship and shift its trading patterns to put more emphasis on India’s rapidly growing middle class, now numbering more people than the entire U.S. population?

  11. Pat's Gravatar Comment by Pat on January 8th, 2011 at 12:42 pm

    If we could stop the wasteful spending of the government and the illegal imagrents where not allowed to work and not pay taxes and send our money to the other countries maybe that would help .I don’t understand why that is so hard for our politicians to fix I guess they are more conserned about there on government payed pensions and votes than what’s best for our country.

  12. FMR's Gravatar Comment by FMR on May 1st, 2011 at 3:44 am

    The US electorate is to blame.They gave us George W. Bush TWICE.What followed was a healthy national economy being handed over from Bill Clinton to an administration consisting of people that were arrogant and ignorant.

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