Free Market

Default! Default!

The Free Market

The Free Market 19, no. 11 (November 2001)


We will never resort to a bailout, said the Bush administration concerning the financial failures of the Argentinian government. That was one week before the same administration arranged an $8 billion line of credit for the same government. Nobody believes it is going to do much good. By once again rewarding fiscal profligacy, the bailout postpones the day of reckoning and causes much to happen (to American taxpayers among many others).

So why did the Bush administration give in? Everyone knows this is a compromising administration, in which public principles and actual policy are often in conflict. Courage seems to be in short supply, which doesn't make the Bush administration different from, well, every other administration since the beginning. (For details, see Reassessing the Presidency, John V. Denson, ed. [Auburn, AL: Mises Institute, 2001].)

In this case, the decision to be so generous with tax dollars came about because of the fear of default. The administration was willing to say no to foreign handouts until that magic word was mentioned. It's as if they didn't expect that the troubles were so serious that the government would actually end up writing off foreign loans, and thus stiffing lending banks.

US money-center banks are among the lenders, with a total exposure exceeding $62 billion in all of Latin America. The fear was that if Argentina defaulted, other governments might follow. The prospect of contagion, crisis, and panic, and the loss of any prospect for repayment, is what did the trick.

Imagine a wayward son forever borrowing money from dad and going on spending sprees. The dad keeps threatening to cut him off, but gives in every time the son raises the prospect that he will have to live on the street. Every time, the dad gives in at the last minute. If the son knows this, he faces every incentive to live on the edge.

It is worse in dealing with governments, because the loan packages arranged for Latin America are not drawn from anyone's private financial holdings but rather public monies. It is our collective wealth that ultimately backs these loans, pushed by banks that also know that they are too big to fail. In short, these are welfare clients lending to welfare clients, arranged by big shots whose only financial incentive is to maintain short-term stability.

I'm not telling you anything that people in the Bush administration wouldn't acknowledge over drinks and cigars. Why, then, do they keep it up? Because no one seems to understand that default would not be the end of the world. In fact, from an economic point of view, a default on loans has many advantages.

Consider that Argentina, and any other government that defaulted with it, would have its credit rating fall to zero and would be shunned by every conceivable lender. This is the best thing that could happen to these countries.

The governments would be forced to shrink dramatically and would be permanently blocked from raising revenue through any means other than tax increases that would be politically unpopular. Nothing could be better for Latin American prosperity than dramatically shrinking governments.

Part of Argentina's problem is the vast number of bureaucrats and union workers who live off the government. When the checks don't show up, they protest, sometimes violently. And they usually win. But if the money wasn't there, and there was no prospect of the IMF or the US providing it, it might be easier to explain to the grasping class that they need to move on with their lives.

Even from the lenders' point of view, they would face a short-term pinch but would be taught the important lesson that loans to governments are not inherently safer than those to private parties. In the long run, this knowledge would vastly increase the financial stability of these lenders. With sound portfolios, they would be less vulnerable to panic every time some third-world politicians get in trouble.

And, by the way, this permissive attitude toward default shouldn't be limited to foreign countries. It should be extended to bond-issuing US cities, counties, and states--even to the federal government. All bonds issued by governments should have a default premium, just like those in the private sector.

Among all the privileges the government sector enjoys, the most coveted is its ability to print itself out of any financial crisis. That is also the one that is most dangerous because it generates ongoing incentives to choose financial socialism over fiscal soundness.

Yes, bringing back the default would create short-term instability, but that is a far better choice than the current path, which can only lead to long-term erosion of money's purchasing power, here and abroad.

Llewellyn H. Rockwell, Jr., is president of the Mises Institute and editor of (


Rockwell, Llewellyn H. "Default! Default!" The Free Market 19, no. 11 (November 2001).

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