Blog cafe : Paranoia or reality?

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: Sovereign debt crises happen suddenly. One day, a country is paying normal interest rates and has full control over its fiscal and monetary policy. Then, investors lose confidence. Within days, the country has collapsed, and within weeks the savings of the majority of its people are wiped out, as the government either defaults or radically devalues its currency.

The election is not the source of my paranoia. I think that Obama is more likely to have advisers who understand the concept of currency crises.

What has me paranoid is the enormous surge of debt issuance that is coming. If enough international investors decide that they need a large risk premium to compensate them for funding this debt, we could find ourselves with a lot of Treasury bills to roll over in an environment where interest rates are 10 percent or more. The government will not be able to afford to pay those rates, and so something drastic will have to be done.

At that point, what are the government’s options? Sharp spending cuts? My guess is that will be unthinkable (we might still be in a recession, after all). Print money to pay the debt? My guess is that option will not look attractive politically.

That leaves the option of declaring a national emergency and enacting what is known as a wealth tax or a capital levy. The idea is you undertake a one-time confiscation of assets and promise never to do it again. You hope that this has zero adverse incentive effects but brings in a boatload of money.

Only a relatively small portion of the population will be affected—and even they can be persuaded that the alternative is riot or revolution. So it can be the least bad alternative from the standpoint of political survival.