<http://www.pimco.com/LeftNav/Latest+Publications/2004/Dialynas+Paper.html>
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Moreover, restructuring the global economy will require a dramatic reduction in American living standards.
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The reduction of America's debt requires an extreme reversal of personal privileges. The time for extreme sacrifice in the U.S. is upon us. The re-examination of "rights" is required as debt accrues in the U.S. Debtors hold very few rights, let alone personal liberty, albeit one important one-the right to default. They can default and, fortunately for them, avoid debtors' prison. As noted in my 1993 paper, the form of default is important, because default is a form of taxation. The simplest, most effective method of default is via cessation of payment. Because the U.S. needs relief from abroad by virtue of the trade deficit, it needs to start the adjustment. The U.S. default would be directed at the foreign holders of its debt. The side effects associated with outright default would be enormous. Foreign investment in U.S. bonds might stop. The U.S. dollar could plummet. The adjustment would be off to a fine start as long as U.S. interest rates did not rise substantially. Other methods of indirect debt default include inflation and currency depreciation. Employing inflation and currency depreciation to make the adjustment will take time and will not work. Unfortunately, an inflation tax is not a viable alternative for U.S. policy makers because the average maturity of government debt is only four years, the majority of entitlements are indexed to inflation and an increasing proportion of U.S. government debt is itself indexed to inflation. In any case, these polices promote only a gradual adjustment of global imbalances, if any, but more dramatic and immediate changes are needed. We are out of time. More time with the status quo will result in a more severe adjustment, less flexibility and, ultimately, a much harsher outcome.
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