OUR own Grep Ip had a very interesting op-ed recently on the possibility that America might default on its debt. He noted that the credit derivatives market (American sovereign CDS traded at 82 basis points last Friday), now peg the probability of default at about 6%. That's amazing—last summer I found it incredible that CDS traded at 24 basis points. The rising CDS spreads are the result of speculation that spreads will rise even further, rather than the belief America will actually default. But even still, it suggests that markets are at the very least considering the possibility of a debt downgrade.

Mr Ip believes the government will sooner try and inflate down the debt than default, which is probably true. But he reckons that in the unlikely event America must choose between hyperinflation and default, the unthinkable could occur. In November, I imagined a scenario in which default could happen for political reasons, but that currently seems equally far fetched.

But could it be the case that American default is simply inevitable? As Mr Ip points out, the government must address its looming entitlement crisis. A solution there will involve either increased taxes or reduced benefits (and will probably some combination of the two), which is really just another form of default. Social Security is a pay-as-you-go system which means that there exists a social contract that current contributors will receive a particular annuity (based on wage and price inflation). Altering the benefit formula violates that contract, because the government will no longer pay what it promised cohorts when they paid into the system.

Still, a Social Security “default” or restructuring is probably the best alternative. Markets do not like surprises and most American put the probability of a change to entitlements near unity.

Update: Felix Salmon directed me to an earlier discussion on Social Security "default"