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Thread: Government Debt: Why it Doesn’t Matter for the U.S.

  1. #1
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    Government Debt: Why it Doesn’t Matter for the U.S.

    September 16, 2009

    For the past few months there has been a great deal of controversy over government debt and the cost of issuing additional stimulus and new programs such as health care reform. Critics say the U.S. is taking on too much debt and that it will eventual implode the country. Well is should come as no surprise that the U.S. government is not like me and you when it comes to finances.

    U.S. debt doesn’t matter; it is merely a statistical score sheet. You can actually liken U.S. government debt to the dead beat that never pays his credit cards or other bills and simply rolls over debt with consolidation loans or uses one credit card to pay for another. The problem for the individual is this credit line eventually gets cut. However, the U.S. credit line will likely never get cut and here’s why.

    The U.S economy is still the largest economy with Gross Domestic Product (GDP) of 14.4 trillion dollars for 2008 (13.3 trillion in 2005 dollars) and is approximately double that of China for all the hype it gets. In terms of a percentage of U.S. public debt to GDP the U.S comes in ranked number 24 or about 61%. This is better than notable economies such as Germany (64.4%), Canada (63.8%), India (61.3%), France(68.1%), and Japan (173%) of outstanding debt based on IMF estimates ( The worst country in terms of debt as a percentage of GDP is Zimbabwe coming in at 259.40%. Many joke that the U.S dollar will become the Zimbabwe dollar but it seems we have ways to go before that happens. If you look at debt in terms of a fraction of GDP, then the U.S. is far better than it was in 1940 ( and in reality we are circa the 1955 levels. In terms of GDP using purchasing power parity (ppp) aka bang for your buck, per capita the U.S ranks 6th in the world by the IMF and is by far the best largest country in the top 10 while China only comes in at 100th. Being that China has many more people, they should be producing much more. Seeing that 61% of our GDP is foreign national debt, foreign nations have a vested interest in keeping the United States alive and well. To “stop buying” our debt would be suicide and akin to trying to only burn down only 25% of your house; especially for larger economies. US debt is pretty much owned by every major economy. China coming in at number one with 24% followed by Japan at 20% Like it or not, every nation is in this together. Worse comes to worse, the U.S. debts will just be forgiven as countries are left with little alternative until they find another consumption behemoth or another planet to trade or invest with. Debt forgiveness happens frequently with African governments and many times over.

    In terms of consumption, the U.S represents approximately 7 trillion dollars or about 11% of the entire world’s consumption This is roughly 1.4 times the size of Japans economy and about 1.6 the size of Chinas ( This is a staggering number that shows the United States ability to spend that cannot be ignored by any nation. Certain news articles even state that it would take “five earths” if the entire world consumed like the U.S ( Environmental concerns aside, this is a powerful percentage that simply cannot go away. Foreign economies depend on our excessive appetite for consumption and are left with little alternative. This mutual dependence is why foreign economies depend on the U.S. debt and are being forced in. This brings me back to the financial model. If banks have no one to lend to, then how would they make money? In theory, it is the same for government. Foreign governments are forced into buying other nations debt because they need to do something with their money. The sheer dollar volume involved (trillions) makes it impossible to be absorbed by the private sector and so the only alternative is to lend to the world’s largest economies no matter how fiscally irresponsible they may be.

    The massive stimulus response and quantitative easing by the US government to address the recession will ultimately not affect the U.S. economy. While the bailouts and stimulus packages have been criticized by many calling it socialism bailout advocates are simply taking a page out of Keynesian economics. Government intervention is nothing new. In fact it has always been a major component of GDP and is actually part of how the formula is calculated. Without going into the macro economics side of things too much, GDP = C (Consumption), I (Investment), G (Government spending) and X − M (Net Exports) (or GDP = C + I + G + (X − M). John Maynard Keynes, a famous economist, essentially states that the private sector screws up sometimes and leads to inefficient macroeconomic outcomes (no need to inform TARP recipients) and therefore advocates public response through either monetary or fiscal policy to stabilize the business cycle. He also states that excessive saving is a serious problem encouraging recession or worse depression. So it comes as no surprise that the US government enacts monetary policy by making saving the least profitable endeavor by lowering the fed funds rates in turn affecting all interest rates and making borrowing that is either used for investment or spending cheaper. All this is in an effort to boost the economy. With fiscal policy, we could call this a bridge loan until things get better and we are able to pay it back. Aside from the eventual crowding out affect of fiscal policy because the government essentially "pushes out" the private sector by creating artificial demand, fiscal policy is not an issue as long as it eventually unwinds. In economics “eventually” can be years so time will tell. While I personally favor more the Milton Friedman’s view of economics that only favors monetary policy, stimulus is sometimes needed. Political agendas aside, when properly utilized economic stimulus is a tool that has been successfully and unsuccessfully utilized for centuries dating as far back as the Roman Empire.

  2. #2
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    With stimulus there comes the question of how do we pay for it? The U.S. can finance and eventually pay for stimulus either through higher taxes or inflation. Since no one favors higher taxes either politically or socially, inflation is the easy answer. Now inflation often gets a bad rap because it could be considered taxation without legislation, but it is nothing new and is actually necessary for a healthy economy as long as it is controlled. The definition of inflation is “a rise in the general level of prices of goods and services in an economy over a period of time" ( You just have to listen to your grandparents talk and I am sure you have heard “a cup of coffee used to cost 10 cents” and “I remember when the movies were 50 cents” etc. So inflation is actually good for markets and the economy since companies now have pricing power and can raise prices resulting in higher profits and most likely expanding and subsequent employee hiring. Companies can only raise prices when there is more demand for their product. Furthermore, with inflation would you rather own cash (dollars) that is becoming less valuable or say stock in a company that is increasing profits and probably expanding? So the fear of rampant inflation and the subsequent tanking of markets is wrong. The U.S. would have to spend something to the tune of 30 trillion dollars in a single fiscal year to become the next Zimbabwe. So the whole goal is for the U.S. government is to bring back inflation across the board steadily and not just in certain sectors like healthcare.

    In summary, the U.S is still in decent shape despite all the mass headlines and articles to the contrary. There is no need to go procuring food and ammo. The U.S. productivity in terms of working hours is still one of the highest in the world with the average working hours per week coming in at 35 hours. ( ). While unemployment remains high, it had to reach these levels and will be actually be a good thing moving forward. Companies have gotten rid of the waste and have become more efficient at utilizing their capacity and are now more productive. A reallocation of the U.S. workforce is needed to shift from traditional stagnant industries to new growing ones. The industrial revolution, widely held as one of the most successful economic periods in our time, had very high unemployment. Traditional peasants were being replaced by machines and new technology but eventually this new technology caused a sustained rise in real income per person despite the debate over the definition of the standard of living for the time. Today, one could even draw the same similarity to what is going on in the U.S. car industry. The U.S. is simply in the midst of a workforce “shift”. Laid off auto workers may now change professions and head toward growing sectors like alternative energy. Reallocation and an improvement of technology are essential for a growing economy. The free market is very efficient and while not always seemingly fair, it forces the best outcomes. Competition breeds excellence and capitalism will always prevail if simply not for the plain fact that humans are inevitably greedy.

    With that, the United States finds itself with economic conditions that are quite manageable. However, to coin John Adams “all the perplexities, confusion and distress in America arise not from defects in their Constitution or Confederation, nor from want of honor or virtue, so much as downright ignorance of the nature of coin, credit, and circulation”…seems like we are still working on that 200 years later.

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  4. #4
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    A contrarian viewpoint (the clip at the end is especially cheerful).

  5. #5
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    Exporting Inflation

    January 13, 2011

    For years, Michael Maloney has been talking about the “exorbitant privilege” granted to the U.S. dollar with its role as the premier international reserve currency. Over the years, the United States has abused its role as issuer of the world’s reserve currency—silently stealing wealth from the world through currency creation.

    Behind the machinery of the world’s financial systems, dollars are the medium of exchange the world transacts in. So every time the Federal Reserve creates a new dollar, the rest of the dollars in the world get devalued—whether they are in the United States or the United Kingdom. The “exorbitant privilege” comes from the United States’ ability to essentially dictate monetary policy to the central banks of the world.

    Here’s what we mean: If the Fed engineered a drop in the value of the dollar, foreign central banks would have two choices: a.) allow the dollar to fall and the allow resulting rise in the local currency, or b.) force the local currency to fall alongside the dollar.
    If the dollar fell, it would take more dollars to buy other currencies. For example, say today one dollar would buy you 82 yen. If the dollar were to fall tomorrow, then tomorrow one dollar might only buy 80 or 81 yen. Conversely, if the dollar fell, it would take fewer yen to purchase one dollar; therefore, each yen would have a higher value against the dollar.

    Option A, a falling dollar, would result in bad things for exporters. If the local currency rose, exporters that depend on the U.S. consumer would see painful rises in the prices of their goods. If the Japanese yen rose, the prices of yen-based goods (think Sony PlayStations, Toyota Tacomas, and Nintendo Wii’s) would rise. Fewer yen-based goods would be sold because of those rising prices. This would bring massive pain to export-dependent countries, which would now be priced out of the markets of the all-powerful U.S. consumer. This scenario is the road less taken.

    Option B, forcing the local currency to fall as the dollar fell, would result in inflation of the local currency. Just as the Fed would print currency, the Bank of Japan (hypothetically) would create more currency in an attempt to maintain the former exchange rate. Currency creation equals inflation because the more units of currency there are in existence, the less each unit of currency is worth—in other words, the value of the currency would be less. When the value of currency decreases, prices go up. Inflation of a currency results in price inflation.

    What this means is that the U.S. could export inflation to its trading partners. But this “exorbitant privilege” might be coming back to bite the United States, as prices, which central bankers believe are controllable, have begun spiking up in places where the financial powers-that-be don’t want them to—oil, food, Chinese goods and services, and of course—precious metals. And even though credit—the bedrock of our credit-based monetary system—is still disappearing (see chart below from the Fed of San Francisco), the Federal Reserve still believes that inflating its way out of recession and financial crisis is a good idea.

    The meaning of true monetary deflation is when the currency supply collapses. Credit—which is the basis of the modern fiat currency system—continues to contract, meaning that the currency supply is collapsing as well. That is why the Fed has an itchy trigger finger for quantitative easing and anything else it can come up with to battle back against that deflation. But inflation will continue to rear its ugly head in the places where they Fed least wants it. Free markets have a funny way of behaving naturally—every single time!

    Take away: Fed policy, intentional or not, is creating inflation around the world. Food prices will soar making the poor more vulnerable as they don't have the resources or wiggle room to get by. They have no savings. They generally have fixed incomes. Stimulus, QE1, QE2 may be good for America, but not for America's poor or the worlds poor.

    Don't turn a blind eye to it. It's already happening. Look at gold, wheat.....

  6. #6
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    The Latest American Export: Inflation

    In 2010, prices rose by more than 5% in major emerging markets such as China, Brazil and Indonesia..

    January 18, 2001 WSJ

    What do the years 1971, 2003 and 2010 have in common? In each year, low U.S. interest rates and the expectation of dollar depreciation led to massive "hot" money outflows from the U.S. and world-wide inflation. And in all three cases, foreign central banks intervened heavily to buy dollars to prevent their currencies from appreciating.

    When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.

    The world saw a surge in the dollar prices of primary commodity prices in 1971-73 following the Nixon shock of 1971 when the U.S. abandoned the gold standard. There was also a commodity price surge during the Greenspan-Bernanke shock of 2003-04, when the federal-funds rate was reduced to an unprecedented low of 1% followed by a falling dollar.

    Now we have what one might call the Bernanke shock. The Fed has set U.S. short-term interest rates at essentially zero since September 2008, followed in 2010 by quantitative easing to drive down long-term rates. Predictably, primary commodity prices in 2009-10 surged. In 2010 alone, all items in the Economist's dollar commodity price index rose 33.5%, while the industrial raw materials component soared a remarkable 37.4.%.

    The longer-term inflationary and economic consequences over the next decade of this most recent U.S. loose money shock remain to be seen. But we can glean useful hints by looking at the aftermaths of the two earlier shocks. In the 1970s, "stagflation" (inflation combined with cyclical bouts of unemployment and wide swings in exchange rates) seemed intractable. Productivity growth in mature industrial countries fell sharply.

    In the early 1980s, a necessary but savage disinflationary policy was instituted. Fed Chairman Paul Volcker imposed extremely high interest rates (the fed-funds rate touched 22% in July 1981), and he ultimately succeeded in killing stagflation. With credibility in America's long-run monetary policy restored, hot money, which had flowed out in the inflationary 1970s, came back with a vengeance. The dollar soared in the foreign-exchange markets and became extremely overvalued by the end of 1984.

    To prevent even more precipitous depreciations of their currencies, foreign central banks were forced to sell dollars and let their domestic money supplies contract. At the storm's center, the combination of high interest rates, an overvalued dollar, and large fiscal deficits caused a sharp increase in the U.S. trade deficit—mainly in manufactures. The upshot was the world-wide recession of 1982-83 and the creation of America's "rust belt," particularly in the industrial Midwest.

    The Greenspan-Bernanke interest rate shock of 2003-04, followed by a weakening dollar into the first half of 2008, created the bubble economy. Primary commodity prices began rising significantly in 2003-04, then flattened out before spiking in 2007 into the first half of 2008.

    But the biggest bubble was in real estate, both commercial and residential. With low mortgage rates and no restraining regulation on mortgage quality, average U.S. home prices rose more than 50% from the beginning of 2003 to the middle of 2006. This led to an unsustainable building boom—with echoes around the world in countries such as the U.K, Spain and Ireland. The bubbles in primary commodity prices collapsed mainly in the second half of 2008. But the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008-09.

    So what lessons can we draw from these episodes of U.S. easy money and a weak dollar for the stability of the American economy itself?

    First, sharp general price increases in auction-market goods such as primary commodities or foreign exchange (i.e., a weakening dollar) is an early warning sign that the Fed is being too easy—a warning that the Fed is again ignoring as we enter 2011.

    Second, beyond the rise in primary commodity prices, general price inflation in the U.S. only comes with long and variable lags. After the U.S. monetary shock, hot money flows into countries on the dollar standard's periphery cause a loss of monetary control and general inflation to show up there more quickly than in the U.S.

    In 2010, consumer price indexes shot up more than 5% in major emerging markets such as China, Brazil and Indonesia, while the consumer price index in the U.S. itself rose only 1.2%. Similarly, after the Nixon shock of 1971, there was much more explosive inflation in Japan in 1972-73 than in the U.S. But by December 1979, inflation in America's producer and consumer price indexes was more than 13%.

    The U.S. is a sovereign country that has the right to follow its own monetary policy. By an accident of history, however, since 1945 it is also the center of the world dollar standard—which remains surprisingly robust to the present day. So the choice of monetary policy by the Federal Reserve can strongly affect its neighbors for better or for worse.

    Beginning with the Nixon shock in 1971, American policy makers have frequently ignored foreign complaints. But by ignoring inflationary early warning signs on the dollar standard's periphery, which in turn lead to rising domestic prices and asset bubbles, the Fed has made both the world and American economies much less stable.

    Take Away: The US needs to be good stewards of the dollar through monetory and fiscal policy.

  7. #7
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    Exporting inflation is a very interesting concept, and one that doesn’t get the attention it deserves. It is a very real concept, and occurs mainly because the – dollar – is the reserve currency of the world.

    Most countries hold their reserves in dollars, which is a safe – haven of sorts, and that is why the dollar is known as the – reserve currency – of the world.

    United States and Domestic Inflation
    To counter deflation’s bad effects, and to stimulate the economy – Mr. Obama plans to spend billions of dollars over the next few years.

    Since, the US runs a large deficit, it can finance this stimulus in only two ways -

    Issuing Debt
    Printing Money
    As the global recession tightens its grips on countries across the world, the appetite for US debt is getting smaller. The yields on US government debt are already at all time lows, and then there is the small matter of – the stimulus that other countries need.

    Countries like China, India, Japan, Russia etc. also need to stimulate their domestic economies. They plan to do this by using their dollar reserves, and buying more debt at this time is hardly feasible.

    The other option for US to finance this debt is by printing money. Many countries ranging from Germany to Argentina to Zimbabwe have already done this throughout the history of the world. While, you may not see a 100 billion dollar US banknote, inflation is the natural consequence of printing money or quantitative easing and is unavoidable in the current circumstances.

    Domestic Inflation effectively reduces the ability of American consumers to buy Chinese goods, Russian oil and Indian software, among other things. As prices rise, people can afford lesser goods and services.

    More importantly, domestic inflation reduces the ability of the Chinese, Indian and Russian exporters to sell their stuff to US, and keep their own domestic economy going.

    Inflate or Die
    Faced with the increased supply of dollars in the market, other countries have two options:

    Let the values of their own currencies rise, relative to the dollar.
    Print more domestic currency to match the depreciating dollar.
    If the central bankers allow their domestic currencies to rise, then many exporters will lose their competitive edge, and ultimately shut shop.

    When the dollar rose to about Rs.39 (Indian rupee) a few months ago (as opposed to above 45 – earlier) a lot of Indian BPOs, that export to US – lost their competitive edge, and began lay-offs. Some of them even closed down. Similar things happened in other countries of the world too.

    Faced with such a scenario – the governments across the world will need to print money to adjust themselves with the depreciating dollar.

    When countries around the world print domestic currency – it would lead to inflation in those countries, which, is effectively due to the steps of the US, and dependence on it.

    What if they let the dollar fall?
    Developed countries like Canada who are also major exporters to the US can in fact, let the dollar fall, and allow their domestic currencies to rise. This will contain inflation, although it will impact exports, and slow the growth of their economy. Since, Canada is already a developed and rich country – it can allow that.

    Countries in the developing world can’t allow a hit on their growth – because that will have severe social and political consequences.

    So, there you have it, inflation export – from one country to another – due to the tightly integrated financial markets, and the reserve currency of these markets – dollar.

  8. #8
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    This is a good topic.

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