Currencies

How to Reduce the National Debt by 15%

I usually hate it when a blogger gives a long introductory build-up before getting to his point, so I will cut to the chase and then explain later.  How can we reduce the national debt by 15%?  Default on it.

Wait!  How can we default on 15% of the national debt without ruining our ability to sell bonds to investors, pension plans and foreign governments?  Simple, by defaulting only on the debt owned by the Federal Reserve.

Here is a chart of who owns the federal debt.

US Debt Pie Chart

As you can see, the Federal Reserve owns 15% of the debt.  All we have to do is tell the Federal Reserve that all those Treasuries they hold are now worthless.  BOOM!  We wiped out 15% of our debt.

Who would complain if we wiped out the Federal Reserve debt?  Would China and other foreign bondholders complain.  I don’t think so, because we are now less likely to default on their debt.  The same goes for pension plans.  We demonstrated that all these others debtors are so important, that we chose to default on the Fed to make our other debts more stable.

The Federal Reserve might complain, because they were looking forward to collecting the interest payments on that debt.  But, the Fed has to give most of their profits back to the US government anyway.  But won’t the Fed be less likely to buy more Treasuries with printed money?  Maybe, but if you could print money to buy guaranteed bonds paying three percent, would you stop?

Now, let me do the background and refresh your memory on how we got into this debt situation.  It’s all the fault of the Federal Reserve.

I believe that it’s one of a government’s primary responsibilities to protect and regulate the currency.  The United States (and other major governments) have abdicated this responsibility by farming out the responsibility to a separate entity, the Central Bank (the Federal Reserve in America’s case).

How did America get talked into giving up its responsibility and power to regulate the currency?  The idea was that if the government were allowed to print money, the irresponsible politicians would just vote to keep printing money, and the value of the currency would decline.  That certainly sounds like a good argument, but it didn’t work.

Now, since Congress can’t vote to print more money, they vote to increase the debt.  In addition to the money being printed, we now have to pay it back with interest.  What kind of sense does that make?

But if the government just printed money, wouldn’t that result in inflation?  Yes it would.  The pain would be immediate rather than delayed by going into debt.  The citizens would immediately feel the adverse effects of money printing rather than delaying the pain so their children will feel it.

The housing bust was caused by people being able to borrow equity from their house to spend on consumption.  This spending boosted the economy for a few years until the pain, delayed by debt, came home to roost.  If people had to earn more money to spend more, the pain would have been immediate rather than delayed.

It’s easy to understand how a person, or a government, can overspend if the pain is delayed.  If you want to control a system, you need immediate feedback.  Any delay in the feedback loop can cause instability.

If the government could just print the money, the citizens would know the cost and could decide if a stimulus plan created enough jobs to warrant the decreased purchasing power of the dollar.

If the existence of the Federal Reserve actually kept the government from spending too much money, then it might be a good idea.  But really, do you think it has worked?

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Sunday, October 28th, 2012 Currencies Comments Off on How to Reduce the National Debt by 15%

Our Sovereign Debt Crisis

[Note: This blog post is almost entirely derived from other people’s work.]

The national debt of the United States is increasing at an alarming rate. The chart below is from Dave Short at Dshort.com. It shows the ratio of Federal Debt to Gross Domestic Product (GDP).

Federal Debt to GDP Ratio

Below is a synopsis of historian Niall Ferguson’s presentation at the Peterson Institute for International Economics, taken from BusinessInsider.com. Ferguson explains the causes and effects of excessive government debt.

What Causes These Sovereign Debt Crises?

  • Excessive debt
        Measured by debt to GDP or to revenue or to exports
  • Excessive interest payments
        Measured by debt service to GDP or to tax revenue
  • Excessive reliance on foreign capital
        Measured by debt to exports or net international investment position
  • Economic weakness
        Low growth
        Low returns on private sector investment
  • Political weakness
        Excessive expenditure and insufficient taxation
  • Irrational exuberance
        Investors keep forgetting to learn from history

What Are the Ways Out of a Debt Crisis?

In theory, there are six ways out:

  1. A higher growth rate of GDP [Possible for the USA, but not likely.]
  2. A lower interest rate on the public debt [We can’t go much lower.]
  3. A bailout, meaning either a current transfer payment or a capital transfer from abroad [Who’s going to bail out the USA?]
  4. Fiscal pain, meaning an increase in taxes and/or a cut in public spending [In our current climate, I don’t think so.]
  5. Increased recourse to seigniorage (revenues from monetary issuance, aka “printing money”) by the central bank [BINGO!]
  6. Default, including every form of non-compliance with the original terms of the debt contract, including repudiation, standstill, moratorium, restructuring, rescheduling of interest or principal repayment etc. [I don’t see the USA refusing to pay its debts, unless we go to war with our creditors.]

Usually, only ways 4 through 6 are used: Cut, Print or Default.

  • Cutters are few and far between
    Only Britain, 1815-1914, reduced debt burden exclusively through budget surpluses, lower interest rates and higher growth, and Britain had the advantage of the industrial revolution
  • Printers
    States with monetary sovereignty [e.g. the USA]
    Sates with debt in their own currency [e.g. the USA]
  • Defaulters
    States with limited monetary sovereignty
    States with foreign currency debt

Lessons of history

What Governments do NOT do with World-War Size Debt Burdens (One exception: Britain 1815-1913)

  • Slash expenditure on entitlements
  • Reduce marginal tax rates on income and corporate profits to stimulate growth
  • Raise taxes on consumption to reduce deficits
  • Grow their way out without defaulting or depreciating their currencies

What Governments USUALLY do With World-War Size Debt Burdens

  • Oblige central bank and commercial banks to hold [buy] government debt
  • Restrict overseas investment by firms and citizens
  • Default on commitments to politically weak groups and foreign creditors
  • Condemn bond investors to negative real interest rates

What Are the Geopolitical Consequences of Crises of Public Finance?

  • In fiscal stabilizations, discretionary military spending is usually the first casualty
  • In cases of default on external debt, conflicts with creditors can arise
  • In cases of currency depreciation, reserve currency status can be lost to a rising rival

Ferguson has succinctly described the causes and seemingly inevitable consequences of the rapidly-growing US debt. I have read other similar arguments giving numerous examples of governments who printed too much money and caused their currencies to crash and lose most of their value. With the national debt increasing, holding the local currency is financial suicide.

Given this irrefutable logic presented by some very smart people, Why don’t I just sell everything and buy gold? click here.

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Sunday, February 20th, 2011 Currencies Comments Off on Our Sovereign Debt Crisis

Why I’m Not Selling Everything and Buying Gold

Lately, I’ve been reading and studying quite a bit about the problem of our national debt.  The growth of this debt is gaining speed like a runaway train, and the interest payments are projected to become an onerous part of future budgets.  All solutions to slowing this runaway train require measures of sacrifice that the US population is unlikely to accept.

We have all been riding the train for so long, that we can’t bear to leave the dining car even though we believe that at the end of the tracks is a cliff over a vast crevasse.  There are still miles of track ahead of us, and this party isn’t over yet.

We read about personal analogies to this national debt.  Families have gone too heavily into debt and have seen all equity vanish in their major investment, their home.  These families have lost their homes, and prospects for a prosperous future have vanished.  Many Americans are able to see how this applies to their own lives, and they are trying to reduce their debts and live within their means.  “Living within your means” was a popular philosophy during most of the Twentieth Century, but fell into disrespect as an outdated and unsophisticated financial strategy.

The logical conclusion to this runaway debt is the crash of the US Dollar.  The only logical outcomes are either 1) Default on the debt or 2) Devaluation of the Dollar.  Either outcome will result in the Dollar losing much of its value and purchasing power.  Pundits have given many examples of this happening to countries in the past.

I have read the logical arguments proving this inevitable result, and I honestly don’t have any logical counter-arguments.  I am regarded as a very logical person, so why don’t I just sell everything and buy gold?

According to most of these logical arguments, the only sure-fire way to preserve my wealth is to convert it all to gold.  History has proven that gold holds its value during times of inflation and the collapse of currencies.  When the currency collapsed in countries in the past, people who had gold survived financially.  So, why don’t I just sell everything and buy gold?

Something has been nagging at my brain as I read these essays of doom.  It’s not that I don’t believe them; I do, and I have blogged about these problems and probably will again in the future.  The trouble is, I don’t believe them “with all my heart.”  Although my logical mind is convinced, I have a nagging doubt – a lapse of faith in the science of economics.

I can hear your response right now, “You are just in denial.”  That may be true, but I am not denying the facts.  I absolutely agree that too much debt is very bad.  Paying off the debt will be bad, and defaulting on it will be bad.  There’s no denying that.

Well then, you say, “You are just paralyzed.  You are so terrified of the inevitable collapse of the Dollar, that you can’t take any appropriate action.”  That’s not entirely true either.  I have a significant percentage of my net worth in gold, but it’s nowhere near “everything.”  So, why don’t I just sell everything and buy gold?

Maybe its because I’ve heard this story before.  I remember Howard Ruff and other gold bugs in the late ‘70’s and early ‘80’s saying much the same thing.  They predicted doom and its been over thirty years.  Surely they didn’t think it would take this long for us to go to Hell in a handbasket.

Also, I am acutely aware that I don’t know everything.  Too many times I have been certain about something only to have something else unexpectedly happen.  And since I am smarter than the average bear, I must conclude that nobody else knows everything, either.  Other pundits may not admit to ever having been wrong, but I am skeptical.

I took a lot of philosophy classes in college, but I have to admit that it took a recent blog posting to remind me of Hume’s problem with inductive reasoning.  You see, all these arguments of doom and gloom rely on the assertion that “This has always happened in the past, so it will happen in the future.”  This is inductive reasoning.  Inductive reasoning draws upon past experience to predict future experience.  One famous example of this is:

All of the swans we have seen are white.  Therefore (“ergo” for you philosophers),
All swans are white.

As Hume points out, it only takes one counter-example, a black swan for instance, to invalidate the theory.  Hume concludes that, no matter how many repetitions there may be, we are not justified in extrapolating things we have experienced to things we have not experienced.  He further concludes that we are not even justified in arguing the probability of things we have not experienced based upon past experience.

On the other hand, George Santayana said, “Those who cannot remember the past are condemned to repeat it.” I have a counter-assertion, “Those who rely on the past are condemned to repeat it.

Let me repeat, I do not see any painless way out of our national debt problem.  It’s just that I am not so convinced that I am willing to go “all in” and sell everything to buy gold.

This blog post is not intended to make you, or me, comfortable with our national debt.  It’s not even intended to be a rationalization for investing in the same old things we have always invested in.  This is just an introspective look into why, counter to logic and reason, I don’t just sell everything and buy gold.

How about that, a blog post with no charts or graphs.

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Sunday, February 20th, 2011 Currencies, Gold 1 Comment

Why Gold Isn’t Money

Although I am a big believer in the prudence of owning gold, I’m tired of hearing gold bugs claim that gold is the only real money.  It truth, gold isn’t money at all.

The gold bugs claim that the dollar is “fiat money” – that is, the dollar is proclaimed to be money without any basis in fact.  Well just what do they think money is?

The Merriam-Webster dictionary defines “money” as “something generally accepted as a medium of exchange, a measure of value or a means of payment.”

In the USA, gold is none of these things.  Most importantly, it is not generally accepted as a medium of exchange or a means of payment.  You can’t go to the grocery store and pay for your food with gold.  You can’t fill up your car’s tank with gasoline and pay for it with gold.  You can’t pay your electric bill with gold.  Gold is nothing like money.  You might just as well carry around molybdenum in your pocket.  If you have gold and need food, you have to convert your gold into dollars to buy food.  Dollars are money.

Neither is gold a measure of value.  In the USA, everything is valued in dollars; even gold is valued in dollars.  When you ask someone what their home is worth, nobody replies “185 ounces of gold.”

Now, gold IS a store of value.  This is the area where it is validly likened to the dollar.  When someone is accused of being so afraid of losing their wealth that they “put their money under the mattress” or “bury their money in the back yard,” they are referring to dollars as a store of value.  By hiding his dollars under the mattress or burying them, the fearful investor thinks he is preserving the value of his wealth.

Just because dollars are real money and gold is not real money, doesn’t mean that preserving dollars preserves your wealth.  The purchasing power of dollars, as well as the value of gold, goes up and down.  Dollars may not be a good store of value.

Gold bugs deride “fiat money” because it isn’t backed by anything of intrinsic value.  Because of this lack of intrinsic value, dollars may not be a good store of wealth and the gold bugs may be right.  You can make a case for gold being a much better store of value than the dollar.  I will have more to say about this in future posts.  As long as gold is convertible into money (e.g. into dollars), gold can be a good store of value.

Although gold is a good store of value and a good investment, gold isn’t money.

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Friday, October 22nd, 2010 Currencies, Gold 2 Comments

What does “The Dollar is Falling” mean?

Your hear excited talking heads on TV proclaiming “The dollar is collapsing” or “The dollar is getting crushed” or maybe “The dollar is falling.”  But what does this mean?

Does it mean that tomorrow a loaf of bread will cost $5?  Does it mean that if you go to France you will have to pay $1.50 for every euro?  Does it mean that gold costs $2,500 per ounce?  Well, generally it means different things depending on who says it.

When a currency trader says “The dollar is falling,” he means that the value of a dollar is declining relative to some other currency, such as the yen, or to a basket of currencies, such as euros, pounds, yen, etc.

When a gold bug says “The dollar is falling,” he means that gold is getting more expensive if you buy it with dollars.

When a consumer expert says “The dollar is falling,” he means that inflation is increasing in the USA and goods and services cost more.

The chart below shows the value of the dollar over the past three years.  The straight lines just connect the starting and ending points of each graph.

The Value of the Dollar

The green line shows how inflation has affected the buying power of the dollar.  We haven’t had much inflation (as measured by the CPI), so the dollar’s purchasing power hasn’t fallen very much.

The black line shows the value of a dollar relative to a standard basket of other currencies.  Although this value has gone up and down, it is now at about the same level as it was three years ago.

The red line shows the value of the dollar relative to the price of an ounce of gold.  The red line makes it look like “The dollar is getting crushed.”

Now, when you hear that “The dollar is falling,” you’ll know to question the pundit’s motives.

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Tuesday, October 19th, 2010 Currencies Comments Off on What does “The Dollar is Falling” mean?

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I am not a registered financial advisor. I only offer opinions, and sometimes these opinions veer off at weird angles from conventional wisdom (That's probably why you are here). My advice is, "Don't take my advice." Read my sidelong glances at economic issues and form your own conclusions.

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