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Stop fretting: US is not going broke

Publication Date : 24-07-2012


Don't we have enough real economic problems in the world that we now have to invent fake ones?

The International Monetary Fund (IMF) last week warned against a 'sharp and sudden' tightening of the fiscal stance in the United States.

The IMF's concern is valid.

A cataclysmic drop in the deficit, equivalent to 4 per cent of gross domestic product (GDP), will wipe out US$600 billion in demand for goods and services. That will surely push a weak economy over the edge. No wonder economists are calling it a 'fiscal cliff'.

If the Democrats and the Republicans don't cut a deal on extending income and payroll tax breaks that are set to expire, and if they can't shake hands on delaying spending cuts that will automatically kick in next year, a US recession is guaranteed.

For no reason at all.

Where, after all, is the need for this fiscal 'correction'? Are bondholders - those who lend money to the US government - demanding it? Far from it. The yield on the 10-year US bond is less than 1.5 per cent. Investors, it seems, can't get enough of the safety that US government securities offer in today's topsy-turvy world.

Doomsday prophets, however, see this as a temporary reprieve, a lull before the storm. The government of the United States, they would tell you, will one day be like Greece - broke.

Republican presidential hopeful Mitt Romney ridicules incumbent Barack Obama for leading the country forward - "forward on the way to Greece".

It's just a bugbear. No such dystopian future awaits the US.

The pessimists point to statistics on public debt, which in the US has risen to 103 per cent of annual gross domestic product. And this is just the beginning. According to the Congressional Budget Office, the government's debt burden will balloon to 247 per cent of GDP by 2042, close to the level at which Greece imploded.

Making matters worse, US debt is bought, in large quantities, by central banks of China, Taiwan, Russia, Brazil and Saudi Arabia, the alarmists argue. What will happen if the foreign buyers one day stop being so generous, they ask.

To be sure, these concerns have been expressed, time and again, ever since the onset of the global financial crisis and the consequent surge in government deficits. And they have been expressed not just by politicians but by financial experts as well.

This anxiety over a sovereign debt crisis in the US is misplaced, especially since almost nobody disputes that the private sector in the US needs to rebuild its net worth.

Therein lies a minefield for champions of fiscal austerity. How can anyone ask the private sector to aggressively save more of its income to atone for excessive, debt-fuelled past spending and at the same time wish that the government will tighten its belt?

I will spare you the algebra, which shows the impossibility of the task. In plain English, it is like this: Any increase in the domestic private sector's net financial assets - the part of private wealth not tied up in real assets such as factories, machines, inventory and houses - must come either from a public sector deficit or a national current account surplus.

If the current account, or the excess of exports over imports, is balanced or in deficit, the government must run a deficit to fulfil the private sector's desire to enhance its financial net worth.

The private sector includes both households and domestic companies. Of course, it is entirely possible for households to add to their net worth by buying corporate equity and debt.

But that only gets companies to sell more shares and raise more debt. What are assets for households are liabilities for companies. They cancel each other out.

For the private sector in the aggregate to acquire financial assets, the government has to supply them by running deficits. This is just what the US is doing.

Or, like in fiscally prudent Singapore, they have to come from outside the country, via persistent current-account surpluses.

This is not an opinion. It's an accounting truism. In the last 40 years, post-Keynesian and modern monetary theorists have made devastating use of this simple, bean-counting logic to make many useful predictions, which have fallen on deaf ears.

As for the US collapsing like Greece under a mountain of public debt, it cannot occur for the same reason that it hasn't happened in Japan, where gross public debt last year was 220 per cent of national income.

The euro zone governments are different. They 'use' euros just like households and companies in Europe do. That's because the European Central Bank does not work on behalf of any of the euro zone's 17 governments.

But the US and Japanese governments - supported by the Federal Reserve and Bank of Japan - are not users of currencies. They are 'issuers' of dollars and yen. And monopoly issuers at that.

If the governments of the US or Japan had tied the exchange value of their currencies to gold, silver or another currency, they could also have run out of money.

But ever since US president Richard Nixon ended the Bretton Woods system of fixed exchange rates, involuntary local-currency sovereign defaults have become a logical impossibility, barring a destabilising regime change. (Russia defaulted in 1998 because it ended up with Soviet-era debt.)

Technically, cheques written by the US Treasury can bounce. But they can bounce only as a result of the kind of political brinkmanship we saw last year when the federal government needed lawmakers to raise the congressional limit on how much it is allowed to borrow.

A debt ceiling is an artificial construct, an institutional arrangement. Presumably it reflects the society's desire for 'small' governments. But these collective desires are bound to change over time. Hence institutional arrangements cannot be cast in stone.

How, for instance, can we be sure that just because the Fed is currently not allowed to give an overdraft to the Treasury, or to directly buy its debt, that such arrangements are sacrosanct, especially when the alternative is a cataclysmic sovereign default?

If the institutional arrangements are altered, then the alarmist narrative in which the US is hostage to China's desire to buy its government's bonds falls flat.

Think about it. Why should it matter to the US if China said, 'We don't want to buy your bonds'? Why should it matter even if all other buyers of US bonds get spooked by China's decision and decide to join the strike?

Last year, the Fed bought 61 per cent of net US Treasury issuances. It could as easily buy the whole lot. And if the Fed is the only buyer of these securities, the Treasury will surely not pay any interest on them.

The bond market will vanish, and there will be a crisis in insurance and pension industries that meet their liabilities out of the coupons they earn on safe US debt. But the US will still not come to resemble Greece: It won't run out of money.

This does not mean that the United States, as a sovereign issuer of paper money, can get away with any amount of deficit spending for any number of years with the help of an obliging central bank. There is a limit, but it isn't debt default. It's inflation.

The act of government borrowing money is best thought of as a monetary policy tool. The interest rate on government bonds is what is needed to maintain slack in the economy - a euphemism for keeping some people unemployed.

When there's already a lot of slack, like there is in the US economy now, the government would rather pay negative interest. (It can't, simply because there's another risk-free sovereign liability that pays zero interest: cash.)

Had there been a monetary authority clever enough to prevent inflation while keeping the economy perennially at full employment, there would have been no need to maintain a resource slack. Interest-bearing safe bonds would have become redundant.

So the real constraint on a modern government's spending behaviour comes from inflation. To prematurely tighten fiscal belts out of a fear that the US would run out of money and end up like Greece is just political humbug.


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