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How bad is the accumulated US debt to the world economy?-

15/10/2012

When the day of the US debt repayment comes the government will have three ways to repay it, either to increase taxes, to cut budget or to print money. Eventually which way to go will depend on the situation, the economy will be in the day of the repayment. If the unemployment of production capacity prevails, the government will do it by printing money, if the economy will be at full employment or close to it, it will rise the taxes or cut the budget (probably both). This government step would be necessary anyway, without to consider if there is need to repay debts or not. So the problem how to repay the domestic debts in the future in reality doesn’t exists.

As to the bonds owned by the foreigners, this is mainly the foreigners problem (about half of it is of Japan and China). If they stop to purchase the bonds, it will cause depreciation of the US dollar against their currencies, assuming that production capacities are unemployed, this will increase the US exports and employment. If the production capacity will be fully employed, the depreciation of the US dollar will cause inflation, with it reduction of domestic consumption and depreciation of the value of the US debts in real terms. Again the foreign bond holders are paying the price. If the foreigners not only stop to purchase new bonds but start to sell the old once in huge scale, the effect will be in the same direction, but with much bigger and immediate response. This could be very devastative to the whole world and not only to the US or the foreign bond holders economy. Let us all pray, they don’t come up with such a policy.

As mentioned above, the main problem with the huge US government debt is, that it was created to finance increased households consumption and government expenses, (mainly military), and not to finance investment to create additional potential capacity for future economic growth. To whom it is not obvious, increased government expenses used for education, health, infrastructure, are all investments with positive effect in the future potential economic growth, military expenses are not. (I don’t count the development of technology, that is side product of the military budget, since this aim could be achieved more effectively by investing directly into science and high education.)

The main problem of the government debt is the growing interest rate, the government has to pay on its debts. This may negatively influence its fiscal economic policy flexibility. The solution to this is repurchasing government bonds by printing money, and if this step would cause inflation pressures, it can be corrected by increasing to the commercial banks the demanded minimum reserve requirement rate, that would cause credit squeeze.

2 Comments
  1. One should agree first about one is talking about when talking about the debt of the USA. The New York Times often claims that the debt to GDP is less than that of Germany or France.

    The New York Times, Krugman and company claim that the debt of the USA is around ten trillion dollars. That modest sum is obtained by neglecting the part of the debt due TO Medicare and the Social Security Trust funds…

    However, including those sums owned “within the government”, the debt to GDP of the USA is 111%. For a total of 16.5 Trillion dollars.

    This is what Eurostat, “The Economist” or the IMF, among others, consider: USA debt/GDP = 111%. And the deficit of the USA is 7% of GDP. Differently from Italy, which has NO primary deficit, the 7% is fully primary. It’s clearly unsustainable.

    I do not think it’s “liberal” to ignore a 7% primary deficit. I do not believe in the optimistic Congress Budget Office predictions, that the deficit will shrink.

    The argument can be made that the 7% deficit is just the equivalent of throwing money at “We The People”, the way the Roman emperors used to do, to gain time, and ingrain ever more the triumph of plutocracy.

    President Eisenhower proclaimed a debt emergency, and, to pay back World War Two debt, imposed a 92.5% tax on the richest people.

    We have a much greater emergency now. It’s not because one cut to the bone many of yesterday’s old government services, that the situation is good enough.

    By investing in USA government debt, others, notably China, have bought insurance to the USA, and shown their good faith. Just like the deficit is similar to giving gold, bread and circuses to the People, to the Plebs, the exchange of debt versus factories reminds me of the exchange of hostage the Romans or the potentates in the Middle Ages used to love.

    So the debt is not about repayment. It’s about creating interdependency between plutocrats, a bit like bacteria form films together, and are stronger that way.

  2. Hello Eugen. I much appreciated our discussion about economics when we crossed paths while traveling this past week. I look forward to reading your future posts, which definitely help an amateur economist make more sense of what is happening in the world.
    – Sonja

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