Friday, March 12, 2010

Inaccurate Happy Talk on U. S. Fiscal Problems

The MSM continues to misinform its followers. One new example is a column in Forbes by Bruce Bartlett, a former Treasury economist. He says in the conclusion of America's Foreign-Owned National Debt that:

As long as the U.S. national debt is entirely denominated in dollars, there is no risk that we will run into the sort of financial crisis that small countries often run into. What gets them into trouble isn't the debt per se, but an inability to acquire sufficient foreign exchange with their own currency to service it. While the U.S. Treasury has never issued bonds denominated in foreign currencies, it is conceivable that it could be forced to do so if the dollar falls sharply and foreign demand for U.S. bonds wanes. That will be the point at which our debt problem becomes more than theoretical and we are really on the road to national bankruptcy.

This is erroneous on several levels.

Factually, America has in fact issued foreign-denominated debt:

"The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold "Carter bonds", denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries."

More substantively, innumerable countries have issued debt in U. S. dollars and did not declare national bankruptcy.

Even more important, simply being able to issue debt in one's own currency does not guarantee that there are buyers for that debt. Too much principal and too much interest are quite possible even if the Treasury follows a dollar-only financing policy. No one cares if the U. S. cannot run into the same sort of problem as small countries, as Dr. Bartlett asserts correctly. The U. S. is not a small country!

The point is that the U. S. has become an increasingly irresponsible custodian of the world's reserve currency.

The idea that the Government can safely run large deficits so that the private sector can show large profits or income is the idea that shell games are sound and honest. Either Fannie/Freddie obligations are obligations of the Federal Government or they are not. Based on securities pricing, the market believes they are permanent obligations. Based on that sort of consideration and the possibility of an FDIC bailout, then Federal debt is understated, and an improving economy that pushes up interest rates will limit the cyclical decline in debt repayment costs, since the Feds have chosen to go short-term in issuing debt.

Bartlett ignores the possibility that all lenders to the Feds could in the future be domestic, so that relative values of the dollar vs. other fiat currencies may not be the key to a funding crisis. The key is income vs. expenditures, including debt servicing costs. The risk of getting into a situation where the government has to borrow simply to service its debt has increased. Focusing on Chinese and other foreign holdings of the debt is a misplaced focus. The situation can be remedied but the facts are stubborn things. A government can default on its debt even if all debt is domestically held.

Copyright (C) Long Lake LLC 2010

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