I was a little blown away the other day when my mother-in-law asked me how the United States government could possibly pay the hundreds of billions and subsequent trillions of dollars that it will ultimately cost taxpayers for the financial bailouts and stimulus plans. I keep forgetting that most people were not finance majors in college like I was. So, if my mother-in-law is asking the question, then I guarantee most Americans are as well.
So, what is the answer? We are printing the money of course! And, we are borrowing it by the truckload too. It is a little ironic to think that we are getting out of the trouble we have created for ourselves from excessive debt by borrowing. We are literally trying to spend ourselves (with money we do not have) out of a spending and debt problem. Crazy, right?
Issuing Treasuries. The US is the biggest debtor nation in the world with over $10 trillion dollars as a national debt. When the federal government needs to reach into its wallet and grab its credit card to pay for items in the budget that it cannot afford like the bailouts and stimulus plan, the politicians print IOUs in the form of Treasury Bills or bonds. Like a Fortune 500 company, the government issues bonds to people, businesses, retirement plans, and foreign governments like Saudi Arabia and China, etc. to pay for the shortfalls. Those bond holders give our government its cold hard cash, and the feds give them a promise to pay them back their principle plus interest. Now granted, the interest is not much because there is very little risk that the US government will default (we’ll just print more money if we have to after all). But, more and more of our debt is being bought by foreign governments that may not have our best interests at heart.
Printing Money. The United States government has greatly enjoyed the dollar’s global supremacy for the past half century. When other countries are worried about their own currencies, they turn to the American dollar. The dollar has long been the benchmark of free market, fluctuating currency since coming off the Bretton Woods System and essentially the gold standard in 1971. If you think about it, it makes sense. There are only a handful of safe currencies in the world market like the dollar, British pound, the Euro, etc.
The last two years not withstanding, the dollar, pound, and euro are stable currencies because they are backed by stable governments. The Mexican peso and Russian ruble, for example, are not the bellwether currencies of the world because of their countries underlying political instability. The only thing backing up the value of that flimsy little cotton paper in your wallet is your full faith and confidence in the United States government guaranteeing that your one dollar bill is actually in fact worth one dollar. A little scary isn’t it?
The world keeps investing in America and subsequently buying more dollars that keeps the currency stable. A recent New York Times article discussed this very issue. The Federal Reserve, who oversees the nation’s money supply, has the authority to print more dollar bills when it is needed. In August 2008, the Federal Reserve had approximately $900 billion that made up the money supply that circulated around the world at any given time. Since then, the Fed has added an additional $1.3 trillion that did not previously even exist to replace some of the billions that were wiped out in the recent financial crisis.
So, What Is The Big Deal? I do not know about you, but if I was the federal government, I would just print more money too to settle all my debts. It is a rough life being able to create money out of thin air. The US government literally does have that money tree in the backyard that our parents always yelled at us about.
Eventually, people and foreign governments will stop lending to us. Or, they will require higher and higher interest rates as our nation’s debt balloons. In Fiscal Year 2008, the U. S. Government spent $412 Billion on interest payments alone for the national debt. That is a huge part of the nation’s operating budget. That is almost four years worth of the war in Iraq. To give you a comparison, the federal government only spends approximately $60 billion per year on education in America. Interest expense on the National Debt is the third largest expense in the federal budget. The interest on our national debt already accounts for approximately 3% of America’s Gross Domestic Product ($14.2 trillion in 2008). Every three cents out of a dollar produced in the United States is going to pay the interest only on our national debt. We are not even trying to pay the principle back yet. And, we have been fussing at consumers for taking out interest only mortgages! Like consumers with credit card debt, we could be using those interest payments for so much better uses like replacing our crumbling bridges and roads or people Americans back to work.
Classic finance theory tells us that printing money leads to inflation. Eventually, the value of the dollar will decline against the value of other currencies which will lead to higher costs of imported goods.
So, what is the answer? Who knows, but what I have learned about my own finances is that borrowing money is seldom the right answer. I have spent almost my entire adult life trying to get out of debt. And, now that I am finally succeeding, there is no way that I’m going back down that slippery slope. I hope that the American government will learn these same lessons itself soon.
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Of all the other options in front of the US government, this seems to be the least worse. Ultimately they will have to inflate away the debt, can’t possibly repay those trillions, with trillions getting added every year.
This is why investment bloggers should not be writing about macroeconomics. There are so many half-truths and misunderstandings in this article. I’ll address just a few of them.
“Classic finance theory tells us that printing money leads to inflation. ”
Right, but that has absolutely no relevance here. During recessions an economy will go through deflation, a far more dangerous phenomenon than inflation. Inflation, as long as it is controlled, is perfectly healthy. And when we are potentially in a deflationary spiral, the best solution is to take on debt and stimulate the economy.
“I have spent almost my entire adult life trying to get out of debt. And, now that I am finally succeeding, there is no way that I’m going back down that slippery slope. I hope that the American government will learn these same lessons itself soon.”
This is frankly a ridiculous thing to suggest. It is reasonable for an individual to be debt-free, but even for a reasonably small company debt is integral to growth. Any business, country, or even individual that goes through cycles require debt to operate. Banks sell commercial paper to cover operating expenses. Governments go into deficits during recessions and pay back during booms (although the latter rule was violated by the Bush administration). And many people have credit cards that they use to purchase items and then pay at the end of the month. Is it irresponsible to purchase discretionary goods using a credit card knowing that you will receive the income required for that purchase at the end of the month? Not at all. The same is true for bigger economic entities. Your suggestion that the U.S. government should not take on debt is ludicrous. We should be prepared to pay off debt once the economy recovers, but now is the worst possible time to be considering the deficit.
“Eventually, people and foreign governments will stop lending to us.”
There is no evidence that this is true. The US is and will remain a very reliable borrower. We will not, as fear-mongerers claim, default on our debt. Our current debt is manageable. As long as we drop the Reagan/Bush trend of returning surpluses as tax cuts once recovery is complete, we can reduce the debt.
Again, these are just a few of the more egregious errors here. Econ 101 and Finance 101 simply don’t apply during an economic crisis.
Econ 101 and Finance 101 apply in all circumstances and at all times and especially during an economic crisis.
Maybe I phrased that wrong. You are saying that anyone who has taken a high school econ class would know what to do here. It’s not that the basics don’t apply, it’s that the situation is nowhere near as simple as you make it seem.
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