Debt Financing 101

Continuing from the Why are you...? thread.

I keep hearing this rumour, which is why I keep getting surprised that you don't know any.

Debt Financing 101

The deficits are leading to increasing amounts of public debt, this much we know.

That is to say, to keep running deficits, the Treasury needs to keep issuing debt, and someone has to keep on being willing and able to buy it.

Those buyers may be US residents, or they may be (nasty) foreigners (of whom I am one).

In aggregate, US residents can only keep on buying their government's debt if they're saving enough overall to have enough "spare cash" to do so.

If US residents are not soaking up all the extra debt issued each year, then nasty foreigners like me have to be willing to do so.

To keep on issuing debt when much is already out there, bond prices have to fall, which is to say, interest rates have to rise. Expect this as a likely outcome in the future.

When the debt comes to be repaid, which will typically involve some hiking up of taxes, then:
a) if the debt is held by local residents, it is local residents who are being slugged with the tax hikes with the government's "left hand", and then being paid back their debt with the government's "right hand". This has distributional consequences but to a first approximation, it "keeps the money in the country."
b) if the debt is held by nasty foreigners (like me), then you guys get slugged with the tax hikes, and I get the debt repayment.

So what's it to be?

Well, one way of assessing who is lending to whom (and hence, who is holding debt and who will be relied on to keep buying it as it keeps being issued) is to check out the current account deficit.

Why?

Because the current account deficit is balanced out by the capital account surplus(the balance of payments has to balance, after all), and the capital account surplus measures how much a country is borrowing from the rest of the world. That is, if you're a net importer of goods and services (current account deficit) you have to be a net exporter of assets (capital account surplus), which is to say, the rest of the world (nasty foreigners) is lending you money.

Now, what this says is, if you're running large current account deficits, your nation is a net borrower. If the government is adding to all the national borrowing requirements by running big budget deficits, there is an increasing need to find more and more nasty foreigners to keep holding more US debt.

In the first three quarters of the 20th century, this wasn't a big issue, as US trade was fairly evenly balanced.

Now, however, the US is in an era of record current account deficits.

Nutshelled:
- the US as a nation is now borrowing like fuck from the rest of the world
- the US government is increasingly issuing more debt, i.e looking for more people to borrow from, thus adding to the overall national borrowing requirement
- those people (who you will be borrowing from) are mostly going to be non-US residents
- when the debt is repaid, the money will be leaving the country, not staying in it
- this is a very different situation than the US faced post-WW2.

I wish you guys luck.

Who is your alternative for risk-free return?

Keep buying those t-bills, thanks.

[Edited on Sep 24, 2004 by stockula]

They are not risk free.

Default risk is very low, but that is true of the debt of many sovereign nations.

The risk of capital loss from holding bonds gets higher in the environment I'm describing, and if it gets high enough, it gets harder and harder to keep on selling them.

And that makes the default risk start to creep up.

And then seriously scary times are upon us.

(Do try and keep up.)

Moreover, as to the point you keep missing, the repayment of the debt has serious consequences for aggregate demand, much more so than in the post WW2 environment where it was US citizens (in large part) being paid back by their own government.

You're going to have high interest rates, and THEN a drain on your aggregate demand as payments are continually made to debt holders OUTSIDE the country.

(You slept in class, didn't you.)

This is surreal. Totally surreal.

http://www.nytimes.com/2004/09/23/politics/23tax.html?th

I blame idiots like Stockula for pretending to offer "expert testimony" that all this lunacy is in fact reasonable long term fiscal policy.

Also note that big buyers of our financial instruments sometimes get a pass that others don't. Chiina would be a great example of this: they artificially depress the value of their currency, making their products ~30% cheaper than they should be, we buy lots of cheap chinese goods and they use the money to buy lots of our financial products.

If we pressure them on human rights, their artificial currency values, or fair markets they stop buying our bonds and T Bills, and we have problems...

Japan buys lots of our bonds, etc and usuallty reinvests when they hit maturity. If they got out, we would be in trouble too.

See a pattern here?

So what? What are you going to do? The nation that's borrowing from you also serves as a huge market for your exports. Are you going to kill the goose that lays the golden eggs? Default and write off how many trillions in treasury debts that will torpedo the global economy? A negotiable alternative will be sought if it ever gets that bad, and it never will. Our debt's denominated in dollars, remember. And who makes dollars? Why we do. Lucky us. We owe a couple trillion in debt? By next week, a trillion won't be worth what it used to be. Not that we'll screw our creditors out of ALL our debt, but there will never be a bankruptcy situation.

Nothing is fucked, the game will continue for a long time, barring a catastrophe like a nuke taking out DC or Manhattan that calls American supremacy into doubt. At that point, we're fucked and creditors will panic. And the world will be in trouble.

I'm not happy about the fiscal deficit thing. I would prefer to see the federal government gutted in areas it isn't mandated a responsibility for in the Constitution to balance the tax cuts.

[Edited on Sep 24, 2004 by stockula]

Which further raises an issue stockula keeps turning a blind eye to.

Exchange rate risk.

He thinks that because the US government was hugely in debt at the end of WW2 (and it certainly was) and that it recovered, that everything will be hunky dory this time around.

Problem: much of what went on during WW2 was the government asking the American public to buy bonds (lend it their money) as a patriotic duty, not as a way to make money in financial markets.

Now it's going to be appealing to people to buy its bonds as an investment, so bonds will be assessed on their risk-adjusted profitability. Moreover, as explained above, much of the buying public for these bonds will be nasty foreigners (like me).

Stockula wants to believe their risk-adjusted profitability will be just fine, and people will continue to be willing to buy further debt issues, again and again. But people who buy large quantities of financial assets don't simply want to hold on to them until maturity, they want to trade them. Therein lies the rub. To buy an asset, you want it to be able to at least hold its value and preferably grow in value, which means you can sell it for more than you bought it for.

If you're this kind of person, knowing there will be more, and more, and more debt landing on the market for years to come, the price of the debt you hold will be only likely to fall. not rise. This is the rising-interest-rate effect ... to sell more debt, interest rates must rise, which is to say, bond prices must fall. The bond holder risks a capital loss, and new buyers are less willing to buy US government debt because they know the risk has increased too.

Here's the money shot though. Many of those bond holders are now foreigners, holding US assets denominated in US$. If the risk of holding US debt is increasing, and there's less desire to be caught holding US debt, and the US government is facing difficulties selling further US debt ... the prospect is of a large scale dumping of US bonds, a conversion of US$ sale proceeds into other currencies, and a major collapse of the US$.

Nutshelled: stockula's deranged bravura aside, the risk being attached to US government debt is going to rise because of the increased prospect of capital losses. Those capital losses can arise from interest rate movements or exchange rate movements. The prospect of a serious and damaging collapse in the US dollar is a real one.

I was just finishing this post when I noticed that stockula had responded to my earlier ones, and he's actually reinforcing much of what I'm saying.

You're assuming that the holders of US debt act (a) collectively and (b) in their respective nations' interests rather than their own.

Since currency collapses occur because of the fact that individual aset holders act IN THEIR OWN SELF INTEREST and hurriedly dump assets that they're getting nervous about, I'm worried that your don't-worry-be-happy scenario is based on people not panicking when they suspect their portfolios are going to take a hit, but instead all banding together before the shit hits the fan, all group-hugging and saying "Let's all be reasonable."

The first part, I agree with, but it may take things getting really bad first. It's not likely to mean happy times for Americans. The second part is your usual wishful thinking on this. Demented, but predictable.

Well, that's the currency collapse scenario I described above. "By next week, a trillion won't be worth what it used to be." Imagine life in the US when, within a week, a trillion is suddenly worth half what it used to be worth.

Coulda fooled me.


[Edited on Sep 24, 2004 by TheFuckOffKid]

I dont know for sure, but I would imagine most foreign debt is held by banks and central banks who have selfish interests that are simpatico with a viable global economy. Their commercial borrowers are probably dependent on a healthy US economy. The US economy, such as it was, was the only thing keeping the world economy together over the last 2 years.

Think back to the Mexican crisis 10 years ago, and how the American government rallied to save the investments of big houses like Citi, etc whose loans were jeopradized by the peso's collapse and the Mexicans' inability to finance their debt. Ok? That was freaking Mexico. And Mexico more or less got its shit in order, as much as can be hoped for a country like Mexico.

The importance of the US to hundreds of countries' economies, and the endangering of plutocrats' investments here, means that it would very much be in the interests of holders of US debt to ensure the US does not default and there would be ample pressure around the globe, by the wealthy and by central banks and the Fed, to ensure that does not happen.

This is the ultimate in hubris but I can't think of a better, clearer way to say it, the US is too big to fail. Letting the situation you think is leading to disaster is preferable to the alternative of a financial reckoning. You wouldn't like to see that any more than you'd want to see Bruce Banner when he's angry,

[Edited on Sep 25, 2004 by stockula]

let's all look at some boobies.

Yes, the US is "too big to fail."

Yes, I don't want to see Bruce Banner get angry.

But at the very least, the expectations for the future in the US, without a collapse in the whole economy, are:
-- lower standards of living
-- lower national productivity
-- a serious reduction in government spending NOT MADE UP FOR by a concomitant increase in private spending
-- higher taxes
-- higher interest rates
-- a dramatic fall in the dollar (good for US exporters, mostly bad for US consumers who are already hurting as the US economy is slowing).

This is likely to be the GOOD outcome. Capiche? The one where gloabal financial disaster is avoided.

And this thread is here because in the other thread over there, you were upbraiding Democrats for having no eye for future consequences.

Have you NO shame at all?

Don't bother answering. Rhetorical question.

Well, I doubt it, from a lifetime of empirical evidence of seeing doom-and-gloomers being wrong time after time after time.

In 1932, Leftists thought the system was done for. Then again in 1968. The in the 70's we were going to have to settle for a more meager future and just accept it, then Reagan was going to start a nuclear war, then NAFTA was going to cause widespread unemployment, blah blah blah blah.

One of the reasons I am so right-wing and unconcerned with intellectuals and activists wringing their hands about the dire situation facing us is......they always seem to be wrong.

I prefer to put my faith in the US system and free markets, discount the naysayers and the alarmist media, and let the chips fall where they may. You might find this simple or idiotic, but I look at it as tried, true, wise and RELIABLE.

This is at the heart of why I believe what I believe. This is fundamentally what it means to be conservative.

[Edited on Sep 25, 2004 by stockula]

Yeah. that explains why you're not voting for Kerry. Wasn't he predicting that oil would run out in 199 ...wait ...or was he claiming that NAFTA was going to create a great sucking sou... no wait, that was Perot ... but surely no Republicans ever thought NAFTA was a bad bad thing *cough*PatBuchanan*cough* ..so anyway, Kerry claimed ... um ...that capitalism would fail under its own weight and be replaced by an anarcho-syndicalist comm... no, wait ...um ....

I give in.

It's because he's really a Frenchman in disguise, isn't it.

The American government rallied to save the investments. Who is going to be able to rally and save the investments when the American Crisis hits?

stockula's been assured the Martians are maintaining a watching brief, and that they've got America's back.

The wealthy have influence and power upon governments. I dont think this is anything anyone can deny, especially on the Left. While the Right accepts it as a condition of reality, the Left thinks it is a wrong that must be corrected. Unless your name is Soros, Heinz, or Kennedy of course.

Either way you look at the situation, the situation remains the same. And the rich will want to protect their loans to what they considered a safe haven: US government debt. And they'll pull whatever strings need to be pulled in order to protect those investments. This might be at the expense of foreign countries' taxpayers. But US taxpayers guaranteed the risk of US investors in Mexico, even while they collected premium rates to compensate for higher risk.

This is just how the world works; by the Golden Rule. He who has the gold, makes the rules.

[Edited on Sep 25, 2004 by stockula]

[Edited on Sep 25, 2004 by stockula]

You're getting stockula's reasoning worked out now, right?

Nutshelled:

"Don't vote Democrat because Kerry (who is French) probably believes the world is about to end.

Do vote Republican, because Bush may be a big-spending idiot, but the rich will band together and make everything right again."

Well no. I dont think you should vote for Kerry or the Democrats because they're not serious about national defense even in the face of war, and because Kerry essentially stands for nothing, has no plan, has no vision, and he has very bad judgement.

Come ON, it's ME you're talking to. Jesus.

This is bullshit. You know it, I know it, and you KNOW I know it. You're spruiking unapologetically for a guy who has all those poor qualities in spades.

The Bushies aren't SERIOUS about national defence, they're just PISSED OFF and LASHING OUT. And the consequences of their stupidity and obstinacy has been coming home to roost for months.

Bush has had no plan on defence except start a war with someone, and no domestic plan except cut taxes.

He has POSSIBLY THE WORST JUDGMENT on both domestic and foreign issues in US presidential history. Any competent person, anyone with minimal abilities to comprehend a budget, would never have gotten the US into the financial state we've been discussing in this thread.

I can only think you wrote the above words as a joke, except I know you're not.

The real reason you remain believing what you believe is still a mystery.

I think it's denial.

I never paid much attention to anything political but uh... this sucks. Surely not the most intelligent thing to say, but not much else to say. Well I could always add in there that Bush sucks, but again unintelligent and pointless.

Edited to delete an And.

[Edited on Sep 25, 2004 by HairyGod]

You have to admit this is a confronting picture.



From here.

[Edited on Sep 26, 2004 by TheFuckOffKid]

How has this thread not been locked? Its essentially a giant, long attack on a fellow board member.

When did it become fair game to single out stockula?

I have already flagged this thread twice.

It violates several parts of the TOS.

TFOK, what makes you think Kerry is going to reverse that trend of deficit spending? His whole political history shows him to be for high-priced government projects the require tax increases to fund them. He's clearly in favor of increased social spending and decreased defense expenditures to offset the rise in social spending. Nowhere does he show a record of reducing spending. Even if he raises taxes, as he's promised to do, that won't be enough to balance the budget or create a surplus that will allow us to pay down the National Debt.

What his history does show is that his preference for lower defense and intelligence spending leaves this country vulnerable to attack from small groups determined to kill innocent people. After the first Gulf war, Kerry voted to slash military spending and intelligence spending. Those cuts made us dependent on other nations for co-operation in areas like Kosovo, they left unable to succeed in areas like Somalia, and they left us blind everywhere else.

So, to sum this up, Kerry is a proven 'tax-and-spend' old school Democrat, with a socialist agenda and a disdain for needs of national defense, who wants to return things back to a time when we were more vulnerable and dependant on others to help fight our battles.

In contrast, Bush has repeatedly cut taxes, strengthened the military, and has shown a stubborn determination to use that strength to attack threats, both current and potential. Has he cut spending? No, but as you point out, we are fast approaching at time when that must occur, and I think Congress will take care of that, just as they did in the '90s.

You make a great case against Bush, but you can't make a case for conservatives to support Kerry because his record proves him to be an anathema to our core beliefs. That leaves us no choice. Nothing you post here is going to change that. Accept it and move on.

SB, I can't speak for what conservatives will or won't do. All of my sound and fury may not change one single vote, in which case, c'est la vie and all that.

I don't have any way to predict how good or bad Kerry will be. What I suspect, very strongly, is that Kerry is not blindingly incompetent the way George is. He's a political creature, sure, and he'll want to spend money (deep down, don't we all?), and how he'll respond to the pressing urgency of deficit reduction is something to be watched out into the future. My gut feeling is he KNOWS it has to be done, like Clinton knew it had to be done, and unlike Clinton, he won't have such impressive economic growth rates helping him out as he goes about it.

(I mean, we've discussed this at length. The deficit control of the 1990s was not at all purely due to Congress, albeit they forced Clinton's hand. The process started under Bush Sr, and continued under Willie, with the Gingrich Repubs upping the ante as time went on. Under Bush, you'd have a congress doing battle with the King of the Clueless: "What deficit? Huh?")

George, on the other hand, is a proven 'cut-taxes-and-spend' Republican, with his own "socialist agenda", and a stubborn determination to not understand the consequences of anything he does.

He has impoverished your country, BIG time.

He has mired you in a war for which there was little pressing case, and it will continue to be a drain on your economy, your polity, and the stature of your nationa internationally, whether or not that matters.

My only case for Kerry comes from the observation that relative to Bush, he's not an incompetent nutjob. How conservatives reconcile "He's not an incompetent nutjob, but, ewwww, he's a socialist!" is up to you guys.

Anyway, this thread was really about one thing, and it's this.

Put serious analytical pressure on stockula to explain his positions and his claims, and he will be found wanting.

Done and done. I'm sure he'll still happily vote for Bush, but whatever. I can't force him to deal with his denial issues.