It’s The Economy II

To the best of my knowledge, the United States of America is the one and only country in the world whose national debt is owed in its own currency, the one and only Greenback, the Buck, the American Dollar.  Many aren’t aware, but the way this national debt works is as follows.  The United States, in order to fund its programs, collects taxes.  Taxes aren’t enough to fund the government, so it issues and sells securities to the public, for a determined amount of time, promising to buy them back with interest when the term is over.  The public buys the securities, and trades them (or keeps them).  The closer the term is, the closer the value of the securities are to face value (which is rather obvious, as they are submitted to the government for payment, and the government will pay the face value, not a penny more).  The United States never defaulted on its debt, and its credit rating was a perfect AAA until last week.  AA+ isn’t so bad, but it isn’t perfect.  Anxiety gripped the markets worldwide.

Now, the American government, with its conveniently dollar denominated debt, can simply decide to pay up the debt in its entirety by building a couple of more mints, and having them work nights and weekends in printing brand new notes.  What would happen as a result?  Immediate inflation, correct?  With the sudden abundance of newly printed $100 bills (heck, might as well print large, nicely designed, multi-presidential $1M dollar bills, it will lower the shipping costs), the purchasing power of the American Dollar will go spiraling down right away.  For those who read The Hitchhiker’s Guide to the Galaxy – it’s like tree having leaves become the currency.  In order to keep the spending going at the same rate (and even speeding it up some), the government will have to print and sell even more bonds (set up new mints, work holidays in addition to nights and weekends), which in turn will have to offer better interest rate, or nobody will buy them at all, and then, of course, print more money to pay them up.

By the way, it’s not that the purchasing power of the dollar is constant or growing.  Far from it.  In fact, ever since the connection between gold and dollar was severed years ago, the purchasing power of the dollar has been deteriorating significantly.  (See here for more)

Simply stated, nobody wants the United States to print its way out of debt.  The world wants the US to maintain the buying value of its currency, so it when they cash in the bonds and securities, they gain, and not lose.  The people want a plan.  A plan that will suggest that the United States of America is serious about handling money, serious about paying up its loans, serious about consuming, about industry, manufacturing, jobs.  Mainly about correlating its spending with its income.  Something that’s expected from households…

But of course, it isn’t as simple as it sounds.  Some, if not all, of the major debt owners, want the US to keep spending, a lot, even more than it does today.  Why?  Because large amounts of this money is spent in other places.  If the US suddenly becomes stingy, careful, frugal about money, some very large world economies may collapse overnight.  So it looks like a classic Catch 22.  If the US overspend and owes a lot, it’s credit rating gets cut.  Printing money is not an option, defaulting is even a worse option.  A plan is needed.  A plan to cut spending.  But if the spending is cut, economies would collapse.  Spending is encouraged and there we go again…

There were some voices not long ago that investors should move to the Euro.  I thought then that it was a joke.  I now think it’s not even funny.  Some may say that the Euro may not be as long lived as expected.  Spain, Greece, Italy, Portugal, Ireland, Iceland and possibly other countries in the Euro Zone are showing signs of economic distress.  Some are already bankrupt or close to it.  Over the weekend I heard on CNN an interesting idea: an international currency.  Interestingly, the strongest economy in Europe is one that preserved its manufacturing and industrial power despite its price – Germany.  But I can’t but wonder how will this resolve this interesting situation: the developing world is developing because of conspicuous consuming habits developed over the years in the already developed world which in turn moved from manufacturing to services.  In order to keep the developing world developing, the consuming world must keep consuming.  As the populations grow on both sides of the equation, more manufacturing is needed to support the population, and hence more consuming is necessary on the other side.  Is it possible that this is a positive feedback process which may spiral all economies to oblivion?  As soon as consumption is restrained, manufacturing will too.  If the developed country won’t be able to pay for the goods, there will be no way to feed the hungry mouths of the developing world.

Looks like something more creative needs to arise.  Something that will better distribute resources amongst people.  Something that will curb consuming without causing disastrous effects on the manufacturing countries.  The way things are going, well, simply put – we are not going to better places.  And we all know, in the past of the human race, fighting over resources always lead to wars.  Not price wars.

One last comment (not original, but I can’t remember who said it): “If the US Government is rated AA+, then everybody else should rate AA or less”.  My small addition is that playing politics (Congress, Senate, The President of the United States, and S&P) where the stakes are so high should come with consequences (see: “It’s the Economy, Stupid).  No disrespect, of course.  Let’s all remember, 2012 is a General Election Year, and there’s a good chance the results will be determined by the economy.