Can the US Government Afford Future Bailouts? 17 comments
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Simply put, yes it can. In the days following the bailouts of Fannie Mae (FNM) and Freddie Mac (FRE) there have been countless pundits on television and many articles on Seeking Alpha and other investment sites proposing the misplaced thesis that we should worry about the US government's finances following the recent bailouts. The prevailing idea is that if the market's bad debts are transferred to the government, then the government will be the one having the problems.
The responsibilities piling onto the government include the Bear Stearns (BSC) liabilities, the Fannie Mae and Freddie Mac liabilities and potentially Lehman Brother’s (LEH) liabilities. While these are significant issues and will likely act as albatrosses around the neck of the next administration, they were necessary actions that will support the financial framework of not only the United States but the world as well.
Below are some of the more common questions that have appeared around the financial community over the last several days:
- How much can the government add to its $9.6 trillion debt before it too cannot handle its own liabilities?
- When will foreigners refuse to let the US government borrow money?
- When will the dollar truly collapse?
The people asking these questions misunderstand the nature of money and the function of the dollar in the modern global economy. So, how much can the government add to its $9.6 trillion debt before it too cannot handle its liabilities? The answer is that the government can borrow as much as it wants and that it will never be unable to service its debt.
There is a prevailing view that people want to look at government in the same way that they look at a business. People mistakenly look at tax receipts as revenue and government spending as an expense. When the government has a budget deficit and is borrowing money to make up the difference people think the government is losing money.
Certainly, if the expenses of a business were greater than its revenues for the last 150 years the business would go bankrupt and people would at some point refuse to lend money to a failing business. The key difference between a private business and the government is that the government has infinite access to money, since the government can literally print its own money. If foreigners will not buy US government debt to make up the budget deficit, the government will always have the ability to print money to make up the shortfall. Fortunately, foreigners will not stop buying our debt because they have no other choice.
Take China for example. China's economy is built on selling products to the US. If China stops selling products to the US, China would face a terrible recession, which would cause severe political unrest for the country’s political authorities. As a result, China is going to keep selling its products to the US. When China sells its goods to the US, China is literally trading goods for US dollars. At the end of the day, China always ends up holding a huge and growing number of dollars.
China has few options on what to do with these dollars. The country can either hold them and earn no interest, buy US treasuries and earn interest, buy other US financial assets, other US exports or sell the dollars for another currency. Holding dollars and earning no interest simply is not sensible. China can also buy US financial assets and US exports, and it does that.
As for selling the dollars, what would China sell the dollars for? Euros? Yen? If this were done, China would be left with the same set of choices all over again. The real bottom line reason that gives the dollar value to foreigners is the products and services that you can buy with dollars, namely US exports. Despite the fact that we are a net importer, the US is still the highest gross exporting country and this gives us substantial leverage in world affairs that is routinely understated. China can either spend all of its dollars now or it can save those dollars for later by purchasing US treasuries.
The idea of the government printing money for any purpose is frightening to many. However, it is not as bad as one might first assume. Printing more money is inflationary, which is one of the main principals that worry people. However, for a better perspective on the issue we should look at the Fannie and Freddie bailouts.
If Fannie and Freddie were to have gone bankrupt (instead of being placed into conservatorship), their debt probably would have become worthless and the value of the mortgages that they insure would have dropped substantially. If this happened it would set about a self-reinforcing trend beginning with nearly all financial institutions having severe problems supporting their own liabilities which would force them to stop lending. This would cause economic activity to grind to a halt, further worsening the health of the banking system. Bill Gross described this scenario as a “systematic debt liquidation” and I talked in greater detail about such an event here.
As a result, we are faced with the choice of either possibly causing some inflation at a future date or allowing another Great Depression to happen. One should not have to think too long about which alternative one would prefer. This is especially true when you consider that things can be done in the future to fight inflation, such as raising interest rates or raising taxes net of spending. Given the fact that the current credit crunch is deflationary, the inflation caused by the expansion of the government’s balance sheet is likely to be a good thing in the near term.
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This article has 17 comments:
Running the presses may work fine for the government and its assorted cronies and sycophants, but what about the poor schlub who ends up paying $10 for a gallon of gas or a quart of milk?
You have to be a tool of the first magnitude to think that we can print unlimited amounts of dollars without serious consequence. For an example, look at the end of any fiat currency in history. Heck, look at the value of the dollar since the creation of the Federal Reserve! They managed to destroy 95% of the dollar's value so far. Why do you think the last 5% will fare any better?
If we are printing money to cover a shortfall when foreigners stop buying our debt, we are the Weimar Republic. Don't kid yourself that other nations will keep us afloat forever.
I can chose between this terrible thing called depression (yuck - noooobody wants this) and no limits money print inflation. Benign, mild, you will not even notice (Aha, gimme some of this, that s more to my liking).
Well why then all this fuss about a financial market crisis, Wall Street in turmoil, bail outs? Why even issue Government debt, treasury bills, bonds, notes and the like? Why not just print money, as you go, as you need. That s what the author tells us we can do. And while we are at it – why pay taxes, why doesn’t t the Treasury just send a check to every American, every month – and we all live happily ever after?
No wonder the US is in a mess when such goofy theories are making the rounds. But then why not put the entire world on halluncinogen and off we are to financial Nirvana
And if someone doesn’t t want to buy into this idea of paradise on earth, there are still mighty military options open – with no limits, with all the resources one can dream of, paid with the no limits Government money print our author just invented.
Mind boggling!
Have a good day
Remember, all of this is taking place while some still believe we will avoid a RECESSION. That level of denial assures a 6,000+ point drop in the Dow over next 1-3 years.
WOW!!!
I can't believe I actually read that!! We are all just jumping up and down with joy over the good news.... They usually advise you not to make any serious decisions for 24 hours after being under anesthesia.... I will assume you have been recently sedated....
so...
Government = Debt to foreign creditors + Taxpayer equity
As the national debt has increased Liabilities, it has reduced Equity, resulting in foreign creditors having a greater claim to the assets of government than taxpayers do. This is the same process that occurs when a company goes bankrupt. The remaining assets become controlled by the creditors, rather than equity holders. Additionally, in this case, the government is completely dependent on continued borrowing from foreign creditors for its daily operations. These borrowers could cut off funding tomorrow if they wanted to. The equity holders (taxpayers), on the other hand, do not have the option of refusing to pay taxes, so their interests are inherently at a comparative disadvantage.
For these reasons, the focus of government has shifted from benefiting taxpayers to benefiting the foreign creditors on which it depends. When the fed shifted the cost of trillions of dollars in dumb foreign investments from the creditors to the taxpayers, they were pursuing the interests of the liability owners at the expense of the equity owners. The alternative was to risk having foreign creditors clamp down on lending to the U.S, which would result in a currency crash and a government cash shortage - like Russia in the 90's, when the govt. couldn't even pay the salaries of its employees.
These factors will not change soon, and most people can't even figure out what is going on, so expect more of the same and invest accordingly.
1900 yrs ago the romans did not have access to a printing press, it's probably just as well. instead they steadily debased their coinage which after some time became worthless. we all know what happened to the romans.
> jack
1) Physically revolt
2) Voter revolt
3) The nation is conquered. Actually, with all the foreign lobby holding our debt, this in part has already occured. And as they squeeze the middle class, they can expect a giant middle finger at some point leading to outcome 1 or 2. At some point, the foreigners holding a large portion of our debt will get the finger. I am not saying it is right that this happens, I am just stating what is probable at this point.
Well, I think the consumer's printing press came in the form of home equity loans. Wonder how many of these are upside down?