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A Modest "Thought Experiment" - The "Two Americas" Problem

Some experiments are too expensive or too impractical or too time consuming to perform and so we have to try to think through "what if" scenarios in order to evaluate various courses of conduct or more basically various hypotheses about how things work. One of the constant refrains I hear is that the United States is heading toward ruin because of the National Debt. I have written about this already and I tend to be in the "deficits don't matter" camp and many people view me the same way that they would view a nutrionist who recommended junk food.

One way to think about this problem is to do a thought experiment which I will call the "two Americas" experiment. It will seem a bit far fetched but bear with me. I am assuming we are put in a time capsule and sent forward 10 years and wake up right where we are in Washington D.C. (I would love to check real estate listings and stock prices but there will be no time for that). We do the experiment twice and wake up in two different countries. The two counries are absolutely identical in every respect down to the last blade of grass except for one very important difference. Each country is prosperous, an investment in infrastructure has been made and our roads, airports, bridges etc. are in reasonably good shape. The education level of the population has improved over the past 10 years and we have a workforce which matches the demands of the job market. We have attracted lots of talented and energetic immigrants and the population has increased. There is only one big difference. In the first instance, the national debt is a small number and the Treasury does not owe any money to the Federal Reserve. In the second instance, the national debt is that first small number plus $25 trillion dollars and the $25 trillion is owed by the Treasury to the Federal Reserve.

Of course, in the second America the Treasury must pay a lot of interest to the Federal Reserve and one would think that this interest would "crowd out" other worthy federal projects. But since the interest would be earned by the Federal Reserve, it would be periodically remitted to the Treasury so that the "net interest" cost of the $25 trillion would be close to zero.

What difference would the $25 trillion debt make in the relative strength, happiness, productivity, prosperity, or other relevant factors with respect to the "two Americas"? I have thought this through as best I can and I cannot see any relevant difference at all. Of course, on the way to piling up this debt, we may - indeed, probably will - generate more inflation. But that identifies the relevant problem with more precision than a generalized concern about the National Debt. We addressed inflation very effectively in the 1980s while we were running big deficits and we can do that again. If inflation is the only real downside here, it also means that deflation can be countered with deficit spending until it is brought under control and inflation actually materializes.

I now want to talk about a third America. This is the America which we are likely to see if Eurozone type austerity is put into effect. Young people find it increasingly difficult to find jobs and so they postpone family formation. The birthrate goes down, suicides increase, and we start to see net out migration in search of jobs. Infrastructure decays as state and local governments cannot afford upkeep. More and more public schools lay off teachers and go to four day weeks. College enrollment declines and the employability of our population deteriorates. China gets further and further ahead in scientific education and technical training and skilled jobs start to leave the country. Many Americans spend decades burdened with unsustainable student loan debt and the mortgage mess never really goes away because real estate prices keep declining. But - hey - that's just one side of the picture. There is also some very good news. The Treasury does not owe the Federal Reserve one red cent.

Does anyone in his right mind want to live in the third America rather than the second 10 years from now?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.