If Congress goes on their one-month vacation in August without coming to a deal on the United States public debt, I think the stock market goes into a downward correction. We may not even need to wait that long. Congress has about 6 weeks to come together and reach a deal to raise the debt ceiling.
United States Public Debt Scam
What Democrats did was to run up the national debt so high, that austerity would be forced on the next administration which would all but assure that person a one-term President. We know this because Democrats admit asking Yellen to keep interest rates low and to not raise them until after the election.
Credit Suisse said that they think markets may well be able to continue without too much consternation through most of July, but if it becomes apparent that Congress will head out on its August recess – which lasts the entirety of that month-having made no progress, then fears of a delayed or missed payment should start to build.
Why is Congress going on a one-month vacation before raising the debt ceiling? You don’t use the debt ceiling to enforce austerity. That’s like using Accounts Payable to control spending costs.
The US national debt just broke above $19.5 trillion. Both Democrats and Republicans are to blame, but it is important to note that President Obama and Democrats increased the national debt more than all President’s before combined.
George Bush exploded the national debt by $3 trillion in response to an imploding economy and 911. Obama exploded the national debt by $10 trillion in response to an imploding economy.
Debt increases are a function of the government not being able to pay its bills because it has too little revenue (taxes) compared to costs (spending). When spending exceeds revenue you have a deficit. Since 2002, this is what quarterly deficits (or surpluses) have looked like.
The last time we have a surplus was back in 2001, some 16 years ago. That’s sad.
The interest on the $19.5 trillion dollar debt is about $482 billion a year or more than $60,000 per US citizen.
How does the US government finance the deficit?
The Crowding Out Effect
The U.S. Treasury sells IOUs in the form of bonds or treasury bills directly to the private capital markets and uses the proceeds of the sales to finance the deficit.
The US Treasury is competing directly in the capital markets with private corporations, which may also be seeking to sell bonds and stocks to raise money to invest in new plant equipment. To compete for these scarce investment dollars, the Treasury typically must increase the interest rate it is offering to attract enough funds. Running a huge deficit is largely a zero sum game because funds to finance the deficit would otherwise be spent on private sector investment (the I variable in the GDP formula).
Money used to finance the deficit is money that would otherwise have been borrowed and spent by corporations and businesses on private investment. Deficit spending by the government is said to crowd out private investment. Crowding out is the offsetting effect on private expenditures caused by the government’s sale of bonds to finance the deficit. The larger the deficit and the more government needs to spend on financing that deficit, the more crowding out occurs.
The crowding out effect, which is one of the most important concepts in macroeconomics, is illustrated below.
The initial equilibrium is at Y, where the aggregate expenditure curve AE, crosses the aggregate production curve AP. However, expansionary fiscal policy shifts the aggregated expenditure curve up to AE1. This leads to a new equilibrium of Y1. However, because the government has had to borrow money from the private capital markets to finance these expenditures, interest rates rise. This reduces investment and a resulting contractionary effect shifts the aggregate expenditure curve back down from AE1 to AE2.
The final equilibrium is now at Y2 as the net economic expansion equals Y2 minus Y. At the same time, the partial crowding out of private investment may be measured by Y1 minus Y2. The level of partial crowding out rises the more government borrows from the private sector.
It is my opinion that government deficits are a weak fiscal policy tool at best, and I think the last eight years of President Obama increasing the national debt and running the largest deficits in US history has proven that point.
A few readers have asked me if crowding out can be reduced by printing money. The idea is to avoid crowding out by printing money and here is how that scheme works. The Federal Reserve accommodates the Treasury’s expansionary fiscal policy by buying Treasury’s securities itself rather than letting the securities be sold in the open capital markets. In essence, the Federal Reserve simply prints new money.
The problem with this option is that the increase in the money supply can cause inflation. Moreover, if such inflation drives interest rates up and private investment down, as it is likely to do, the result of the print money option will be a crowding out effect as well. In other words, there is no escaping the crowding out effect when it comes to financing the deficit. Again, look at the last eight years of President Obama and look out how much he has put this country in debt and ask yourself has it really benefited the U.S. economy that much? Perhaps some, but ultimately crowding out took away much of the initial gains from Democrat’s expansionary fiscal policy.
Deficits Impact On International Trade
Deficits and a rising government debt is a serious threat to the US. Chronic budget deficits have not only been responsible for crowding out private investment, but also for America’s huge trade deficits over the last several decades. The macroeconomic relationship between deficits and international trade is illustrated below.
As government deficits drive interest rates up in boxes 1 and 2, we observe crowding out in box 3. Now look at box 4. Higher US interest rates attract foreign investors but, for these investors to invest, they must exchange their foreign currencies for dollars. This not only leads to an increase of US external debt in box 5, but it also drives up the value of the dollar in box 6. A stronger U.S. dollar makes U.S. exports less competitive, and exports decrease in box 7 even as imports increase in box 8. The result is a larger trade deficit in box 9, and that’s why economists refer to budget and trade deficits as the “twin deficits.”
A trade deficit means a country is not exporting enough to pay for its imports. The difference can be paid by either borrowing from abroad or by selling US assets.
Mortgaging America
To finance its trade deficit, the US has had to sell off assets such as factories, shopping centers, hotels, golf courses, and farms to foreign investors. This mortgaging of America has reduced both the rate of economic growth and the level of real income of Americans.
Deficit Doves Say Don’t Worry
Deficit dove economists that work for Democrats and the Obama Administration say don’t worry about the national debt because most of that debt is internal debt owned by the country to its citizens. Obviously, that argument by Democrat economists is not so good as evidenced by the broken US economy some eight years after Democrats and Obama took office. I list four reasons below why this “don’t worry be happy” argument is wrong and how it has hurt the US economy.
#1: Internal Debt Leads to Higher Taxes
Internal debt requires payments of interest to bondholders. This, in turn, means higher taxes which distort the allocation of national resources and lead to an efficiency loss.
#2: Internal Debt Redistributes Income From Poor To Rich
Paying interest on the internal debt unfairly redistributes income from the poor and middle class to the rich. This happens because government bondholders as a group tend to be wealthier than taxpayers as a group.
#3: Servicing The Debt Cuts Government Services
Paying interest on the debt uses $482 billion each year, and this money could otherwise be spent on providing taxpayers with more education, health care, and other government services. The size of the interest payments to service the debt, relative to total tax revenues, has been rising every year. If nothing is done, we will eventually wind up using all available tax revenues simply to service the debt.
#4: A Burden On Future Generations
The accumulation of such a large debt places an unreasonable burden on future generations, which must pay this debt off. I don’t know what to even tell my daughters about the $19.5 trillion national debt, so I choose to say nothing. I could say I voted for Obama because I wanted to vote for the first African-American President and I thought he would save our household money on medical care. Then say, oops, my bad, now here’s the $9 trillion he added to the national debt during his Presidency that you have to pay off when you’re old enough to work. Thank you and have a nice day.
Niall Ferguson thinks that the “age of debt” is coming to an end. Apologies for the sub-titles but this Hard Talk interview has an important message.
With a growing crowding out effect, it may be impossible to increase GDP in a meaningful way until the national debt and deficit spending is reduced.
The velocity of money has hit the lowest level ever recorded as I wrote about here. I believe the crowding out effect is at least partially to blame for the slowdown in the velocity of money.
President Obama has run the national debt up to nearly $20 trillion, more than all President’s before him combined. This expansionary fiscal policy has crowded out private sector investment.
Crowding out is the offsetting effect on private expenditures caused by the government’s sale of bonds to finance expansionary fiscal policy. When the Federal government borrows money to finance a budget deficit, the U.S. Treasury sells IOU’s in the form of bonds or treasury bills directly to the private capital markets and uses the proceeds from the sales to finance the deficit. The Federal Reserve is out of the loop as the U.S. Treasury is competing directly in the capital markets with private corporations, which may also be seeking to sell bonds and stocks to raise money to invest in new plant and equipment.
To compete for these scarce investment dollars, the Treasury typically must raise the interest rate it is offering in order to attract enough funds. This means that running a deficit is largely a zero sum game. The money used to finance the deficit is money that would otherwise have been borrowed and spent by corporations and businesses on private investment. This is how deficit spending by the government is said to crowd out private investment. This crowding out effect is illustrated by these two figures.
On the left-hand figure, an increase in investment demand by the government shifts the investment demand curve from Id1 to Id2. This raises the interest rate and reduces private investment as is made clear by the right-hand figure. Note that in this figure, if the economy starts at point a and moves to point b, crowding out will be equal to h1 minus h2; however, if the economy starts at point C in a recession and moves to point B, crowding out need not occur.
I believe that substantial crowding out has occurred during the Obama Administration and their expansionary fiscal policy which has reduced the velocity of money.
Banks don’t need savers money because they have large surpluses of cash and can borrow money cheaply from the Federal Reserve; thus savers are penalized as they are paid very low-interest rates on their savings.
The next President of the United States needs to reverse course in my opinion and reduce the crowding out effect to get the velocity of money going up again. The way to do that is to stop using fiscal policy and government spending to drive economic growth. In the GDP formula: GDP = C + I + G + (Exports – Imports), the reliance on fiscal policy should be reduced because increases in G (government spending) are largely being offset by declines in I (investment by businesses).
Unfortunately, most modern Keynesian economists recognize the possibility of crowding out, but they do not think it is a major problem when business borrowing is depressed because that’s what usually happens in a recession; therefore, an activist expansionary fiscal policy is appropriate.
In 2016, foreign countries have dumped a shocking $192 billion worth of U.S. Treasury bonds. This dumping of bonds is the biggest selloff of U.S. debt since 1978.
China, Japan, France, Brazil and Colombia are the leading countries that are dumping U.S. debt.
U.S. Treasury bonds are the safest investments in the world. Countries often hold large portions of their cash reserves in U.S. Treasury bonds. Countries are dumping U.S. debt because they need the money.
Most countries are selling everything including the kitchen sink to come with the money required to pay the bills and to try and stimulate their economies.
Foreign sales of U.S. debt appear to be primarily driven by economic necessity.
Debt Sales Also Driven By Record National Debt
The U.S. debt held by China is $1.243 trillion, as of April 2016. That’s 30% of the $4.046 trillion in Treasury bills, notes, and bonds held by foreign countries. The rest of the $19 trillion debt is owned by either the American people or by the U.S. government itself.
Between 1789 and 1992, the entire national debt was about $4 trillion. Today, $4 trillion is just what we owe other countries. The total $19.3 trillion national debt could be spooking U.S. debt buyers. At what point do debt buyers begin to question the ability of the U.S. government to service the $19.3 trillion national debt? The U.S. government can’t even hike rates more than a quarter-point some seven years after the last recession because the economy is so weak. If the U.S. economy goes into another downturn, that will mean more stimulus and spending that will drive the national debt beyond $23 trillion in the blink of an eye.
U.S. government debt as a percent of GDP has recently broken above 100%.
[graphiq id=”4iWDyD7B3YF” title=”Gross Government Debt of United States in Percent of GDP” width=”440″ height=”582″ url=”https://w.graphiq.com/w/4iWDyD7B3YF” link=”http://country-facts.findthedata.com/l/1/United-States” link_text=”Gross Government Debt of United States in Percent of GDP | FindTheData” ]
With the U.S. consumer’s buying power destroyed by years of offshoring at the hands of corrupt political parties taking money from foreigners, what value does the U.S. have beyond its natural resources? At some point holding U.S. debt becomes too risky and not worth the low yields paid as shown in the chart below.
If Congress goes on their one-month vacation in August without coming to a deal on the United States public debt, I think the stock market goes into a downward correction. We may not even need to wait that long. Congress has about 6 weeks to come together and reach a deal to raise the debt ceiling.
