US deficit

[Number Six]

The budget deficit is the difference between how much the government spends and how much it takes in. Very roughly (and someone can probably get more precise numbers) the US will spend $2.5 trillion this year while taking in $2.1 trillion, making for a $400 billion deficit.

That is just for one year. The total budget deficit is the sum of all the past annual deficits and it currently stands around eight trillion dollars (in numbers that is $8,000,000,000,000.00).

What happens when the US government wants to spend more than it takes in? It gets the extra money by selling...I'm not sure what they're called...bonds, perhaps? But the idea is that it's a safe investment because the US is stable and therefore other countries, like China, can invest safely by buying US government bonds.

OTOH the trade deficit is the difference between how much US imports and exports each year. I'm really not sure what the annual trade deficit currently is...$200 billion maybe? That means that Americans will spend $200 billion more on foreign goods this year than foreigners will spend on American goods.

 

[Ed]

Please, those here who seem to be more in the know, could you please explain in at most two syllable words whether or not the deficit means that 'the overspending is made up of loans (US bonds) and the selling off of US assets (ports, real-estate, etc)' or not.

As I understood it the ports have not been under US control for some time. I suspect that the bulk of the deficit is made up by borrowing.

And in either case, whether that means foreigners are owning more and more of the US capital assets or not? And in either case, whether that is a problem?

I suspect that they probably do. But owning an asset, per se, is meaningless. They presumably are using those assets to make money thus providing jobs and tax money. Whether the tax situation is a net negative would depend on how they are governed. I really have no idea.

 

[CapelDodger]

The US was overspending last year and has been overspending for quite a number of years, which meant that if you spend more than you have, you either need to loan (via US bonds) or sell assets (real-estate, for example).

A currency has a current flux and a capital flux. The current flux comprises visibles - goods imported and exported, services bought and sold, tourism in and out - and invisibles, the financial stuff. Interest, dividents, rents. The current flux can be out of balance.

The capital flux is money flowing in, either in direct investment - building a factory, say - or as a loan. The capital flux can be out of balance.

Current plus capital flux cannot be out of balance. That's a rule.

You can only spend above your income if you sell things or somebody extends you credit. And credit isn't free. So if you take on credit your outgoings increase, your current imbalance worsens. That way lies disaster.

 

[WildCat]

Enlighten me, Oh Great One. Seriously.

I thought US bonds could be bought by anyone.

The gov't sells bonds to finance the budget deficit. You said this was about the trade deficit, I'm not sure what it's about now!

 

[WildCat]

Actually, wealth isn't increasing there, debt is. The increase in interest rates is meant to slow down the increase in credit.

The Federal Fund Rate has been increasing in order to slow down growth, which can lead to inflation.

If you look at US GDP growth in detail you'll see that most of it is in the retail chain, and much of that is in unloading imported goods, transporting them to outlets, and selling them. Another chunk is down to construction, often funded by debt raised against inflating property prices. Another chunk is down to increased bank earnings.

And the point of this is...?

Then there's the excess demand created by the government deficit. US military equipment may be made in the US, but the people that make it buy Japanese TV's from their incomes.

So?

You can only live on credit for so long before somebody forecloses on you. Or sends round the leg-breakers.

Foreclosures happen when the debt is defaulted on. The part of the interest rate that accounts for this is the risk premium, do you have any evidence that the risk premium for US bonds is increasing?

 

[CapelDodger]

I suspect that they probably do. But owning an asset, per se, is meaningless. They presumably are using those assets to make money thus providing jobs and tax money. Whether the tax situation is a net negative would depend on how they are governed. I really have no idea.

At the heart of this is the dollar. What the dollar can buy out there. That depends on supply and demand.

If an asset is foreign-owned and makes a profit in dollars the owner will remit those profits in their own currency - they will offer dollars for sale, demanding their own currency. That's crude, I know, but bear with me. This puts downward pressure on the dollar. If the asset was US-owned that wouldn't happen.

The big question is why a profitable asset in the US isn't owned by US capital. Perhaps the US just doesn't have that much capital anymore. And what it has is making silly returns re-mortgaging inflated property-values. This is all so 1929, but different.

 

[AWPrime]

Why would anyone with common sense buy US bonds?

 

[egslim]

I've heard some say that the absolute value of the budget deficit doesn't matter but rather what matters is the size of the budget deficit relative to the GDP and that by that measure the deficit isn't that bad.

The way I see it, the government is 'owned' by the people. If the government has a deficit that's not so bad, as long as its held by those same people.
It will result in inflation, but as long as the deficit is small compared to the GDP that won't be a large effect.

Unfortunately, a large part of the US governments' debt is in the hands of foreign investors - 46% of all outstanding federal government debt paper, http://mwhodges.home.att.net/reserves_a.htm. It would be interesting to know how much foreign debt is in the hands of US investors. However, according to http://mwhodges.home.att.net/family_a.htm#saving average savings by US consumers are down to -0.7% and descending. A larger trade-deficit means less money is left at home to finance the governments budget deficit.

You have to keep in mind economic growth doesn't tell the whole story. For example, housing prices in the US are rising at some 15% per year. Homeowners can mortgage this 15% increase and use it to buy consumer goods. But where does this 15% come from? It's not because of higher production costs, but because people believe housing prices will continue to rise. As they therefore try to get on-board, they simultaneously fuel the continued increase.
Such a system is vulnerable. If, for any silly reason, people lose this belief the 15% anual increase will slow down, make others nervous, and as they sell prices will drop. That's basically what happened with the stocks in the '29 stockmarket crash - people lost their belief in the continued rise. From self-fulfilling prophecy to self-fulfilling catastrophy.

There is a difference, though. Back then the US was the world's leading manufacturer. People may have zero confidence in money, stocks, bonds and whatever, but they still require consumer goods. Which the US produced in large quantities. Those goods had tangible value - even without money they would have been traded for sheepskins, or anything.
But nowadays the US is mostly dependent on other countries for its consumer goods. The US makes money, not goods. Money has no tangible value - if people lose their confidence it becomes worthless. Living this way is dangerous.

 

[CapelDodger]

The Federal Fund Rate has been increasing in order to slow down growth, which can lead to inflation.

We're all monetarists these days, aren't we? The mechanism by which the Federal Fund Rate slows down growth is its effect on the growth of credit. Increasing credit increases the money supply and thus fuels inflation if it exceeds production growth. Sadly, fiddling with Base Rate has no great impact when you consider what people pay for credit-card debt.

point of this is...?
...
So?

Your economy is living on credit. Private, public and trade. You're selling the family silver to keep yourself in posh frocks. That's the point. You're not borrowing to invest, you're borrowing to consume. It's a fool's Paradise.

sures happen when the debt is defaulted on. The part of the interest rate that accounts for this is the risk premium, do you have any evidence that the risk premium for US bonds is increasing?

The Federal Funds Rate keeps increasing. What other evidence do you need?

 

[WildCat]

The way I see it, the government is 'owned' by the people. If the government has a deficit that's not so bad, as long as its held by those same people.

Why?

It will result in inflation, but as long as the deficit is small compared to the GDP that won't be a large effect.

How does a budget deficit fuel inflation? Keep in mind that the budget deficit was much smaller in the 1970's, yet inflation was many times what it is today.

Unfortunately, a large part of the US governments' debt is in the hands of foreign investors - 46% of all outstanding federal government debt paper, http://mwhodges.home.att.net/reserves_a.htm. It would be interesting to know how much foreign debt is in the hands of US investors. However, according to http://mwhodges.home.att.net/family_a.htm#saving average savings by US consumers are down to -0.7% and descending. A larger trade-deficit means less money is left at home to finance the governments budget deficit.

Perhaps US consumers are optimistic about the future?

You have to keep in mind economic growth doesn't tell the whole story. For example, housing prices in the US are rising at some 15% per year. Homeowners can mortgage this 15% increase and use it to buy consumer goods. But where does this 15% come from? It's not because of higher production costs, but because people believe housing prices will continue to rise. As they therefore try to get on-board, they simultaneously fuel the continued increase.
Such a system is vulnerable. If, for any silly reason, people lose this belief the 15% anual increase will slow down, make others nervous, and as they sell prices will drop. That's basically what happened with the stocks in the '29 stockmarket crash - people lost their belief in the continued rise. From self-fulfilling prophecy to self-fulfilling catastrophy.

People have to live somewhere, the population is rising, and they aren't making any more land.

There is a difference, though. Back then the US was the world's leading manufacturer. People may have zero confidence in money, stocks, bonds and whatever, but they still require consumer goods. Which the US produced in large quantities. Those goods had tangible value - even without money they would have been traded for sheepskins, or anything.
But nowadays the US is mostly dependent on other countries for its consumer goods. The US makes money, not goods. Money has no tangible value - if people lose their confidence it becomes worthless. Living this way is dangerous.

Money has no tangible value? I'd be willing to take all yours off your hands...

 

[a_unique_person]

We're all monetarists these days, aren't we? The mechanism by which the Federal Fund Rate slows down growth is its effect on the growth of credit. Increasing credit increases the money supply and thus fuels inflation if it exceeds production growth. Sadly, fiddling with Base Rate has no great impact when you consider what people pay for credit-card debt.


Your economy is living on credit. Private, public and trade. You're selling the family silver to keep yourself in posh frocks. That's the point. You're not borrowing to invest, you're borrowing to consume. It's a fool's Paradise.



The Federal Funds Rate keeps increasing. What other evidence do you need?

In theory it doesn't matter, people know how much debt they can pay, lenders also only lend them what they can pay. In practice, living off debt can become a habit. When it's time to cut off the supply, withdrawal symptoms can be severe.

 

[Ed]

This explains it.

Please shoot me if I give any signs of enjoying reading this stuff.

http://www.foreignaffairs.org/20050301facomment84201/david-h-levey-stuart-s-brown/the-overstretch-myth.html

 

[WildCat]

We're all monetarists these days, aren't we? The mechanism by which the Federal Fund Rate slows down growth is its effect on the growth of credit. Increasing credit increases the money supply and thus fuels inflation if it exceeds production growth. Sadly, fiddling with Base Rate has no great impact when you consider what people pay for credit-card debt.

I wasn't talking about credit card debt or personal debt.

Your economy is living on credit. Private, public and trade. You're selling the family silver to keep yourself in posh frocks. That's the point. You're not borrowing to invest, you're borrowing to consume. It's a fool's Paradise.

Gov't cannot invest, and doesn't invest. Private individuals and institutions invest. You seem to be intermingling the two.

The Federal Funds Rate keeps increasing. What other evidence do you need?

The Federal Funds rate is not the bond rate.

 

[CapelDodger]

Why would anyone with common sense buy US bonds?

Not immediately obvious, but in the banking world US bonds are real assets that can support multiples of credit. And there's a good market for credit in the US. The secret is to get out at the right time - and everybody thinks they will, of course.

I have no idea what US bond prices and coupons are just now, which has made me realise that I've kicked a habit without noticing.

 

[a_unique_person]

I wasn't talking about credit card debt or personal debt.


Gov't cannot invest, and doesn't invest. Private individuals and institutions invest. You seem to be intermingling the two.


The Federal Funds rate is not the bond rate.

Government invests in infrastructure.

 

[AWPrime]

This explains it.

Please shoot me if I give any signs of enjoying reading this stuff.

http://www.foreignaffairs.org/20050301facomment84201/david-h-levey-stuart-s-brown/the-overstretch-myth.html

Quite laughable

 

[CapelDodger]

I wasn't talking about credit card debt or personal debt.

That's because you don't understand the mechanism by which the FFR affects the economy. I tried to explain it.

Gov't cannot invest, and doesn't invest. Private individuals and institutions invest. You seem to be intermingling the two.

Governments can invest in productive assets. The Trans-Continental Railroad was built on government money, and paid back handsomely. The British motorway system was built on government money and has paid back handsomely. These are investments, just as much as the private investments that take advantage of the infrastructure.

The current US government deficit isn't going on this kind of productive investment, it's going on day-to-day consumption. Where are the grand projects of yesteryear?

The Federal Funds rate is not the bond rate.

It has a bearing on the money-market rates - that's short-term money, very liquid - and thus the dollar. The Feds, being inflation-averse, are very conscious of the dollar. The money-market rates include a risk-factor (of currency decline). An increase in risk has to be countered by an increase in yield. Ergo, FFR goes up when the risk-factor increases.

I must check out bond prices ... There's not just a bond-price, you know. There's a nerd's Paradise in there.

 

[egslim]

Why?

Because if a foreign party owns a significant share of US bonds that gives them power over the US government. They can threaten to sell them off, lowering the demand and thus making life of the Treasury more difficult. If the demand becomes low enough, potentially interested parties will make additional demands on US internal and foreign policy.

How does a budget deficit fuel inflation?

Because if money is created without an accompanying increase in productivity, inflation will automatically result.

Perhaps US consumers are optimistic about the future?

Most likely true. What's your point? The average US consumer is living beyond his means, as the -0.7% average savings indicate. In a healty, self-sufficient economy consumers provide both consumption for the industry's produce and capital (savings) for its investments. US consumers don't save.

People have to live somewhere, the population is rising, and they aren't making any more land.

Is the population rising 15% annually? And an increase in productivity should work to decrease the price. 15% annual increase is way too high - this is because of speculation.

Money has no tangible value? I'd be willing to take all yours off your hands...

I bet you would, they're Euro's.
But seriously, take a look at German hyperinflation in 1923:
http://www.usagold.com/GermanNightmare.html
From the price index table:
July 1923 194,000.0
Nov 1923 726,000,000,000.0
That's because money has only value because we believe it does. If for any reason that belief is lost, you end up with postagestamps only millionairs can buy. At that point of course, everyone is a milionair.

 

[RandFan]

The overspending is made up of loans (US bonds) and the selling off of US assets (ports, real-estate, etc).

Could you justify the relationship. I don't think one has anything to do with the other. Are you suggesting the US government is holding a fire sale to pay of debt?

 

[CapelDodger]

In theory it doesn't matter, people know how much debt they can pay, lenders also only lend them what they can pay. In practice, living off debt can become a habit. When it's time to cut off the supply, withdrawal symptoms can be severe.

It can become a habit lending people money when they're eager to borrow. You make the interest this year, next year, no reason not to think that it'll be made every year and the principal at the end. No reason to think otherwise, because that could mess up your whole day. You have security - property, for instance, which is inflating because you're pushing credit into the market. Whoops. Or shares which are inflating because you're pushing credit into the market. Whoops again. Or tulip bulbs. It's like Enron, you make your bonuses and when it all goes down the pan nobody asks for them back.