This article deals with how America’s public debt problem may be dealt with. In the first of these three articles, the problems of US debt were outlined. The second article looked at how the problem should be dealt with.
Given the magnitude of the US debt problem and the lack of political will, the most likely policy is FMD — ‘fudging’, ‘monetisation’ and ‘devaluation’.
There is no shortage of creative ideas of financing government debts. Bankers suggested the US issue perpetual debt, that is, the government would not be obligated to pay back the amount borrowed at all. Peter Orzag, former director of the US Office of Management and Budget under President Obama and now a vice-chairman at Citigroup, suggested another creative way to correct the problem - lotteries. To encourage savings, banks should offer lottery-linked accounts offering a lower rate of interest, but also a one-in-a-million chance of winning $1 million for each $100 deposited.
As governments printed money to service their debts, US Post issued 44-cent first class ‘forever stamps’ that had no face value but were guaranteed to cover the cost of mailing a first class letter, regardless of how high that cost might be in the future. Between 2007 and 2010 the public bought 28 billion forever stamps. The scheme summed up government approaches to public finance — US Post was cleverly hiding its financial problems, receiving cash up-front against the uncertain promise to pay back the money somewhere in the never, never future.
Extortionate privilege…
Debt monetisation — printing money — is the favoured option. The US Federal Reserve is already the in-house pawnbroker to the US government, purchasing government bonds in return for supplying reserves to the banking system. Expedient in the short term, it risks debasing the currency and setting off inflation. The absence of demand in the economy, industrial over capacity and the unwillingness of banks to lend have meant that successive rounds of “quantitative easing” — the fashionable moniker for printing money - have not resulted in higher inflation to date. But the longer term risks remain.
Monetisation is inexorably linked to devaluation of the US dollar. The now officially confirmed zero interest rates policy and debt monetisation is designed to weaken the dollar.
On October 19, 2010, US Treasury Secretary Timothy Geithner told the Financial Times: “It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity and Competitiveness. It is not a viable, feasible strategy and we will not engage in it.” The facts show otherwise.
Despite bouts of dollar buying on its safe haven status, the US dollar has significantly weakened over the last two years in a culmination of a long term trend which with minor retracements. In 2007 alone, the US dollar weakened by about 8% improving America’s external position by $450 billion, as US foreign investments gained in value but its debt denominated in dollars were unaffected.
On a trade weighted basis, the US dollar has lost around 18% against major currencies since 2009. The US dollar has lost around 30% against the Swiss Franc, 25% against the Canadian dollar, 37% against the Australian dollar and 16% against the Singapore dollar over the same period.
US dollar devaluation makes it easier for the US to service its debt. In the balance of financial terror, it forces existing investors to keep rolling over debt to avoid realising currency losses on their investments. It also encourages existing investors to increase investment, to “double down” to lower their average cost of US dollars and US government debt. The weaker US dollar also allows the US to enhance its competitive position for exports - in effect, the devaluation is a de facto cut in costs. This is designed to drive economic growth.
Valery Giscard d’Estaing, French finance minister under President Charles de Gaulle, famously used the term “exorbitant privilege” to describe the advantages to America of the role of the US dollar as a reserve currency and its central role in global trade.
That privilege now is not only “exorbitant” but “extortionate”. How long the rest of world will allow the US to exercise this “extortionate privilege” is uncertain.
A world without the US dollar…
Winston Churchill famously observed that Americans can be counted on to do the right things but only after all other possibilities have been exhausted. Unfortunately, it is doubtful that the US debt problem will be resolved by resolute American actions. The deployments of FMDs seem more likely.
America remains the world’s only military super power and constitutes a quarter of the global economy. This means that what happens in America is unlikely to stay in America. The world must prepare for the denouement of the US debt crisis. At best, actions by America will usher in a prolonged period of stagnation for the US economy reducing global economy growth. At worst, continuation of a strategy of FMD and maintaining the balance of financial terror will create a volatile and dystopian economic environment.
As a significant amount of US government debt is held outside the country, foreign investors will suffer significant losses, through depreciation of the US dollar. These investment losses will limit the financial flexibility of these countries, limiting their future growth.
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