The World Won’t Buy Unlimited U.S. Debt

Barack Obama has spoken often of sacrifice. And as recently as a week ago, he said that to stave off the deepening recession Americans should be prepared to face “trillion dollar deficits for years to come.”

But apart from a stirring call for volunteerism in his inaugural address, the only specific sacrifices the president has outlined thus far include lower taxes, millions of federally funded jobs, expanded corporate bailouts, and direct stimulus checks to consumers. Could this be described as sacrificial?

What he might have said was that the nations funding the majority of America’s public debt — most notably the Chinese, Japanese and the Saudis — need to be prepared to sacrifice. They have to fund America’s annual trillion-dollar deficits for the foreseeable future. These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand.

These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people. When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher) and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

But just because the game has lasted thus far does not mean that they will continue playing it indefinitely. Thanks to projected huge deficits, the U.S. government is severely raising the stakes. At the same time, the global economic contraction will make larger Treasury purchases by foreign central banks both economically and politically more difficult.

The root problem is not that America may have difficulty borrowing enough from abroad to maintain our GDP, but that our economy was too large in the first place. America’s GDP is composed of more than 70% consumer spending. For many years, much of that spending has been a function of voracious consumer borrowing through home equity extractions (averaging more than $850 billion annually in 2005 and 2006, according to the Federal Reserve) and rapid expansion of credit card and other consumer debt. Now that credit is scarce, it is inevitable that GDP will fall.

Neither the left nor the right of the American political spectrum has shown any willingness to tolerate such a contraction. Recently, for example, Nobel Prize-winning economist Paul Krugman estimated that a 6.8% contraction in GDP will result in $2.1 trillion in “lost output,” which the government should redeem through fiscal stimulation. In his view, the $775 billion announced in Mr. Obama’s plan is two-thirds too small.

Although Mr. Krugman may not get all that he wishes, it is clear that Mr. Obama’s opening bid will likely move north considerably before any legislation is passed. It is also clear from the political chatter that the policies most favored will be those that encourage rapid consumer spending, not lasting or sustainable economic change. So when the effects of this stimulus dissipate, the same unbalanced economy will remain — only now with a far higher debt load.

If any other country were to face these conditions, unpalatable measures such as severe government austerity or currency devaluation would be the only options. But with our currency’s reserve status, we have much more attractive alternatives. We are planning to spend as much as we like, for as long as we like, and we will let the rest of the world pick up the tab.

Currently, U.S. citizens comprise less than 5% of world population, but account for more than 25% of global GDP. Given our debts and weakening economy, this disproportionate advantage should narrow. Yet the U.S. is asking much poorer foreign nations to maintain the status quo, and incredibly, they are complying. At least for now.

You can’t blame the Obama administration for choosing to go down this path. If these other nations are giving, it becomes very easy to take. However, given his supposedly post-ideological pragmatic gifts, one would hope that Mr. Obama can see that, just like all other bubbles in world history, the U.S. debt bubble will end badly. Taking on more debt to maintain spending is neither sacrificial nor beneficial.

Originally published at the Wall Street Journal and reproduced here with the author’s permission.

12 Responses to "The World Won’t Buy Unlimited U.S. Debt"

  1. Guest   January 23, 2009 at 3:05 pm

    US does not need the world to buy US debt. The world cannot afford it, and nobody can save the US but Americans.With American savings rate going up, trade deficit goes down, and the government does not need as large a bank bailout fund because the banks can now get money from deposits.

  2. Anonymous   January 23, 2009 at 3:27 pm

    two solutions1. more government debt and higher taxes, or2. more printing of dollars and high inflation

  3. steveballmer   January 23, 2009 at 3:46 pm

    We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to lower level of business and consumer spending based largely on the reduced leverage in economy.

    • Bob Dobbs   January 24, 2009 at 7:54 am

      Amen brother Steve. The economy here in the US is indeed resetting – back to antebellum conditions. Say friend, wouldn’t this be a great time to GPL Vista. Let’s share some of its toxic code base with those pesky Linux freaks, with their infernal stable operating system?

  4. Anonymous   January 23, 2009 at 4:02 pm

    hopefully the government will let this process happened instead of reinflating still another bubble in bonds

  5. Anonymous   January 23, 2009 at 4:52 pm

    we are not in a once in a life time set of conditions.we are in a carefully orchestrated, and preset situation.Learn the history of money, hard currency, the illegal federal reserve board and it all becomes clear. It might behoove to read about the austrian business cycle, which predicted all this as well.This is Fiat currency doing what it is designed to do, create the impression of false wealth with “boom cycles” that leave everyone in debt to the bankers in the end when it goes bust.That is what the USA, Federal Reserve Act of 1913 was designed to do.Foolishly the rest of the world tied themselves to that concrete slab as it sinks via the Brenton Woodds agreement, i believe signed in 1945 or 46.This cannot be saved, fractional reserve banking is fraud and has left the entire developed world bankrupt, and all the banks as well.there is no fixing this, it’s time to rebuild, when will we start?after it gets really really bad.

  6. devils advocate   January 23, 2009 at 8:22 pm

    actions speak louder than words-in a few weeks the “stimulus” law will show us if we’re headed down the crapperso far, the House bill: $275 billions for tax-backs47 billions for unemploymenta lot of the cash will end up in savings like the last stimulusbecause many people still work and just want to savethis is one way to replenish the banks capitalbut will have minimal short-term effect on the economyI think another $20 billions for special eda bunch for weatherization of low-income housing-which needs it – and will job createbut how much will finally end up stimulating business-creation? industry-making? …the actual details in the law will soon tell us

  7. Anonymous   January 23, 2009 at 10:44 pm

    Is it any wonder that the Chinese are devaluing the yuan. How else can their get a reasonable return on their near 0% interest paying US Gov’t investments?

  8. Guest   January 24, 2009 at 12:30 am

    I wouldn’t put $1 in the US or UK right now … they are both technically bankrupt!!!After all, the dollar, has no inherent value. It is the height of American conceit to assume that even friendly countries, let alone China, Russia, and Arab states, will continue to accept our debt when it is tied only to the full faith and credit of the United States – currently a wasting asset.Now who in their right mind is stupid (crazy) enough to continue to buy US debt going forward?The world is not that foolish!

  9. George Harter   January 24, 2009 at 1:18 am

    Sadly, I am in agreement with all the conclusions of this good article. Obama as already shown himself to be a straw man. Siccing his “trout” Geithner on the Chinese for currency manipulations.Comparing a possible jump in value of the Yuan of 40%, losses in Treasuries will be small. Maybe the Chinese can STOP buying American toilet paper, let the Yuan float, see exports decline, but still grow economically as a nation.And to foreign commentators, blame Bernanke, Paulson, Geithner, Bush, Obama but there is no need to insult the common people, the Financial Cabal OWNS and OPERATES this nation. We are only here to sweep streets, pay taxes and die(more taxation).George HarterI think Bernanke and Greenspan are both VERY strong arguments for making the Chairman’s position an elective one.Think of this: with no Federal Intervention (beginning with Geithner and friends at AIG, or even Bear S.) would we REALLY have been worse off?? CITI STILL hasn’t revealed the magnitude of THEIR disaster. Look, with a trillion $ 5 new, solvent banks could be opened, then grow, and all the old commercial garbage could sink deeply into the ocean.Their won’t be a dire need for excessive financial activity or institutions in the next 3-5 years. 5 biggish banks and the regionals should suffice.George Harter

  10. Young Economist   January 24, 2009 at 1:32 am

    One of the crowding-out effect of monetary and fiscal policy is the effect of capital outflow. Too much intervention both monetary policy (bailout, liquidity facility) and fiscal policy (public spending and tax reduction) would trigger the magnitude of capital outflow to exacerbate the demand. The capital outflow would occur from unreliable policy that is expected not to sustain or to cause severe effect of reversal. American should consider seriously the capital mobility effect from policy implementation.Doing too much (reckless intervention) may cause worse-than-expected results because of the capital mobility from the expectation on credibility of government and central bank. This is the same event happening in Asia crises, when Asia central bank support the banks at the controllable level (Asia has low public debt and affordable reserve) if considering the domestic credit figure, but the level of intervention is growing without bound until collapse due to capital outflow without bound (Asia central banks intervene near their abilities and can not reverse until all people are scare that are causing more capital outflow incentive and Asia do not control capital movement during intervention.)The invention should be used at suitable level and must be reliable.

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