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herztical (28.05)

Government Debt: Why it Doesn’t Matter for the U.S.

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September 16, 2009 – Comments (38) | RELATED TICKERS: FNMA , FMCC , AIG

For the past few months there has been a great deal of controversy over government debt and the cost of issuing additional stimulus and new programs such as health care reform.  Critics say the U.S. is taking on too much debt and that it will eventual implode the country.  Well is should come as no surprise that the U.S. government is not like me and you when it comes to finances.

U.S. debt doesn’t matter; it is merely a statistical score sheet. You can actually liken U.S. government debt to the dead beat that never pays his credit cards or other bills and simply rolls over debt with consolidation loans or uses one credit card to pay for another. The problem for the individual is this credit line eventually gets cut. However, the U.S. credit line will likely never get cut and here’s why. 

The U.S economy is still the largest economy with Gross Domestic Product (GDP) of 14.4 trillion dollars for 2008 (13.3 trillion in 2005 dollars) and is approximately double that of China for all the hype it gets. In terms of a percentage of U.S. public debt to GDP the U.S comes in ranked number 24 or about 61%.  This is better than notable economies such as Germany (64.4%), Canada (63.8%), India (61.3%), France(68.1%), and Japan (173%) of outstanding debt based on IMF estimates (https://www.cia.gov/library/publications/the-world-factbook/rankorder/2186rank.html).  The worst country in terms of debt as a percentage of GDP is Zimbabwe coming in at 259.40%. Many joke that the U.S dollar will become the Zimbabwe dollar but it seems we have ways to go before that happens. If you look at debt in terms of a fraction of GDP, then the U.S. is far better than it was in 1940 (http://en.wikipedia.org/wiki/United_States_public_debt) and in reality we are circa the 1955 levels. In terms of GDP using purchasing power parity (ppp) aka bang for your buck, per capita the U.S ranks 6th in the world by the IMF and is by far the best largest country in the top 10 while China only comes in at 100th. Being that China has many more people, they should be producing much more.   Seeing that 61% of our GDP is foreign national debt, foreign nations have a vested interest in keeping the United States alive and well.  To “stop buying” our debt would be suicide and akin to trying to only burn down only 25% of your house; especially for larger economies.  US debt is pretty much owned by every major economy.  China coming in at number one with 24% followed by Japan at 20%   Like it or not, every nation is in this together.  Worse comes to worse, the U.S. debts will just be forgiven as countries are left with little alternative until they find another consumption behemoth or another planet to trade or invest with. Debt forgiveness happens frequently with African governments and many times over.

 In terms of consumption, the U.S represents approximately 7 trillion dollars or about 11% of the entire world’s consumption http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.  This is roughly 1.4 times the size of Japans economy and about 1.6 the size of Chinas (http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)).  This is a staggering number that shows the United States ability to spend that cannot be ignored by any nation. Certain news articles even state that it would take “five earths” if the entire world consumed like the U.S (http://www.naturalnews.com/022890.html).  Environmental concerns aside, this is a powerful percentage that simply cannot go away.   Foreign economies depend on our excessive appetite for consumption and are left with little alternative.  This mutual dependence is why foreign economies depend on the U.S. debt and are being forced in.  This brings me back to the financial model.  If banks have no one to lend to, then how would they make money?  In theory, it is the same for government.  Foreign governments are forced into buying other nations debt because they need to do something with their money.  The sheer dollar volume involved (trillions) makes it impossible to be absorbed by the private sector and so the only alternative is to lend to the world’s largest economies no matter how fiscally irresponsible they may be. 

The massive stimulus response and quantitative easing by the US government to address the recession will ultimately not affect the U.S. economy.   While the bailouts and stimulus packages have been criticized by many calling it socialism bailout advocates are simply taking a page out of Keynesian economics. Government intervention is nothing new.  In fact it has always been a major component of GDP and is actually part of how the formula is calculated.  Without going into the macro economics side of things too much, GDP = C (Consumption), I (Investment), G (Government spending) and X − M (Net Exports) (or GDP = C + I + G + (X − M). John Maynard  Keynes, a famous economist, essentially states that the private sector screws up sometimes and leads to inefficient macroeconomic outcomes (no need to inform TARP recipients)   and therefore advocates public response through either monetary or fiscal policy to stabilize the business cycle. He also states that excessive saving is a serious problem encouraging recession or worse depression.  So it comes as no surprise that the US government enacts monetary policy by making saving the least profitable endeavor by lowering the fed funds rates in turn affecting all interest rates and making borrowing that is either used for investment or spending cheaper.  All this is in an effort to boost the economy. With fiscal policy, we could call this a bridge loan until things get better and we are able to pay it back.  Aside from the eventual crowding out affect of fiscal policy because the government essentially "pushes out" the private sector by creating artificial demand, fiscal policy is not an issue as long as it eventually unwinds.  In economics “eventually” can be years so time will tell.  While I personally favor more the Milton Friedman’s view of economics that only favors monetary policy, stimulus is sometimes needed.  Political agendas aside, when properly utilized economic stimulus is a tool that has been successfully and unsuccessfully utilized for centuries dating as far back as the Roman Empire.

With stimulus there comes the question of how do we pay for it?  The U.S. can finance and eventually pay for stimulus either through higher taxes or inflation.  Since no one favors higher taxes either politically or socially, inflation is the easy answer. Now inflation often gets a bad rap because it could be considered taxation without legislation, but it is nothing new and is actually necessary for a healthy economy as long as it is controlled.  The definition of inflation is “a rise in the general level of prices of goods and services in an economy over a period of time" (http://en.wikipedia.org/wiki/Inflation).  You just have to listen to your grandparents talk and I am sure you have heard “a cup of coffee used to cost 10 cents” and “I remember when the movies were 50 cents” etc.   So inflation is actually good for markets and the economy since companies now have pricing power and can raise prices resulting in higher profits and most likely expanding and subsequent employee hiring. Companies can only raise prices when there is more demand for their product.    Furthermore, with inflation would you rather own cash (dollars) that is becoming less valuable or say stock in a company that is increasing profits and probably expanding?  So the fear of rampant inflation and the subsequent tanking of markets is wrong.   The U.S. would have to spend something to the tune of 30 trillion dollars in a single fiscal year to become the next Zimbabwe.   So the whole goal is for the U.S. government is to bring back inflation across the board steadily and not just in certain sectors like healthcare.   

In summary, the U.S is still in decent shape despite all the mass headlines and articles to the contrary.  There is no need to go procuring food and ammo. The U.S. productivity in terms of working hours is still one of the highest in the world with the average working hours per week coming in at 35 hours. (http://www.billshrink.com/blog/working-around-the-world/ ).  While unemployment remains high, it had to reach these levels and will be actually be a good thing moving forward. Companies have gotten rid of the waste and have become more efficient at utilizing their capacity and are now more productive.  A reallocation of the U.S. workforce is needed to shift from traditional stagnant industries to new growing ones. The industrial revolution, widely held as one of the most successful economic periods in our time, had very high unemployment.   Traditional peasants were being replaced by machines and new technology but eventually this new technology caused a sustained rise in real income per person despite the debate over the definition of the standard of living for the time.  Today, one could even draw the same similarity to what is going on in the U.S. car industry. The U.S. is simply in the midst of a workforce “shift”. Laid off auto workers may now change professions and head toward growing sectors like alternative energy. Reallocation and an improvement of technology are essential for a growing economy.  The free market is very efficient and while not always seemingly fair, it forces the best outcomes.  Competition breeds excellence and capitalism will always prevail if simply not for the plain fact that humans are inevitably greedy.

With that, the United States finds itself with economic conditions that are quite manageable. However, to coin John Adams “all the perplexities, confusion and distress in America arise not from defects in their Constitution or Confederation, nor from want of honor or virtue, so much as downright ignorance of the nature of coin, credit, and circulation”…seems like we are still working on that 200 years later.

38 Comments – Post Your Own

#1) On September 16, 2009 at 12:52 AM, brocksamson (28.32) wrote:

"The definition of inflation is “a rise in the general level of prices of goods and services in an economy over a period of time"  You just have to listen to your grandparents talk and I am sure you have heard “a cup of coffee used to cost 10 cents” and “I remember when the movies were 50 cents” etc.   So inflation is actually good for markets and the economy since companies now have pricing power and can raise prices resulting in higher profits and most likely expanding and subsequent employee hiring. Companies can only raise prices when there is more demand for their product."

The GDP growth rate for the 19th century in the U.S. was higher than the 20th century prior to the creation of the Fed.  That century was deflationary.  So grandmothers back then definitely did not do as you say.  Inflation may be good for equity markets and those who receive subsidized credit first, but they are definitely not good for the broader economy.  This makes any advantages that markets receive short-term.

"Now inflation often gets a bad rap because it could be considered taxation without legislation, but it is nothing new and is actually necessary for a healthy economy as long as it is controlled. "

This graph begs to differ:

http://img110.imageshack.us/img110/3417/thevalueofthedollar1776.jpg

 

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#2) On September 16, 2009 at 1:09 AM, Option1307 (29.76) wrote:

Well thought about post here and interesting, but I don't agree...

In terms of a percentage of U.S. public debt to GDP the U.S comes in ranked number 24 or about 61%. This is better than notable economies such as

Ok, so in 20 yrs. when medicare/caid and SS are broke and our debt swells to 40-50 Trillion (>150%) will you then be worried?  

Seeing that 61% of our GDP is foreign national debt, foreign nations have a vested interest in keeping the United States alive and well. 

Yes I agree, but certain countries have been making very public statements about this policy coming to an end. You honestly believe it is all just PR?

The massive stimulus response and quantitative easing by the US government to address the recession will ultimately not affect the U.S. economy.  

Really? Is free money every truely free? If providing stimulus is so awesome and has no negative effects, why not do it all the time?

 So inflation is actually good for markets and the economy...

Come on now, do you work for the Fed?

The U.S. would have to spend something to the tune of 30 trillion dollars in a single fiscal year to become the next Zimbabwe.

If you look at the actual total of pledge money, we are closer to that number already.

Now I'm not one who thinks the world is going to end and that we are all doomed. I believe there will be some inflation, how high is any ones guesss, but I'm not prediciting Zimbabwe style. This is the most logical conclusion for the Fed, they basically need some inflation. There will be pain but we will get through it in the end. But, to say that nothing is inherently wrong with stimulus and QE etc is kinda ridiculous IMO.

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#3) On September 16, 2009 at 1:29 AM, XMFSinchiruna (27.83) wrote:

Well, you certainly know how to look at a broken glass strewn in pieces across the floor and still construct an eloquent argument to suggest that the glass remains half full.

Like Option above, I commend you for an intelligent discussion of your perspective, but I disagree with your conclusions on the most fundamental of levels for the reasons detailed ad nauseum throughout my articles and blog posts.

Nonetheless, I'm happy to read an alternate perspective, and remain thankful for this community and the myriad perspectives represented herein.

Fool on!

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#4) On September 16, 2009 at 1:36 AM, checklist34 (99.72) wrote:

the 19th century probably saw dramatically higher rates of immigration and population growth ( i don't konw) and also had exploration of an entire country to fuel it.  One would have to filter out all of those variables before deciding if inflation -vs- deflation is a relevant factor or if a conclusion could be drawn about them.

 

i applaud the original poster for daring to be optimistic in a broad stroke here on CAPs.  thats pretty rare.  :)

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#5) On September 16, 2009 at 1:36 AM, herztical (28.05) wrote:

@Brock: of course the growth rate was higehr back then; you can't keep doubling your GDP especially at our current levels.  Just like I will say that China today will appreciate higher growth rates now then in 20 years from now.  Just like stocks, every economy starts out as a growth stock until it evolves through the life cycle eventually maturing.

 @ Option:  Not worried because our GDP will be higher could be inflated dollars but will be higher nonetheless; Absolutely it is just PR it's called currency stability; your currency grows stronger and you export your screwed.  Why do you think China and Germany have been the biggest voices?  Go figure they export the most. Stimulus is "free" or really cheap money bc the government inflates to pay for it and we do use it all the time through Treasury auctions every other week.  That blog post by TMF on the total pledge of money is greatly exaggerated as is represents not stimulus but funds invested.  Alot of that money will be coming back (not all) and I say the US will eventually at least break even on it if not turn a profit; especially if the Fed unwinds it orderly 

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#6) On September 16, 2009 at 1:47 AM, starbucks4ever (98.28) wrote:

I agree with this post. As long as the holders of US debt choose to follow the self-immolation logic described by the poster, they will be getting robbed by the US government and saying "thank you" for that, in the full belief that it was the best thing that ever happened to them. Therefore inasmuch as the rest of the world is run by imbeciles (which has been true so far), the US can do fine with any level of debt.

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#7) On September 16, 2009 at 7:19 AM, njdo (< 20) wrote:

The absolute size of US economy may be 2x larger than China but the US ranks 64th out of 86 countries in real GDP growth rate with a 1.4% increase in 2008. China is 7th out of 86 with a real GDP growth rate of 9.8% in 2008. As of July, real GDP growth rate for US in 2009 is -3.9%. Just extrapolate the numbers a couple years out and the difference in absolute size of US and China economy is greatly diminished.

Why compare the rate of public debt to GDP in US (61%) to other "notable" economies such as Germany (64.4%), Canada (63.8%) and India (61.3%) to show the US rate is "better". Why not choose such "notable" economies as Switzerland (40.9%), Brazil (36.90%), or Australia (13.90%) and show the US rate is worse.

Don't agree that high unemployment is good. The cost of high unemployment is a cost that has to be paid by business and a drain on the economy because the unemployed are not able to consume at the same rate as if they were employed. Many business haven't just cut waste and become more efficient, rather they've gone out of business or the jobs have been outsourced to other countries. Unlike the industrial age where certain countries temporarily cornered the market on mechanization and had a considerable competitive advantage trading machine produced goods for raw materials, we are now living in a multicentered world where mechanization and hi-technology are commonplace. Laid off US auto workers may not be able to retrain for emerging industries, particularly if those industries are emerging in lower cost environments overseas.

My call is that the US is in for quite a hangover with a much smaller economy and less of an economic footprint worldwide. China and Russia are pushing for new global reserve currencies and will not prop up US deficits for any longer than absolutely necessary to protect their own interests.    

 

 

 

 

 

 

 

 

    

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#8) On September 16, 2009 at 7:53 AM, GoodVibe4Ever (< 20) wrote:

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#9) On September 16, 2009 at 8:23 AM, dbjella (< 20) wrote:

herztical

So it comes as no surprise that the US government enacts monetary policy by making saving the least profitable endeavor by lowering the fed funds rates in turn affecting all interest rates and making borrowing that is either used for investment or spending cheaper.  All this is in an effort to boost the economy.

Didn't Greenspan have low Fed Fund rates?  Is seems to me that all that easy money didn't help the housing sector and economy lately.

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#10) On September 16, 2009 at 8:39 AM, Option1307 (29.76) wrote:

Not worried because our GDP will be higher could be inflated dollars but will be higher nonetheless

True, but how much higher will our GDP be. If in 20 yrs we have 50 trillion ni debt which is not an outrageous assumption. We would need a GDP of like 80 Trillion in order to mantain the same Debt/GDP ratio of 64%. 80 Trillion, how likely is that? Not very in my opinion, so I ask again, at what percent does our debt/GDP ratio matter?

 Absolutely it is just PR it's called currency stability; your currency grows stronger and you export your screwed.  Why do you think China and Germany have been the biggest voices?

So your saying that china and germany export the most and thus want a relatively weak currency so the products are attractive to foreigners. I agree. However, as the US dollar tanks, their currencies will rise relatively speaking. Right? This is bad for business. So they essentially do not want the USD to tank, doesn't this make sense that they actually may be concerned about the USD. It seems as though the PR stunt may have some merit behind it.

You say inflation is good, but hasn't the USD gotten destroyed the last 100 yrs? Look at the last 8 yrs, it's gotten killed. Is this good for Americans?

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#11) On September 16, 2009 at 10:01 AM, herztical (28.05) wrote:

@ njdo I didn't include the most efficient economies because Liechtenstein and Luxembourg would be at the top mainly because they are the size of a stamp and have a tiny population relative to their GDP; there are more companies/mailboxes then people in these countries simply for the tax haven; I'm not saying U.S. is the best, I'm syaing we are "in-line" 

@ option it is good for Americans that don't hold paper called currency; this incluses stocks, comodities, private businesses, and god forbid the dreaded word called houses; yes homes.  I could also throw gold in the mix but that is just a shiny piece of metal

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#12) On September 16, 2009 at 10:03 AM, herztical (28.05) wrote:

@ option I would start to be concerned once we go above 100%; just seems logical

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#13) On September 16, 2009 at 10:06 AM, Melaschasm (53.44) wrote:

This is better than notable economies such as Germany (64.4%), Canada (63.8%), India (61.3%), France(68.1%), and Japan (173%) of outstanding debt based on IMF estimates

So you think we should follow Japan's policies, even though they have created a 'lost decade' that is already extending beyond 10 years?

Or should we follow France, which has consistantly slower economic growth than the US over the past 30 years, as well as only a couple years with less than 10% unemployment during that time?

India and China are second/third world countries.  They are not comparable to the US in GDP per Capita, not to mention a host of other economic differences between poor and rich countries.  Unless you think the US should stop being the wealthiest country on earth, why would we want to copy the policies of poor countries?

Germany is often considered the champion of the EU from an economic standpoint, yet they consistantly have slower growth than the US, as does the EU as a whole.  Why would we want to copy a country that consistantly has worse economic performance than the USA?

Which brings us the Canada.  Canada has had a great decade, because of the commodities boom.  It should also be noted that Canada has had a strong dollor policy for the past decade, and their currency has appreciated signficantly against the US dollar.  The current US policy of rapidly growing debt, higher inflation, and a weak dollar has resulted in the US having worse economic performance than Canada for the first time in several decades.  If we were to copy Canada's economic policies, we would be printing less money, and following a strong dollar policy.  The exact opposit that you are supporting.

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#14) On September 16, 2009 at 10:11 AM, herztical (28.05) wrote:

@ dbjella the problem isn't low interest rates the problem was naive and unqualified buyers or borrowers; ARMs reset and most of these people shouldn't have been in houses in the first place.  Yes, you can say low interest rates stimulate borrowing (they do) but it was coupled with poor decisions and actually we only started having problems when the prime rate went 8%+ Also why I belive we will never see those rates again for some time (10+ years?) so we can bring back inflation

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#15) On September 16, 2009 at 10:11 AM, portefeuille (99.60) wrote:

Germany is often considered the champion of the EU from an economic standpoint, yet they consistantly have slower growth than the US, as does the EU as a whole.

That, to some extent, has to do with the unification.

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#16) On September 16, 2009 at 10:13 AM, portefeuille (99.60) wrote:

Actually the unification helped GDP in 1990, too lazy to look up what the current "net effect" is ...

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#17) On September 16, 2009 at 10:40 AM, russiangambit (29.30) wrote:

Well, I rarely see such a good argument with which I disagree 100%. Usually I am swayed by good arguments.

Too many points to address. So, how abot just one - lets agree that US debt will be continue to be bought in the near future. But at what price? If we have to pay much higher rates on that debt due to global competition, how is that good for the US economy?

As for inflation is good for us argument, don't even get me started here. I tend to fly off the handle on this one. 

 

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#18) On September 16, 2009 at 11:04 AM, herztical (28.05) wrote:

@ Melas I guess your Canadain? Who said we should follow the economies I listed?  Clearly we are taking our own path. Well yes, if the U.S. had the abundance of natural resources Canada has we probably would follow; well we probably wouldn't bc of enviornmental concerns and political agendas

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#19) On September 16, 2009 at 11:13 AM, Melaschasm (53.44) wrote:

Port, the unification issue does make this more of an apples to oranges comparison.  As such it probably should not have been part of the equation, just like India and China are not comparable. 

I am not as concerned with current US debt levels as some people are, but it is in my opinion harming the US economy. 

Returning to the original point made by the creator of this interesting discussion.  If US debt does not matter, then why not eliminate all US taxes, and just use debt to fund the government?

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#20) On September 16, 2009 at 11:23 AM, jstegma (29.25) wrote:

The US has some borrowing power to be sure, but it is not limitless.  There have to be consequences (future benefits given up in exchange for present benefits) to the debt, or it becomes ridiculous for people to lend us money.  Otherwise we could just borrow a whole bunch and pay everyone in the country $100k per year in welfare benefits and have no problem.  Hell, don't be stingy, let's have a million.

So we agree that there IS a limit.  Then we need to look at what happens as we get closer to the limit.  The interest rates go up, plain and simple.  Well, we have a huge balance to roll over, so we'll have to pay higher and higher rates.  That means interest eats up a much larger portion of the budget.  It already eats up a healthy chunk, so if you double or triple interest rates, which would still mean only 7-10%, you begin to spend most of the budget on interest.  You have to either cut spending drastically or borrow even more at even higher rates which feeds the spiral.  

So saying that debt levels don't matter at all is totally ridiculous.

You do have a good point about Europe and the Euro.  People like to bash the US Dollar, but the Euro has its own problems.  

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#21) On September 16, 2009 at 12:01 PM, Melaschasm (53.44) wrote:

hertzical, I may have taken your reference to those countries a bit differently than you intended.  However, I was refuting your claim that they are examples of countries with high(er) debt to GDP than the USA, without suffering from the debt.  My point was that we will pay a price for higher debt, and the slower economic growth rates of the high debt nations you mentioned are an example of why we do not want to dramatically increase our debt burden.  Canada still has some significant systemic problems that the US does not yet have, such as nationalized healthcare.  The commodities boom has helped Canada significantly over the past 5 years or so.  If commodities go south, Canada's socialism is going to cause some serious economic problems.  If they were to move closer to a free market economy, they would be in a much stronger position to deal with a collapse in commodity prices.

PS technically I am not a Canadian, but I live in a border state, and travel to Canada often.  Back in the 80s and 90s each US dollar would buy between 1.20 and 1.40 Canadian dollars.  Now the two currencies have close to a 1 for 1 exchange rate.  This is not just an Obama problem, Bush's weak dollar, deficit spending policies played a significant roll in this change. 

 

 

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#22) On September 16, 2009 at 12:12 PM, whereaminow (29.10) wrote:

The massive stimulus response and quantitative easing by the US government to address the recession will ultimately not affect the U.S. economy.  

The U.S. debt is consumption.  You are trading future consumption for present consumption.  If you feel that this has no negative consequences for an economy then I suggest you rewrite every single fundamental fact about economics.

You may be right. Perhaps there is no logic, no reason, no knowledge.  We can just make up whatever economic ideas we want and say that they have no effect whatsoever.  If so, then why have economics at all?  Why have learning and books?  Let's just burn them all and move on.

The fundamental fact of economic life is that resources are not infinite.  They must be allocated.  Wealth is created by allocating certain resources for future use while others choose to consume in the present.  This is irrefutable.  You're post, while fancy, does not address this issue.  It merely states matter-of-fact that this is not true.  We'll just get somebody else to pay for our current consumption reductio ad absurdum.  I have to ask, why should anyone ever attempt to learn if we are going to disregard the most basic principles of economic life.  It would be like giving a math class where we begin by saying that 2+2=6 and accepting it as fact without question.  It's beyond absurd.

David in Qatar

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#23) On September 16, 2009 at 3:39 PM, cthomas1017 (93.96) wrote:

I wonder what would happen if credit froze up and GDP dropped 50-80% almost overnight.  Then the debt to GDP picture would look more like an Argentina scenario, certainly not a Zimbabwe scenario.  I'm not suggesting here that we're even headed for something like Argentina, but inflation rates somewhere in the range of the 1970's with our extreme debt load and lower levels of actual goods produced domestically doesn't make for a rosey picture.

We can shrug our shoulders and say, "Well gee, at least we aren't as bad off as Germany in the '30's.  And hey, Mexico is getting it worse than we are."  But that doesn't absolve our American society from going down the same road as those other 23 countries who will be sitting in deeper do-do than us.  I have never fallen for those who proclaim that we need to be more like Europe.  No offense to many of the wonderful people there, but I have higher standards than using Europe as my target.

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#24) On September 16, 2009 at 3:47 PM, SkepticalOx (99.43) wrote:

While this is specifically targeting the trade deficit, I think it's appropriate to visit the Warren Buffett archive (from 2003) on why running deficits and piling up debt to finance it is not such a good idea. Therefore, I present to you:

SQUANDERVILLE vs. THRIFTVILLE

By Warren E. Buffett, FORTUNE

I'm about to deliver a warning regarding the U.S. trade deficit and also suggest a remedy for the problem. But first I need to mention two reasons you might want to be skeptical about what I say. To begin, my forecasting record with respect to macroeconomics is far from inspiring. For example, over the past two decades I was excessively fearful of inflation. More to the point at hand, I started way back in 1987 to publicly worry about our mounting trade deficits -- and, as you know, we've not only survived but also thrived. So on the trade front, score at least one "wolf" for me. Nevertheless, I am crying wolf again and this time backing it with Berkshire Hathaway's money. Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in -- and today holds -- several currencies. I won't give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.

Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar.

But as head of Berkshire Hathaway, I am in charge of investing its money in ways that make sense. And my reason for finally putting my money where my mouth has been so long is that our trade deficit has greatly worsened, to the point that our country's "net worth," so to speak, is now being transferred abroad at an alarming rate.

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo -- but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off -- or simply service -- the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat -- they have nothing left to trade -- but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are -- in economist talk -- some pretty dramatic "intergenerational inequities."

Let's think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies -- that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island's fiscal pain.

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island's government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.

So what does all this island hopping have to do with the U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment -- that is, our holdings of foreign assets less foreign holdings of U.S. assets -- increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country's "net worth," viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world.

Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.

In the late 1970s the trade situation reversed, producing deficits that initially ran about 1 percent of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.

Since then, however, it's been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4 percent of GDP. Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5 trillion is invested in claim checks -- U.S. bonds, both governmental and private -- and some in such assets as property and equity securities.

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce -- that's the trade deficit -- we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what's already been transferred abroad is meaningful -- in the area, for example, of 5 percent of our national wealth.

More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners' net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding -- goodbye pleasure, hello pain.

We were taught in Economics 101 that countries could not for long sustain large, ever-growing trade deficits. At a point, so it was claimed, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders. And that's the way it has indeed worked for the rest of the world, as we can see by the abrupt shutoffs of credit that many profligate nations have suffered in recent decades.

The U.S., however, enjoys special status. In effect, we can behave today as we wish because our past financial behavior was so exemplary -- and because we are so rich. Neither our capacity nor our intention to pay is questioned, and we continue to have a mountain of desirable assets to trade for consumables. In other words, our national credit card allows us to charge truly breathtaking amounts. But that card's credit line is not limitless [... continues onto WB's solution, which we can skip for the purpose of this post]

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#25) On September 16, 2009 at 4:30 PM, herztical (28.05) wrote:

@ everyone: Appreciate all the dialougue; the headline of the article is just that, a headline to attract readers and conversation; of course there is a limit to government spending but the article was written to state that we are not yet there.

@ dave in Quatar: economics?  Oh you mean the theory of governments? LOL I thik economics is more model / fiction then anything I have ever studied extensively.  You can look at government spending like debt financing; almost every [public] company uses debt in some form or another; it only becomes a problem when the ability to repay isn't there (we can't roll it) OR our cash flow can't cover it.  Well if you use company stock to cover your debts (like the USD) everything is good. Yes, there is a limit but we are far from it.  As the U.S. goes so does the rest of the world.  I think that point was really missed in my post that the U.S. is too big that should something happen, every other nation no matter how fiscally responsible they may be would be affected.  Simply look back to the credit markets of last year. 

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#26) On September 16, 2009 at 5:03 PM, Melaschasm (53.44) wrote:

Great find SkepticalOx.  I will be sending that to some of my friends.

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#27) On September 16, 2009 at 5:07 PM, AvianFlu (41.71) wrote:

Thanks for the Buffett post! I had not read that one...and it makes a lot of sense with it's apt analogies. It provides more evidence that we are merely arranging the deck chairs on the Titanic. Furthermore, the inmates are running the asylum!

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#28) On September 16, 2009 at 5:16 PM, whereaminow (29.10) wrote:

herztical,

You keep using the term "we" in terms of the national debt. "We" had nothing to do with it.  It is not a private contract. It is a social contract. A social contract is a bunch of sick individuals who get together and convince the intellectually weak that "we owe it to ourselves." Then those intellectually weak people hop on message boards and repeat what the sickos told them and inform us that "we" are part of that burden.

Please don't include me in your "we."

The rest of your response was that economics does not exist?  Which knowledge does then?  Are you free to pick and choose? Should I disregard Menger, but only read Marx?  Should I disregard Aristotle and focus on Plato?  Should I throw them all in the garbage?  Why would you even bother to write the post?  We can arbitrarily decide that your knowledge represents no field of knowledge worthy of consdiration.

David in Qatar

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#29) On September 16, 2009 at 8:51 PM, herztical (28.05) wrote:

@ david: ok "we" excludes David; so when I refer to "we" I mean as in the author who lives in the U.S. and elects people who represent us; therefore we are somewhat responsible for them and their decisions. This may be something new to you as you live in a absolute Monarchy (btw that has a GDP about the 1/2 the size ofJPMs market cap) but I guess you can consider yourself lucky that you can dig a hole and strike oil.  You can do whatever you like; my point was that economics is mostly theory nothing to do with knowledge.

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#30) On September 16, 2009 at 9:27 PM, herztical (28.05) wrote:

@ skeptical: So what if Squanderville finds another trade partner called Suckerville? 

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#31) On September 16, 2009 at 9:42 PM, herztical (28.05) wrote:

@ skeptical: and then eventually finds another evolving trade partner called "Centralkingdomville"?

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#32) On September 16, 2009 at 10:42 PM, whereaminow (29.10) wrote:

herztical,

I'll ignore the other silliness, seeing as that I served in the Marines, which gives me just as much right to hold officials accountable as you, and move on to this:

 my point was that economics is mostly theory nothing to do with knowledge.

Oh my lord, son, you really need to open a book and read it.  I suggest a classic to start and maybe some good fiction from Dickens perhaps.  

What's next?  Logic has nothing to do with reason? Rationalism has nothing to do with thought?  Thought has nothing to with learning?  

What an absurd starting point.  It is no wonder that you say the U.S. debt doesn't matter.

Scarcity is an economic fact of life.  Except to you, because it is a theory without knowledge.  Oh man, I almost fall out of my chair laughing at that.  Too rich.

You, sir, are a joke.

David in Qatar

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#33) On September 16, 2009 at 11:07 PM, booyahh (< 20) wrote:

Hangovers always pass, and so will this one. Printing money is like drinking coffee, so you can sober up and drink again. As long as you're young and strong, you can keep up that cycle.

The US is still pretty young and still strong: a free open system, and immigration that takes the brightest and most ambitious minds from all over the world.

Everyone crashes. Russia crashed. China will crash. The difference is that the US crashes quite frequently, so it's much more used to it, more  entrepreneurial and capable of getting back on its feet and fightng the good fight.

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#34) On September 16, 2009 at 11:32 PM, herztical (28.05) wrote:

@ David they were two seperate thoughts and I apologize for the confusion: economics is theory and this (post/discussion) has nothing to do with the topic of knowledge. Yes I was taking a stab at Quatar but please stay on topic;

Let me ask you this though as a former Marine, where do you stand on military spending? Not just now but while you were serving.

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#35) On September 17, 2009 at 12:04 AM, whereaminow (29.10) wrote:

herztical,

I oppose it.  I oppose war in all forms.  I made the decision to join when I was young, naive, and statist.  Very foolish decision, but it could have been worse.  I could have joined the Air Force.

I apologize for the crack on you.  It was unnecessary and over the top.  (Again, why do I post comments after all nighters?)

I just want to say that the economics in this post (even though you seem to wish to call it something else) is in fact nothing more than theory.  It's background is in the socialist economics of the late 1800's and early 1900's (and, truth be told, all the way back ot Plato.)  Praxeologist economists might say that it has no basis in reality, but not in knowledge.

There is a great deal of excellent knowledge in economics, I beg to say as I have read a great deal of it.  You just have to ask the fundamental question.  Is economics about people and their actions, or about statistics?

David in Qatar

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#36) On September 17, 2009 at 12:46 AM, herztical (28.05) wrote:

I just want to say that the economics in this post (even though you seem to wish to call it something else) is in fact nothing more than theory 

Does this mean a truce? I agree

We can discuss topics such as Thomas Sowell and scarcity or go back to ancient Rome and misquote Cicero regarding balanced budgets; but as Galbraith says "economics is extremely useful as a form of employment for economists and in economics the majority is always wrong" Of course there are smart and people who are in economics and I have plenty framed pieces of paper on my wall telling me that!  However, I will say this, that I know no more then the next person about economics or the proper course of action. The Fed has 20+ of the worlds best economic scholars but yet they still foul things up and on a regular basis. So before we make this post even longer we should use this quote quote or probably mis-quote from Baruch: Most of the successfull people I've known are the ones who do more listening than talking.

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#37) On September 21, 2009 at 12:13 AM, herztical (28.05) wrote:

BTW I am dissapointed that no one picked up my reference to cetain counties called Suckerville and Centralkingdomville...Buffets argument only works when there is 1 counterparty

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#38) On September 28, 2009 at 1:46 PM, kstarich (30.83) wrote:

Hertz,

THis is a great article!  Good work.

kstar

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