http://www.theoildrum.com/node/2921 Monetary Policy and Weaseling Out of Debt Posted by Gail the Actuary on August 28, 2007 - 3:00pm Topic: Economics Tags: balance of payments, debt
This is some correspondence between me and an an individual known here as
Shunyata. Shunyata is an individual who is involved with managing financial
derivatives. Shunyata's education and careers have spanned several disciplines,
including actuarial science, statistics, mechanical engineering, and financial
engineering. These have given him a breadth of perspective on the world's
financial situation.
Dear Shunyata,
Some of the financial things I have been reading lately are downright
alarming.
I keep seeing comments by people concerned that other countries will cut off
the US debt spigot.
One concern is the huge amount of sliced and diced debt that has been sold
around the world with very questionable assets behind it.
Another is the US Balance of Payments:
https://www.cia.gov/library/publications/the-world-factbook/rankorder/21...
A third issue is the extent to which countries are unhappy about the US
overstepping bounds militarily.
Any thoughts?
Sincerely,
Gail
Dear Gail,
At the risk of sharing too much opinion, I will speak frankly about my
perspective. Of course these are entirely my PERSONAL opinions.
The current prosperity of the US is the same prosperity seen in a person with
a large home loan, a large car loan, and a mountain of credit card debt. He's
living lavishly and living at the mercy of his creditors. The US is VERY
affluent and has a LOT of debt. And taking the Machiavellian view, the US likes
spending other people's money and has no wish balance its accounts if it can
borrow without genuinely repaying.
How do interest bearing loans get repaid? There are three ways:
1. Devote your future productivity to repaying principal and interest (this
is painful and no one wants to think about this).
2. Expand your monetary wealth through efficiency gain (exceedingly
difficult) or converting your assets to cash (e.g. pumping oil out of the
ground or consuming other endowments).
3. Inflate your way out of debt (more on this, and this scares me the most).
A huge amount of our expanding economy (and hence easy debt repayment) has
come from consumption of our natural endowments. You only need to look at the
correlation between energy consumption and GDP, both across time and across
nations, to see that we have been relying heavily on 'spending the
inheritance'. This realization will slowly dawn on us, although not
voluntarily, and we will modify our behavior accordingly whether we like it or
not. There is a nice graphic comparing a photo of the dark side of earth from
space with a map coded for per capita GDP. It shows electric lights (energy
consumption) line up exactly with per capita GDP!
The inflation angle is more insidious because we are talking about monetary
policy. So long as people think they NEED dollars, the US can print as many as
they like and in effect simply print money to pay off its debts. In the '70s we
went off the gold standard (so that a dollar's value is based in demand for
dollars rather than intrinsic value) and negotiated with the Saudis to trade
physical protection from hostile neighbors for an agreement to conduct all oil
transactions in dollars. What a coup! Now everyone who needs oil needs dollars
and we are all too happy to provide them. (There is evidence/conjecture that
dropping the gold standard and establishing dollar-denominated oil was a
deliberate, coordinated plan.) Rising oil prices are our friend because we can
print more money to pay off our debts and at the same time mitigate the US
impact of rising oil prices. After all, there are more dollars floating around
to buy it! Why do you think the economy hasn't been crushed by $70 oil and $3
gasoline?
This coup is threatened from several fronts:
1. Economically competing countries like China hold vast reserves of these
dollars we have been printing. They are also wise to the fact that their dollar
reserves are being eroded away by the day as we print more dollars. (The Saudis
are also well aware of this. They are are effectively only getting$50/bbl
thanks to the diluted dollar.) They have begun selling their dollars thereby
reducing the global demand for dollars and our ability to inflate our way out
of debt. Heaven help us if we ever really annoy them. They could destroy our
country over night by flooding the world with dollars - more certainly than a
nuclear strike! In fact, China has leaked military documents to this effect!
2. Several countries are moving to euro-denominated oil bourses - further
eroding demand for dollars. The first Iraq invasion was within a few months of
Saddam moving to set up just such a bourse. Iran launched one earlier this
year. Unfortunately I'd say a US military reaction is within the realm of
likelihood, if not outright probable.
3. The rest of the world is becoming concerned that our currency (and ability
to purchase goods or repay debt) could collapse catastrophically. You see
comments from various central banks to this effect, although very obliquely.
The net impact is that the dollar has been hemmoraging furiously for the last
year or so. The US and Canadian dollars are virtually one-to-one now! So far
this has been an orderly and tame development. But the currency markets are
wanton and can move catastrophically with lightning speed. And if our currency
collapses we will have no time to even think of a response. Instantly we will
lose all global purchasing power and all ability to borrow.
If we are running out of resource endowments and we can't inflate our way out
of debt, our only recourse is to tighten our belt and divert our productivity
from leisure (and hopefully not subsistence as well) and apply it to debt
repayment. I fear interesting times lie ahead.
Regards,
Shunyata
What do you think? My note doesn't mention other issues like the tight oil
supply. This is the opinion of one individual. Does this make sense to you? Are
there some happy endings that might come out of all of this?
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