US Debt – What? Why? And What If…?

Bankrupt Culture by Brent Payne
Bankrupt Culture by Brent Payne

“It is good that most people don’t understand our banking and financial system. For if they did there would be a revolution by morning.” Henry Ford

There is only one topic on financial markets: the US debt. As August 2nd drew closer and closer, people all around the world asked, “What if the US will really go bankrupt?” Economists promise far-reaching consequences that will affect the world economy. Despite these warnings, US legislators still haven’t reached an agreement about how to proceed.

What is the US Debt?

The US debt is over $14 trillion, and it is the sum of all debt owed by the Federal Government. Almost two-thirds is public debt, which is owed to the people, businesses, and foreign governments who bought treasury bills, notes, and bonds. They are sold by the US Treasury Department and are considered the safest investments in the world because they are backed by the US government. They are also sometimes referred to as “bonds” or "Treasuries”. Fourteen trillion dollars is such a large number that few of us can even fathom its size. You can see a visualization of the sum here.

The Largest

The US debt is the largest in the world. It is 95 per cent of the national GDP, up from 51% in 1988. Why? Every year, the government has cut taxes and increased spending. This has meant lower profit and higher expenditure. The Social Security Trust Fund took in more revenue through payroll taxes leveraged on Baby Boomers than it needed, and the government borrowed the Fund to finance deficit spending. That brings a new problem: who will finance the Baby Bommers when they retire? However, thanks to this risky step, Treasury Bond interest rates remained low and attractive for purchasers and allowed debt raising.

Non-US citizens also kept interest rates low considering Treasury Bonds as the safe haven. During the recession, many countries (e.g. China and Japan) increased their holdings of Treasuries to keep their currencies low relative to the dollar. Here you can find major foreign holders of Treasuries.

What If…?

Debt Perception by Morning Glory
Debt Perception by Morning Glory

The country’s debt is on its way to becoming so enormous that it will pose many risks to the economy. Projections showed that the national debt will grow from about 60 per cent of the GDP last year to 100 per cent in about ten years, and to 200 percent by 2030. No surprise, then, that international lenders are losing confidence in US reliability.

Mike Huebsch, secretary of the state’s administration department, told reporters that the federal debt crisis could affect Medicaid healthcare spending, student loans, state university research grants, low-income heating assistance, and child welfare.

“This is uncharted territory. I don’t think we know how it could affect us,” said Martha Haynie, comptroller for Florida’s Orange County for Financial post. Richard Ciccarone, managing director at McDonnell Investment Management, said that Washington’s debt ceiling drama makes it clear that any hopes of significant federal aid for state governments in a recession, such as 2009′s economic stimulus program, are pointless.

Others claim that raising the debt ceiling is kind of like increasing blood alcohol levels to solve drunk driving — not a good solution. Meanwhile: lawmakers are trying to come up with a budget plan; economists are running to write the best predictions; and Republican and Democratic leaders tried to find common ground. They had until August 2nd, when the government was expected to hit the US$14.3 trillion limit that could trigger a default and bring chaos to world markets. Luckily, the parties came to an agreement, but how much time will it buy them?

Gold Up, Dollar Down and Some More Currency Consequences

Foreigner investors are getting more and more pessimistic, including Chinese investors. “Many of them look at the politics in the US and see that it’s so dysfunctional that they’re losing hope that the US can actually get its fiscal house in order,” said Stephen Green, head of research for Greater China at Standard Chartered Bank, to Reuters.

All three big credit rating agencies have warned that the United States needs a credible deficit plan to keep its top AAA rating in the long term.

Gold surged to an all-time high in New York, posted Bloomberg on July 27th. Investors are looking for safe havens so they prefer owning gold or silver over investments denominated in the dollar or the euro. The dollar sank to a three-month low against a basket of major currencies. “The dollar became even less attractive as, on top of the US fiscal problems, Australian inflation data reminded investors about the higher inflationary environment in Asia’s fast-growing markets,” said a trader for a Japanese bank.

Most economists (e.g. Xia Bin, a member of the central bank’s monetary policy committee) and politicians (e.g. US Secretary of State, Hillary Clinton) are quite confident that politicians will make a deal to prevent US default. But while they are talking, the debt is growing and growing. So the next hot topic for economists will be what to do with such huge debt.

This entry was posted in Calgary Real Estate News. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *