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« The Cocktail Party Goes On (For Now) | Main | Ron Paul and Benny B »

September 20, 2007


Bond investor

ZB, you seem to forget that (1) no one is forcing the foreign central banks and sovereign wealth funds that own the most U.S. government debt to buy it; (2) these investors are presumably "big boys" who should understand the currency risk they take when buying USD debt when their economies have their own currencies; (3) private investors cannot create or destroy dollars, so the dollar investors will find a home for their dollars received for oil, Chinese exports, etc. They might buy California real estate, stakes in Blackstone or Carlyle, etc., or more Treasuries. (4) The total US debt is about 100% of our GDP, in line with ostensibly "better credit" European countries like Germany and France, and much, much better than Japan.

Zero Beta

Thanks for the feedback. Some thoughts...


I don't forget that nobody is forcing them to buy our debt. They are forced to buy something with their dollars and just have chosen to buy the bonds. I do believe there are political forces at bay but by and large they can do what they want. I agree with you that they are big boys. But they also know that buy buying our debt they keep the machine working. Balking at US debt is a very dangerous notion because of how fragile the dollar is. Since the dollar basically is backed by the "full faith and credit of the US government" perception of creditworthiness is huge. That is no different than what happened a couple weeks ago in the CDO market. I think people like Bear Stearns ended up holding so many CDO's because they eventually got to a point in which if they didn't continuously buy them, they would risk the value of their entire pile. I think thats where the rest of the world is right now. I think gold is getting a huge bid because it is a great hedge for countries such as China who want to ween of the dollar but are afraid of all their current holdings. While it is true that private investors cannot create and destroy dollars, because of the dollar is essentially backed by our word, what they decide to do with their dollars has a very big impact on the dollars value. If they buy bonds, they facilitate the creation of more dollars, but keep the "full faith and credit of the US Government" intact. If they buy gold, they are damaging "the full faith and credit of the US Goverment" buy both refusing the buy the debt and buying something that essentially marks the dollar to market, but at the same time they are transferring real wealth to their nation. It also does nothing really beneficial for our own economic situation. In the same respect, if a large CDO trader sold some CDO's to another investor and bought real estate with the proceeds, it has a different effect on his overall inventory of CDO's than say if he bought Credit Default Swaps on Fannie Mae. Dollars have historically been used to buy assets that are beneficial to our overall economy, but lead to the creation of more dollars. There is no saying that the opposite could not happen - if that does occur a dollar is a liability for every American. \

Additionally, if a company is teetering towards bankruptcy, being a debt owner is much more beneficial than being an equity owner. If the company goes bankrupt, the debt owners have claims on the assets. I think the same is true on the global scale. If China loses money buying shares of Apple, it's they might get $100 to spend at an Apple Store but most likely they get nothing. If they lose money on Treasury Bonds, they get political influence.

4. GDP is a flow variable. It is measured per unit of time. US Government Debt is a stock variable. It is measured at a given point in time. It is sometimes dangerous to interpret ratios between the two in the context of inflation and exchange rates. A oil company's earnings look much different depending on how it accounts for its inventory (FIFO or LIFO) in the context of rising oil. This would cause their mixed ratios such as profit margins and return on equity to look different.

GDP is measured in the final sales of goods and services over a given year where national debt is total debt outstanding at the end of the year (or quarter or whatever). Something such as this is better to look at in a chart because the direction is important . In the context of inflation and a falling dollar, GDP should rise every year, as prices inflate and we produce more and more dollars. The debt may or may not increase depending on our debt structure. Since we run a deficit and our currency has been overall weakening I'm assuming our debt increases every year as the 100 dollars worth of bonds from 1972 are replaced with 800 of its equivalent today. Therefore the level is not as important as the direction and the analysis of the denominator and numerator. If our national debt continues to increase and this ratio increases year over year in the context of inflation, I would think it means we are borrowing but really not producing anything, that we are just basically just devaluing our currency.

I am unaware of the trends in Europe and Japan, but two key differences are that in Europe the Government pays for much more and they are taxed much more than we are. In Japan, they had 0% interest rates for a few years which is a wild phenomenon. Also both countries have much higher savings rates than in the US - something that should be important to both the debt and future gdp of a nation.

Thanks for the comments tho. Let me know what you think. I enjoy the discourse and wish more people would post comments and challenge my ideas because I enjoy the thought that it provokes.



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