Can The U.S. Go Bankrupt?

Okay, there will be no suspense on this one. The answer is no.

Why? Because the U.S. (like Japan, Mexico, Canada, etc.) is a currency issuer. That is, if I'm a currency issuer and I have bills to pay then all I need to do is make more currency. The noise in the United States about defaults is caused by the debt ceiling mechanism inside the U.S. law.

Now, one of my favorite bloggers is Cullen Roche at Pragmatic Capitalism and he's a proponent of Modern Realism (MR) which I have not studied formally. (I have formally studied Milton Friedman's monetarism theories, by the way.)

This won't be a sexy as most of my scintillating entries but Cullen has a very interesting short take on the "can we go broke" question that I'll cut and paste here.

"It’s important to understand what govt spending is in the first place.  Most people don’t get this right.  When the govt taxes it takes from Peter to pay Paul.  When the govt spends in excessive of tax receipts it must sell bonds to finance the spending.  So, they sell a bond to Peter to pay Paul AND issue Paul a bond.  So, the deficit spending results in a redistribution of existing money AND the issuance of a net financial asset (the bond).  So, govt spending is really just a perpetual redistribution mechanism.  It’s not really money printing as most people call it (unless you want to call bonds money which is not correct).  The govt sells the bonds basically by bribing the banks to be their dealers.  So the govt doesn’t “run out of” buyers.  Auctions are literally designed not to fail.  But all this spending can cause inflation.  And the issuance of net financial assets can cause healthier private balance sheets to leverage up by borrowing from banks (who are the real money printers).  This whole process can cause inflation which is the real constraint.  Spending in excess of productive capacity could cause the economy to overheat and could cause any number of problems from asset bubbles to real declines in living standards.  So always remember that high inflation is the constraint."

So, there you have it. The real risk in the Federal Reserves perpetual QE is inflation. If you're a seasoned observer as I am then you'll remember the high inflation 1970s. When will QE lead to inflation, if it ever does? Tune in next time.