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.

Crowding Out and Other Things

I still, for the life of me, don't understand why the term "crowding out" hasn't returned to popularity. In the 1970s it was a very popular term which meant that the U.S. government's use of debt was crowding private economic players out of the market.

This chart comes from a fabulous collection of charts at Business Insider - 50 Important Charts. They cover a lot of topics but they make for a very useful snapshot of our world at the moment.

In the one I've included directly, what you see is the result of increased debt financing of the government. Above a certain level of public debt, each additional borrowed dollar produces less and less output. Or to put it another way, so much money goes to servicing the debt that less and less true investment takes place. Or to put it another way, when the government is hoovering up all the national debt capacity, then more efficient and productive private players are crowded out ... and so productivity declines.

A sad tale but true.

A Balance Sheet Recession - Connecting the Dots

Ignore the political storms of the moment. The best financial description I've heard of our current economic malaise is calling it a "balance sheet recession". Or to put it another way, all the private players in the American economy (and a lot of the rest of the world) were over-leveraged going into 2007. And now all the private players are de-leveraging (or reducing debt).

I remember predicting to a friend in early 2008 that it would be 2012 before we started to climb out and 2017 before we are back to the historic norms. Unfortunately, my prediction seems to be close enough.

Take a look at this article in Pragmatic Capitalism by Jan Hatzius where he goes into the details. In the long run, the news is good. In the short run, there's more pain ahead and more political shenanigans by our ruling class can be expected.

I, Pencil

I picked this up through a post by blogger, Bob Krumm at bobkrumm.com. (Warning, he blogs on political issues so if you don't want to read about politics, avoid the link.) His pithy comment is "Conceivably millions of people have a hand in the making of a pencil. And yet, without any central control whatsoever, somehow, that old reliable #2 is always available wherever I choose to shop."

In a manner similar to Adam Smith's classic take-apart of the production of matches, I, Pencil is a great rendition of how the invisible hand works in economics. The "I, Pencil" article is here.

The After Party

Here's a follow-up to my most recent post about housing prices. These two charts come from jparsons.net if you want a closer look.

This first chart shows that housing prices are approaching their historic averages but are not quite yet there. Keeping in mind that an average is made of both above-and-below average numbers, I expect prices to fall slightly below the average before beginning to recover. Let's see if this guess holds up: prices will stabilize (or stop declining rapidly, I should say) in 2012, stay flat in 2013, and start a slow, slow recovery in 2014.

This chart is more interesting to me. The blue line is housing prices and the purple line is equivalent rentals. The numbers will, historically, be close (each individual makes a purchase decision based on the cost of an equivalent rental home). I didn't know how much they'd separated in the housing bubble of the aughts.

Two years ago I was a die-hard renter. Then when I noticed that local rental prices were substantially higher than mortgage payments for an equivalent home ... well, back into the pool I jumped.

Defending Capitalism

Cullen Roche of the Pragmatic Capitalism blog has a nice post defending capitalism. If I weren't a libertarian, I would say everyone should be forced to read Smith's The Wealth of Nations to understand the superior moral underpinnings of capitalism as compared to any other system yet seen. (Since I am a small-l libertarian then I must say that I encourage students to study Smith.)

But I digress ... check out Roche's post which is well worth the read.

Oh, and as an aside ... there has been a tendency in the last few decades for defenders of capitalism to refer to it as "free markets". I think these well-intentioned folks think capitalism is a dirty word and so need to hide behind another term. I say we should defend the term itself as Capitalism (Big-C) has proven itself to provide more freedom and prosperity to each and every man, woman, and child than any other system ever. Trumpet that from the rooftops Cullen!

Cronyism - The Evidence

Cronyism or Mercantilism? I prefer the second, historic, term but either way it is an accurate representation of much of our political and economic world. It appears to be the natural condition of the unfettered government to create these conditions. I'll get back to the study in this link on the The Economics and History of Cronyism when I have more time to absorb it. It promises to be a enlightening read.