Thursday, July 13, 2017

Can America Escape the Debt Spider's Web?

The national debt of the United States, as of this posting,
is at $19.9 trillion, with no letup in sight. Although, thank
heaven, Barack Obama is no longer in the White House,
the debt is still soaring, powered by long-standing unfunded
mandates and unrestrained federal spending going back to
before President Obama's fiscal profligacy (although, it must
be noted, Obama had increased the debt to record levels,
going so far as to accumulate more debt than has all of
his presidential predecessors combined!). The question
now is, what will our current president Donald Trump
do about the spending, and what will the Federal Reserve
do concerning money supply management?

George Melloan, a former deputy editor of the Wall Street
Journal page, and no stranger to economic matters, blamed
the latest round of debt on the easy credit that came about by
the Fed's zero-rate targets in the wake of the 2008 crash.
While the Fed was not entirely responsible for this state
of affairs, through its "quantitative easing" (basically running
the printing presses at full blast turning out lots of newly
created dollars) had an effect by adding an additional
$3.5 trillion in demand for Treasury bills and for the besieged
Fannie Mae- and Freddie Mac-issued mortgage-backed
securities, which was a part of the housing bubble popping
that touched off the Great Recession of 2008. With cheap
credit, almost free in cost, Washington nearly doubled the
debt in the subsequent seven years. The annual federal budget
deficit still hovers between $500 billion and $1 trillion,
this too with no significant reversal in sight.

In an attempt to avoid runaway inflation, the Fed arranged
for banks to put approximately $2 trillion into their reserve
accounts at the central bank, paying the banks a pittance for
interest (currently 0.5%) in exchange. This maneuver has kept
the excess reserves from overloading the economy via
cheap loans.

As for foreign investors buying and holding U.S. debt, demand
for our debt has slacked off. China was the biggest purchaser
of American debt, but their foreign currency reserves are declining
as business in their country slows, and capital flees for safer
locales. Total dollar holdings by central banks in other countries
have decreased to around $2.8 trillion at present from $3 trillion
in 2013.

A credit cycle when both lenders and borrowers considerably slow
their interactions is what we may be seeing happen now. This
development portends a downward turn in the business cycle,
and will also put the current bull market in stocks in jeopardy.

More direct bond buying --- another method of quantitative easing
--- would increase the debt load with alacrity. The flip side of this
coin shows that selling from the central bank's portfolio will send
interest rates soaring by causing the debt supply to exceed demand.

And President Trump cannot do much about this situation. But he
could worsen this situation by threatening trade wars against
America's largest trading partners; he already has one such trade
war going with Canada. If Trump blocks our industries' ability to
earn dollars, he will hamper our ability to climb out of our debt
swamp. The past decade of government and Fed fiscal insanity is
certainly not his fault, but he shouldn't do anything which could
make things more painful, lest he get the blame, and nasty electoral
repercussions could happen in 2020.


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