Monday, April 18, 2011

Going Broke? This Morning's Federal Debt Scare

The Lehmann Letter (SM)

The stock market slumped this morning after Standard & Poor's presented its warning regarding US government deficits and debt. But the price of U.S. Treasury securities hardly fell.

Apparently bondholders are not overly concerned. The federal government will curtail spending and raise tax revenues in order to deal with the problem. We'll muddle through.

Private borrowing, however, is another matter. During the recession it shrank and then disappeared as households and businesses began to repay their debts rather than initiate new borrowing. The problem is: Spending -- financed by borrowing -- must grow for the economy to adequately expand. Moreover, reducing federal borrowing and curtailing federal spending only serves to magnify the need for additional private borrowing and spending.

And there is an additional difficultly: We used to borrow from ourselves, but now we borrow from the rest of the world. If the American economy spends its way to expansion by borrowing from overseas, our debt to the rest of the world will grow. But foreign lenders to the US often prefer to hold their dollar assets in the form of U.S. Treasury securities because U.S. Treasury securities are safe and readily marketable in massive quantities. Foreign holders of US private debt will exchange those private debts for U.S. Treasury securities.

That's where this morning's S&P report enters the picture. Investors fear a downgrade of U.S. Treasury securities because their price will fall and interest rates rise. No one wants to see a jump in interest rates. But what about a revival of private borrowing from the rest of the world? That, too, will ultimately oblige the rest of the world to increase its holdings of U.S. Treasury securities. If foreign investors become reluctant to hold any kind of American debt -- public or private -- that could compound any increase in interest rates.

© 2011 Michael B. Lehmann

1 comment:

zhonglin said...

U.S. government spending and private borrowing have a relationship of restricting each other. If federal government will curtail spending and raise tax revenues, then for maintain a steady economy growth, private borrowing and spending must increase. However, the problem is the prospects of U.S. economy recovery is not optimistic, the housing market has not improved yet, businesses world-wide are cutting back severely., so no one can guarantee that the private sector(borrowing and spending) will increase quickly. So from my point of view, even the US government deficits and debt remain stubbornly high, government should not cut the spending sharply, in case the private sector has not recovered as they thought.