I have been reading about international debt and the PIIGS (Portugal, Ireland, Italy, Greece and Spain) ever since I took a derivatives seminar. However, the United States is very close to the precipice because of their excessive borrowing and the increase in the nation’s debt.
See, there is a fight in Congress about whether the debt ceiling should be raised again. It now stands at 14.294 trillion dollars. So far, the Us has borrowed 14.293975 trillion dollars and the ceiling is 25 million dollars away (literally pennies away). Should you be worried? You betcha! I will simplify as much as I can so bear with me.
Role of the Treasury: Collect taxes and issue debt in the form of T-Bills, treasury bonds and others. The Treasury is a government agency.
Role of the Fed: Control the flow of money, inflation and other stuff by using adjustments to the interest rates. The Fed is not a government agency. It is a not-profit corporation allowed by the government to operate (a true monopoly). I recommend that you read “The Creature of Jekyll Island”.
So guys what happens in brief:
The Treasury issues bonds to fund the activities of the government (healthcare, food, etc.). China, individual investors, funds, and others buy these bonds and give money to the Treasury in exchange for the future obligation (bond par value and interest payments). The US uses this borrowed money and tax collected to fund their social programs, pay employees, build roads and pay for fancy White House galas. However, Congress has a limit of borrowing of 14.294 trillion dollars. If this limit is not increased what happens?
- Federal employees will have to be laid off.
- Social programs are reduced or cut.
- Social Security payments are reduced or stay the same.
- Voters are pissed off.
- Absent borrowing, US can start defaulting on its debt payments. The credit of the US is downgraded. This is bad because suddenly the interest payments for future bond issues are increased as investors will require better rates of return for risk exposure.
- The Capital Asset Allocation model (CAPM) model no longer holds. US T-bills are used in the model as a risk free return. What corporations will use as their risk free rate?
I bet that the borrowing limit will be increased. Why? Because the Fed can turn the printing presses and pay the debt interests. Another option is to raise taxes substantially. Eventually, the devaluation of the dollar is going to be massive. Right now we are borrowing above 90 percent of Gross Domestic Product (GDP) and increasing.
US Debt 2011 via the Economist
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I am sure this is really disheartening news to every US citizen but I think they should take it up as a wake up call and act for the better of the nation. There is no sense in increasing the ceiling of borrowing as it will only lead the country to further debt. And it is really heart wrenching to hear the places where the cuts will be made. The lowest sector of the society will be the worst hit when and if, social security payments are reduced. Let’s hope they soon take things to hand and will not let the situation to degenerate.
The United State has really hurt itself with the credit situation. I just don’t get it. We pay billions in taxes and the debt just keeps getting higher. Why doesn’t anyone ever have to answer where the cash is going. Just like the workplace, if you are held responsible for your actions, this kind of actions doesn’t happen.
I believe the strategy that the US will default on its credit card debt is insane. How did it arrive to this?
By borrowing too much.