In Part 1 of this series, I made the case that government spending cuts and tax increases wouldn’t be a solution to our countries debt issues. In Part 2, I made the case that many of the fears commentators have about debt causing the end days for the US and the dollar are unfounded. In Part 3, I’m going to make the case that our debt levels weren’t really a choice. They were necessary for the economic system of the last 50 years to work.
Sorry, A Bit Of History First
As I explained in Part 1, the US has open markets. We created a system after World War 2 in which we opened our markets (particularly our financial markets) and protected the shipping lanes across the world. We did it to help rebuild Europe and then Asia as a distinct strategy to beat the Soviets during the Cold War. We were subsidizing our allies.
The classic development model for a country post World War 2 was to extract money from citizens (low benefits, low wages, taxes, etc.) to invest in export driven companies. Those companies would flood the world and particularly the US with cheap goods. Europe did it, Japan did it, South Korea did it, Taiwan did it, and China did it. At first, the US was so big and so productive that it didn’t make much difference here. We were 50% of world GDP post WW2 but over time other countries got more competitive and our share shrank to 23-25% today.
As that share shrank and as other countries’ grew, the flow of money and goods got unbalanced. Post WW2, we still used the gold standard. Every dollar was backed by a set amount of gold in the US. As we bought more and more and cheaper and cheaper goods from the new upstart countries in the 1950s and 1960s, gold started pouring out of the country. Finally, it got to be too much. The US faced a choice, either close its markets or go off the gold standard. In 1971, President Nixon took us off the gold standard.
Debt Wasn’t Really A Choice
You can date the rapid increase in both US debt and foreign imports to that fateful decision1. If we had closed our markets rather than gone off the standard, it probably would have collapsed the world economy. Countries all across the world had structured their economies to export to the US and use the US dollar as a medium of exchange and a readjustment would have ruined them. At the same time, the US got really good at providing assets like Treasury debt to those same countries2. Wall Street took off.
In Part 1 of this series I explained how countries using an export driven model, have to recycle the dollars they get back to the US. If they don’t their currencies go up in value and people in the US stop buying their goods and then they get poor. But what happens if we don’t create assets for them to buy to recycle those dollars?
Answer: they go find other assets. It’s an open market after all. So when the government cuts its deficit and reduces the number of Treasury bonds it sells, the foreign exporters have to find other assets. They buy mortgage bonds, corporate bonds, real estate, stocks, etc. That creates bubbles in the private sector.
Foreign capital flows contributed to the bubbles in Silicon Valley, rising home prices in coastal markets and in particular the housing crisis in 2007-8. Of course, we can stop those bubbles by raising interest rates severely to slow the economy but that comes at the price of sky high unemployment. So in a sense, we are trapped. We either print Treasuries, experience a series of private sector bubbles and busts, and/or accept large numbers of unemployed.
There actually is one other choice. It’s the same choice that Richard Nixon faced in 1971. We could close or restrict our markets. Again, this would collapse the global economy and force a massive adjustment of the world’s economic system. There are no other choices so pick your poison.
Debt Isn’t A Moral Issue
In the end, I think we can see that our national debt isn’t a choice. It is a requirement to run the system we have. We can change that system but we shouldn’t lament the rise in debt as some sort of moral failing. So many commentators today like to portray debt that way. Calacanis and Friedberg do a bit of debt scolding themselves and we all know that only degenerates over lever themselves and should feel ashamed when they can’t pay their debt back. During the housing crisis in 2007-2009, I remember stories of homeowners who felt morally obligated to pay their mortgages even if they were way underwater on the house and struggling to make ends meet. This is some pure grade bullshit3.
A second thing you hear commentators do is analogize the budget of the United States with that of a household. I think the awful 1990s movie, Dave, cemented this narrative: if I ran my household like this government, I’d be bankrupt. Of course you would but you also wouldn’t have the US Treasury, nuclear weapons, and the taxing authority over the largest economy in the history of the world. So skip the analogy. It’s also high grade bullshit.
The debt had to be created given the system we have and whether you create it in the government or the private sector is a choice but not a moral one.
In the End
I am deeply indebted (pun intended) to Michael Pettis and Matthew Klein
and their book Trade Wars are Class Wars for many of the principles behind this series. In researching it, it’s become clear to me that our common understanding of trade, finance, debt, and economics is mostly wrong. This misunderstanding serves the needs of both the parties benefiting from the system (Wall Street, rich people with lots of assets, national security elites, Chinese business owners, etc.) and critics who want to portray the real problem as capitalism itself. Both are wrong. The system is a choice.In future posts I’ll explore what an alternative system might look like. It’s still capitalism and there’s still trade but the system is more self balancing. However, a transition to such a system would require a lose of power and wealth for the most elite members of society.
This is not an argument for a return to gold. The system is too inflexible and there are better ways to deal with the problem.
Remember that our debt is another person’s asset.
Just note how quickly Brookfield Asset Management handed the keys to their office buildings back to the banks last month. https://www.businessinsider.com/brookfield-rxr-related-companies-office-loan-default-2023-2