Money. Doing it Right this Time.

[Flying Pig]

First of all, thanks to both of you for taking the time to write these explanations, and for doing so in idiot-proof terms!

The roof on your house starts to leak. You can borrow the money to have the roof replaced, and you won't have to do it again for a very long time. Or you can continually repair the damage to the inside of your house that the leak is causing. Which makes more sense?

That's all very well, but it's not in the question if you can't afford the repayments. Even if we accept that government debt isn't really going to be paid off - apparently we're only just considering paying off some of our debt from the collapse of the South Seas bubble - the interest payments are still going to cut into the government's spending power in every year to follow. That means that in order to keep the same level of public services, they're going to have to raise taxes, or else there will have to be cuts. If that's going to cost more than the ongoing maintenance (or, as happens now, simply squeezing those affected by the 'leak' harder, by taking money away from welfare, hospitals and prisons) neither of those are possible or palatable, the roof's staying leaky.

EDIT 2: From reading a bit more of the book below (I sense that today is going to be a school day...) what will happen if the government borrows at a greater rate of interest than the rate of increase in GDP (which is, I think, essentially the same comparison that I made earlier), there will be inflation. So the government will continue to be able to spend in order to pay pensions, welfare and wages, but the savings that people have will decrease in real terms, as will any revenues held by private companies and devolved governments. That's bad if it happens too much, which is why governments want to reduce the deficit. Is that correct? So essentially it's a means of ensuring that a greater share of the money rests with savers, companies and privately-employed people than with unemployed and otherwise publicly-funded people?

EDIT: Another question, I'm afraid. I'm reading over the much-praised Seven Deadly Innocent Frauds book, which is currently explaining why the US government can never run out of money. In that case, why did they default on their loan payments a year or so ago? And does that same logic (that the government is simply a score-keeper, and only taxes people to ensure that it destroys an equivalent amount of money when it puts more into circulation) apply to (say) France, which is part of a multinational currency?

As an extension of that, I suppose the argument only holds if the government controls the mint? So it wouldn't apply to a system using (eg) shells as money?

 

[Cutlass]

First of all, thanks to both of you for taking the time to write these explanations, and for doing so in idiot-proof terms!

No problem. I'll take your other question in pieces.

EDIT: Another question, I'm afraid. I'm reading over the much-praised Seven Deadly Innocent Frauds book, which is currently explaining why the US government can never run out of money. In that case, why did they default on their loan payments a year or so ago? And does that same logic (that the government is simply a score-keeper, and only taxes people to ensure that it destroys an equivalent amount of money when it puts more into circulation) apply to (say) France, which is part of a multinational currency?

First, the US did not default on loan payments. It threatened to do so. And the reason for that has literally nothing to do with economics. The United States government is constitutionally forbidden to default on its debts. However, Congress still has to appropriate the money to pay them, or allow the Treasury to borrow more. What happened was that in an utterly hairbrained scheme of political brinksmanship Congress refused to do either, in the hopes of compelling Obama to give in on a list of political demands. Obama didn't, and the Republicans in Congress backed down at the last minute.

Imagine one of your soldier pulling the pin on a grenade in training, but holding the spoon depressed. But then getting talking into putting the pin back in. I'm sure that you'd remove that many from the army as rapidly as you could afterwards. But nearly all of those members of Congress still have their jobs.

As an extension of that, I suppose the argument only holds if the government controls the mint? So it wouldn't apply to a system using (eg) shells as money?

Here's the thing, if a government controls its own money supply, and if its debts are denominated in its own money supply, then it can never really be forced to default, formally, with fiat money. Worst case scenario, it can always inflate the debt away. But that option is not open to a member of the Euro, because they don't control the money supply. And it's not open to a nation like Argentina, because they are borrowing money in US dollars, rather than their own currency. Now the latter is true because no one trusts them enough to lend them money in their own currency. And that is an extension of the fact that they haven't acted in a trustworthy and responsible manner in the past.

EDIT 2: From reading a bit more of the book below (I sense that today is going to be a school day...) what will happen if the government borrows at a greater rate of interest than the rate of increase in GDP (which is, I think, essentially the same comparison that I made earlier), there will be inflation. So the government will continue to be able to spend in order to pay pensions, welfare and wages, but the savings that people have will decrease in real terms, as will any revenues held by private companies and devolved governments. That's bad if it happens too much, which is why governments want to reduce the deficit. Is that correct? So essentially it's a means of ensuring that a greater share of the money rests with savers, companies and privately-employed people than with unemployed and otherwise publicly-funded people?

This is a trap many less developed nations get into. They can only borrow money at high rates of interest. Other nations, such as Russia right now, also fall into this trap because of various histories of mismanagement or other circumstances which lead people to assume that they are a bad risk. This does not happen to the US government. There is no debt in the world which is safer than US government debt. And the reason for that is has always been responsible with it. And so the US government has the lowest borrowing cost which anyone has. In fact, the more economic problems the rest of the world has, the cheaper the US government can borrow money. The UK is not far behind that. Rich nations with stable governments can borrow very cheaply.

Japan, for all it's accumulated debt:

TOKYO—Japanese government bond yields sank to their lowest-ever level Thursday, defying an upswing in U.S. yields over the last week and demonstrating the Bank of Japan ’s overwhelming influence on the market.

The benchmark 10-year Japanese government bond was yielding just 0.31% in afternoon trading, meaning investors were willing to accept just above ¥3 of interest annually for every ¥1,000 invested. The previous low yield of 0.315% was set in April 2013.

Yields on shorter-term Japanese government debt are even lower, or nonexistent. On Thursday, the government auctioned two-year bonds and for the first time received a negative yield—in other words, investors were paying the Japanese government to take their money. The Finance Ministry sold ¥2.7 trillion ($22.41 billion) of two-year bonds for a yield of minus 0.003%.

http://www.wsj.com/articles/japanese-bond-yields-hit-historic-low-1419501488

That's all very well, but it's not in the question if you can't afford the repayments. Even if we accept that government debt isn't really going to be paid off - apparently we're only just considering paying off some of our debt from the collapse of the South Seas bubble - the interest payments are still going to cut into the government's spending power in every year to follow. That means that in order to keep the same level of public services, they're going to have to raise taxes, or else there will have to be cuts. If that's going to cost more than the ongoing maintenance (or, as happens now, simply squeezing those affected by the 'leak' harder, by taking money away from welfare, hospitals and prisons) neither of those are possible or palatable, the roof's staying leaky.

Now, all that said, the reason I am more for debt control than I think I recall Hygro as being is that, yes, if debt gets too high than interest payments can place a squeeze on other government spending. The US's debt problem is fundamentally different than the debt problem of other developed nations in that the total debt isn't about the economy, it's about the politics. That is, since Reagan took office, we've been running deficits not because we need to, and not because they help the economy, but rather as a form of political warfare. And the money borrowed has not gone to help the economy, but rather has been a straightforward redistribution of wealth from the poor and the middle to the top. That is, instead of borrowing money to build roads and bridges, we've borrowed money to buy coke and hookers.

That is, you also have to introduce the concept of 'return on investment'. Government borrowing should have an ROI above 1. Just like a business should. That is, every dollar borrowed by a business should either save that business, or earn that business, or some combination of the 2, more than $1. The same is true of households and governments. The more wasteful the spending is, the more difficult it is to repay down the road. But if the ROI is greater than 1 (or greater than 1+the interest on the debt), then the borrowing pays for itself. But if it's coke and hookers, than the ROI is less than 1, and the debt will eventually become unpayable.

 

[Flying Pig]

First, the US did not default on loan payments. It threatened to do so. And the reason for that has literally nothing to do with economics. The United States government is constitutionally forbidden to default on its debts. However, Congress still has to appropriate the money to pay them, or allow the Treasury to borrow more. What happened was that in an utterly hairbrained scheme of political brinksmanship Congress refused to do either, in the hopes of compelling Obama to give in on a list of political demands. Obama didn't, and the Republicans in Congress backed down at the last minute.

So it's not that the government is physically unable to 'print money' (or, as actually happens, change the relevant numbers on the relevant spreadsheets) to pay its debts, it's that the Constitution or whatever applicable laws there are don't allow it to do so without taking that much money out of circulation. Have I got that right?

Here's the thing, if a government controls its own money supply, and if its debts are denominated in its own money supply, then it can never really be forced to default, formally, with fiat money. Worst case scenario, it can always inflate the debt away. But that option is not open to a member of the Euro, because they don't control the money supply. And it's not open to a nation like Argentina, because they are borrowing money in US dollars, rather than their own currency.

So the key point is that as long as the US government borrows in dollars and the UK government borrows in pounds, its debts will never make it unable to spend. However, the UK government could be made insolvent by debts in (say) dollars or gold.

Now the latter is true because no one trusts them enough to lend them money in their own currency. And that is an extension of the fact that they haven't acted in a trustworthy and responsible manner in the past.

Does that mean that in the past they did inflate the debt away? So doing so now would permanently (or at least very long-term) destroy the US or UK's ability to borrow without risking insolvency?

This is a trap many less developed nations get into. They can only borrow money at high rates of interest. Other nations, such as Russia right now, also fall into this trap because of various histories of mismanagement or other circumstances which lead people to assume that they are a bad risk.

So you could effectively say that for the US, borrowing money is effectively betting on future economic growth - if it borrows an amount of money and intends to hold onto it indefinitely, it's making a bet that the loan is going to cause its economy is going to grow fast enough to make the interest on that loan every year for the forseeable future, plus a bit more - and a bit more on top of that if it ever hopes to get rid of it. Is that the case?

Japan, for all it's accumulated debt:
http://www.wsj.com/articles/japanese-bond-yields-hit-historic-low-1419501488

Why are they buying those bonds? If, as I'm led to understand, a government bond is essentially an interest-bearing savings account, why would anybody settle for such a low rate of interest?

Now, all that said, the reason I am more for debt control than I think I recall Hygro as being is that, yes, if debt gets too high than interest payments can place a squeeze on other government spending.

That is, if the government wants to avoid inflation.

That is, instead of borrowing money to build roads and bridges, we've borrowed money to buy coke and hookers.

You mean, I presume, that money has been borrowed to finance tax cuts for the wealthy?

That is, you also have to introduce the concept of 'return on investment'. Government borrowing should have an ROI above 1. Just like a business should. That is, every dollar borrowed by a business should either save that business, or earn that business, or some combination of the 2, more than $1. The same is true of households and governments. The more wasteful the spending is, the more difficult it is to repay down the road. But if the ROI is greater than 1 (or greater than 1+the interest on the debt), then the borrowing pays for itself. But if it's coke and hookers, than the ROI is less than 1, and the debt will eventually become unpayable.

Is that the same as what I sketched out earlier? So 'irresponsible borrowing' can be interpreted to mean borrowing money which fails to make more money?

 

[Cutlass]

So it's not that the government is physically unable to 'print money' (or, as actually happens, change the relevant numbers on the relevant spreadsheets) to pay its debts, it's that the Constitution or whatever applicable laws there are don't allow it to do so without taking that much money out of circulation. Have I got that right?

The government either has to raise the money in taxes, or in borrowing. To just 'print the money', that's where hyperinflation comes from. I believe other laws are applicable in terms of just printing the money to prevent that. But the US government did just print at least some of the money during the Civil War, and the Continental Congress certainly printed the money during the Revolutionary War. The Confederacy also printed money during the Civil War. All 3 situations caused, well, not hyperinflation, but very significant inflation.

Think of it in terms of basic bookkeeping. Not actually that much more complicated than balancing your checkbook and personal accounts. What goes in has to balance what goes out. Regardless of source. If this ceases to be true, then problems can ensue.

So the key point is that as long as the US government borrows in dollars and the UK government borrows in pounds, its debts will never make it unable to spend. However, the UK government could be made insolvent by debts in (say) dollars or gold.

Yes. This is the problem 3rd world nations such as Argentina has now, and that many nations had back in the gold standard days. In order to pay its debts, most 3rd world nations have to purchase US$. Back in the day nations which had to pay their debts had to buy gold.

Money is 2 things: It is a means of keeping track of other things, accounting. And it is worth only what others will exchange for it. So take Russia's recent problems. What people in the international financial markets will exchange for a rouble has declined by a large margin. This is why the value of rouble in international exchange fell so much. So if Russia want to buy something which is sold in US$, or pounds, or gold, they have to exchange a lot more roubles to get it. If the value of roubles fell so much that no one was willing to exchange them, then Russia just wouldn't be able to get the dollars/pounds/gold that it needed. Now Russia isn't falling that far, but many other nations at various times have. They become forced into default. And many of the worlds biggest inflationary periods have been related to this happening.

Does that mean that in the past they did inflate the debt away? So doing so now would permanently (or at least very long-term) destroy the US or UK's ability to borrow without risking insolvency?

Weinmar Germany. The quip is that the Frenchman said to the German 'It felt like we never received the reparations payments' and the German replied 'it felt like we never paid them.' Yes, it's happened many times. Some call it a 'stealth default' rather than a 'hard default'. And a government which has done that too many times can only borrow money at very difficult terms. Once again, Argentina.

So you could effectively say that for the US, borrowing money is effectively betting on future economic growth - if it borrows an amount of money and intends to hold onto it indefinitely, it's making a bet that the loan is going to cause its economy is going to grow fast enough to make the interest on that loan every year for the forseeable future, plus a bit more - and a bit more on top of that if it ever hopes to get rid of it. Is that the case?

Yes. And not just governments.

Apparently that graph doesn't work.

http://en.wikipedia.org/wiki/Bond_market#U.S._bond_market_size

Businesses and households do the same thing. As long as the value of what is being bought with the borrowed money exceeds the cost of repaying that money, and the costs of servicing the debt interest and fees, then it makes sense to borrow.

Why are they buying those bonds? If, as I'm led to understand, a government bond is essentially an interest-bearing savings account, why would anybody settle for such a low rate of interest?

Safety. The 2 concepts here are 'return on investment' and 'return of investment'. The yields may be very low, but you are going to get your money back. With other savings, that's not necessarily true. Occasionally you may here business or financial reporters talking about a 'flight to safety' as the reason why US bonds do so well when the economy looks so bad. When every other investment has gone to hell in a handbasket, US bonds are the safest investment in the world. Japan, Switzerland, the UK, not far behind.

That is, if the government wants to avoid inflation.

That too. Or, with an independent central bank like the Federal Reserve, a monetary policy which harms the government's ability to borrow.

You mean, I presume, that money has been borrowed to finance tax cuts for the wealthy?

Yes. The money has been spent on luxuries, when the theory justifying the tax cuts was that it would be invested in businesses.

Is that the same as what I sketched out earlier? So 'irresponsible borrowing' can be interpreted to mean borrowing money which fails to make more money?

Yes. Although there can be a lot of dispute concerning where to draw the lines. And saving you money also is a factor. Borrowing money to buy a car is consumption, the car will be used up in a matter of years. But during those years, you didn't have to spend other money on other forms of transportation.

 

[Takhisis]

Yes. The money has been spent on luxuries, when the theory justifying the tax cuts was that it would be invested in businesses.

Once again, Argentina. With some twists, but still.

 

[El_Machinae]

Yes. The money has been spent on luxuries, when the theory justifying the tax cuts was that it would be invested in businesses.

This is part of the zeitgeist I'm trying to figure out how to defeat using easy phrasing. We've somehow become to realize that 'purchasing shares' is 'investing in business' in a way that is good for the economy. I mean, it's clearly investing in a business. But it's not buying labour or new productive capital.

So, each group of earners that is not poor is rapidly shoveling as much money into share-purchasing as they can afford, and the tax-breaks for the rich merely encourage them to do the same ever more.

 

[Takhisis]

A thing that is lacking from Cutlass' side comments on Argentina is the state's internal debt, to its provinces and its own central bank and treasury. Those are being inflated away.

 

[Hygro]

A thing that is lacking from Cutlass' side comments on Argentina is the state's internal debt, to its provinces and its own central bank and treasury. Those are being inflated away.

oh no one pocket paying the other

What do you mean specifically be "being inflated away"?

 

[Takhisis]

The Presidency now collects a majority of provincial taxes and only then, at its leisure, hands it back to the provincial governments which used to collect them. This 'federalises' taxation. Money is doled out in exchange for political favours (photo-ops, public statements, etc.) but always after some delay. Money is misappropriated from the Treasury (which is, technically, constitutionally, outside the Executive's control) on similar terms. With year-on-year inflation at over 30%, any delay really cuts into the buying power of the provincial governments' tax incomes.

 

[Cutlass]

This is part of the zeitgeist I'm trying to figure out how to defeat using easy phrasing. We've somehow become to realize that 'purchasing shares' is 'investing in business' in a way that is good for the economy. I mean, it's clearly investing in a business. But it's not buying labour or new productive capital.

So, each group of earners that is not poor is rapidly shoveling as much money into share-purchasing as they can afford, and the tax-breaks for the rich merely encourage them to do the same ever more.

There are ways in which the common usage of the English language is detrimental to the understanding of economics. Words and phrases can mean fundamentally different things, while sounding like they mean the same thing. To a financier, and to the common 'investor', buying shares in a company is 'investing'. But in economics, unless those are newly issued shares, then it is not 'investing', it is 'speculating'. GE has millions of shares outstanding. If you go and buy a few 1000s of them, GE doesn't get the money from the sale, the previous owner does. Tesla has 0 shares outstanding, and does an initial public offering, and you buy those shares, Tesla does get the money. In the GE case, you are gambling, speculating, that you have a better grasp of what the long term value of the stock is than the person you bought it from. It's zero-sum-game. The only benefit to the company (and be very clear to make the distinction between the benefit to the company, the benefit to other stockholders, and the benefit to the management) is that a company with a strong stock price can probably borrow money on the debt markets at a more preferential rate. Beyond that, the company gets no direct benefit. The company can in no way invest in more of anything, not equipment, not research, not training, because you bought some of their stock. In the Tesla example, the company gets the money, and they can invest in those things.

 

[warpus]

I have a financial dilemma. I am going to Norway in mid July... Now..The Canadian dollar has dropped in value wrt the Norwegian krone over the last 6 months or so. The ramifications: If I had exchanged a bunch of CAN for NOK 6 months ago, I could have saved myself I'm estimating - at least $1,500. (in terms of what I've budgeted out for this trip)

Would it make sense to exchange a bunch of Canadian currency to Norwegian currency and sit on it until my trip in 6 months? Or would it be wiser to just wait and see if the Canadian $ rebounds? See, I think that oil might have to increase in value for that to happen - and I don't know if that's going to happen.. so I'm at an impasse.

Is this thread the right place to ask such a question?

 

[Cutlass]

I can't give you a good answer. And that's because I have no background in foreign exchange to make predictions on what the future may bring. Whomp might. But it's an imperfect science, unless it's a job you're doing all the time. You'd really need to know a low about the factors which effect the currencies of those 2 nations.

 

[Hygro]

I have a financial dilemma. I am going to Norway in mid July... Now..The Canadian dollar has dropped in value wrt the Norwegian krone over the last 6 months or so. The ramifications: If I had exchanged a bunch of CAN for NOK 6 months ago, I could have saved myself I'm estimating - at least $1,500. (in terms of what I've budgeted out for this trip)

Would it make sense to exchange a bunch of Canadian currency to Norwegian currency and sit on it until my trip in 6 months? Or would it be wiser to just wait and see if the Canadian $ rebounds? See, I think that oil might have to increase in value for that to happen - and I don't know if that's going to happen.. so I'm at an impasse.

Is this thread the right place to ask such a question?

If I could give you an answer I'd be making money right about now...

 

[warpus]

I guess I'm not really asking if the Canadian dollar is going to go up or down.. but rather whether it would even make sense to consider doing something like that. I mean, I could just exchange $2,000 or something like that - and then if the Canadian $ continues going down, I would sit on it... and if it starts rebounding I can exchange it back. But I don't know if the fees I'd be charged when exchanging the money are usually high enough for it to not really be a good plan no matter what... or if this could actually be a decent idea. It would also be a lot easier to not have to have $2k worth of money in krone sitting around in its physical form - but rather to have it sitting in an account.. but then... do I need to open up a new banking account at my bank? A Norwegian one? How does that work? I think it'd be easier to open up an American $ account (this currency hasn't been dropping wrt the krone), but I really have no idea.

 

[El_Machinae]

There are ways in which the common usage of the English language is detrimental to the understanding of economics. Words and phrases can mean fundamentally different things, while sounding like they mean the same thing. To a financier, and to the common 'investor', buying shares in a company is 'investing'. But in economics, unless those are newly issued shares, then it is not 'investing', it is 'speculating'. GE has millions of shares outstanding. If you go and buy a few 1000s of them, GE doesn't get the money from the sale, the previous owner does. Tesla has 0 shares outstanding, and does an initial public offering, and you buy those shares, Tesla does get the money. In the GE case, you are gambling, speculating, that you have a better grasp of what the long term value of the stock is than the person you bought it from. It's zero-sum-game. The only benefit to the company (and be very clear to make the distinction between the benefit to the company, the benefit to other stockholders, and the benefit to the management) is that a company with a strong stock price can probably borrow money on the debt markets at a more preferential rate. Beyond that, the company gets no direct benefit. The company can in no way invest in more of anything, not equipment, not research, not training, because you bought some of their stock. In the Tesla example, the company gets the money, and they can invest in those things.

Very good Cutlass! Thanks! "Speculation". That's the word that I needed. It allows us to distinguish stocks from actual investments, linguistically.

 

[Whomp]

Warpus--Are you sure NOK is up against to CAD? Since May, it looks like NOK has gone from 5.50/CAD to 6.37/CAD today. The Canadian economy may have close links to oil but Norway is much more as a per cent of GDP.

Stock investing is not zero sum. Prices can be bid up or down without a share changing hands. Trading options or futures is zero sum through speculating (or hedging) and requires someone to be on the other side of the trade on a contract that will eventually expire.

Also, companies can issue equity instead of debt to raise additional capital.


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[Cutlass]

Warpus, it might not hurt you any to get a few $1000 in US$ and sit on it. Interest is so low on savings it might as well be cash. But the US$ is the only currency that I know of that really seems to be strengthening these days.

 

[onejayhawk]

Warpus, it might not hurt you any to get a few $1000 in US$ and sit on it. Interest is so low on savings it might as well be cash. But the US$ is the only currency that I know of that really seems to be strengthening these days.

Shouldn't this coversation be in the collapse of the dollar thread?

J

 

[Cutlass]

Shouldn't this coversation be in the collapse of the dollar thread?

J

Why ?

 

[Takhisis]

Both overlap, I assume you can quote posts from here to support/coutner arguments there in the best of CFC traditions.