How does a budget deficit result in high interest rates in the context of a restrictive monetary policy (that is, the government doesn't start printing money) ? I figure that it is because the 'government needs money' so the demand for it increases, and thus its price - the interest rate. But well, I still don't quite get it to transparent understanding... Any help?
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Budget deficit and interest rates
- Thread starter sabotage
- Start date
I have developed some very interesting and far-reaching theories by substituting labor for kinetic energy and capital for potential energy and then applying the laws of thermodynamics.
Not that you care.
But in the truest sense, money (think wealth) can neither be created nor destroyed. Sure the government can print more money, but that will cause inflation and thus currency devaluation.
As far as interest rates go, look at it this way. If you keep borrowing and borrowing, eventually you will run out of potential lenders. For simplicity sake, think of an individual person.
At first, maybe they can get a bank loan for say 7%. But when that money is used up, maybe next they will go to an unsecured line of credit at 15%. That's because they exhausted the available money supply at the lower rate. But if they keep borrowing, eventually the only people who will loan them money will be demanding 30% or more.
As far as the government goes, if you exclude Social Security from general revenue (which I think should be the case), we are spending 28% of our available tax revenue on interest payments for the national debt. Just interest. 28%.
If you were a bank, would you loan someone money if they were spending 28% of their net income on the interest payments for their credit cards? Uh, no.
Now here's the other problem. The national debt is not revolving credit. In other words, when you run up a bunch of debt in a low interest rate environment in the absence of a 30-year bond, all of that debt will have to be reissued (rolled over) in say 10 years. What will interest rates be in 10 years?
And when you are able to find financing for your current debts from foreign creditors who at this time have no better means to employ their trade surpluses and are temporarily parking their dollars in your bonds, where are you going to find that money in 10 years?
Just because we have financed $8 trillion in debt at 4.5% interest right now does not mean that we will be able to find financing for $8 trillion at 4.5% ten years from now.
We might be able to find financing for $6 trillion at 10%. But how will we suddenly pay off $2 trillion in debt? Or how will we afford to pay these high rates of interest?
How would you suddenly pay off a large debt? Let's say China "called" their loan of $250 billion. It would be done on the secondary market, which would drive interest rates up, up and away. That is the inverse relationship of bond price to interest rate. So you either pay off the balance (but how?) or suffer the consequences with high interest rates that ravage the economy.
Sad but true.
Maybe you know someone who was in business for himself. It seemed like he was doing well, that business was good. But all of a sudden everything he had was being liquidated and he lost his business. What happened? It seemed like everything was doing fine. Then you found out that it was a long time coming and he did a great job of concealing his financial problems. You never would have guessed that he was in such dire straits. So maybe you know a person like that. Maybe he is your Uncle. Maybe his name is Sam.
Not that you care.
But in the truest sense, money (think wealth) can neither be created nor destroyed. Sure the government can print more money, but that will cause inflation and thus currency devaluation.
As far as interest rates go, look at it this way. If you keep borrowing and borrowing, eventually you will run out of potential lenders. For simplicity sake, think of an individual person.
At first, maybe they can get a bank loan for say 7%. But when that money is used up, maybe next they will go to an unsecured line of credit at 15%. That's because they exhausted the available money supply at the lower rate. But if they keep borrowing, eventually the only people who will loan them money will be demanding 30% or more.
As far as the government goes, if you exclude Social Security from general revenue (which I think should be the case), we are spending 28% of our available tax revenue on interest payments for the national debt. Just interest. 28%.
If you were a bank, would you loan someone money if they were spending 28% of their net income on the interest payments for their credit cards? Uh, no.
Now here's the other problem. The national debt is not revolving credit. In other words, when you run up a bunch of debt in a low interest rate environment in the absence of a 30-year bond, all of that debt will have to be reissued (rolled over) in say 10 years. What will interest rates be in 10 years?
And when you are able to find financing for your current debts from foreign creditors who at this time have no better means to employ their trade surpluses and are temporarily parking their dollars in your bonds, where are you going to find that money in 10 years?
Just because we have financed $8 trillion in debt at 4.5% interest right now does not mean that we will be able to find financing for $8 trillion at 4.5% ten years from now.
We might be able to find financing for $6 trillion at 10%. But how will we suddenly pay off $2 trillion in debt? Or how will we afford to pay these high rates of interest?
How would you suddenly pay off a large debt? Let's say China "called" their loan of $250 billion. It would be done on the secondary market, which would drive interest rates up, up and away. That is the inverse relationship of bond price to interest rate. So you either pay off the balance (but how?) or suffer the consequences with high interest rates that ravage the economy.
Sad but true.
Maybe you know someone who was in business for himself. It seemed like he was doing well, that business was good. But all of a sudden everything he had was being liquidated and he lost his business. What happened? It seemed like everything was doing fine. Then you found out that it was a long time coming and he did a great job of concealing his financial problems. You never would have guessed that he was in such dire straits. So maybe you know a person like that. Maybe he is your Uncle. Maybe his name is Sam.
Afterburner,
Thanks for your thoughtful summary of the theory on government debt and interest rate pressures. It sheds some valuable light on the dark world of my thoughts. Isn't the point of accumulating a deficit to invest it in productive resources that would one at one cycle of the wave turn that deficit into a surplus (the economy would be booming then and the rates high) and use that surplus to pay debt?
Thanks for your thoughtful summary of the theory on government debt and interest rate pressures. It sheds some valuable light on the dark world of my thoughts. Isn't the point of accumulating a deficit to invest it in productive resources that would one at one cycle of the wave turn that deficit into a surplus (the economy would be booming then and the rates high) and use that surplus to pay debt?
"As the Anglo-Saxon economies lost their competitive edge in manufacturing, they tried to make up for it by encouraging consumption. This is the biggest fraud of all. At first, higher consumption feels good. It is like burning the furniture to keep warm; it feels good for a moment. But the sense of well-being is extremely short-lived. When people borrow and spend, they feel as though they are getting richer--especially when their houses are rising in price. The increased consumption even shows up, indirectly, in the GDP figures as growth. But you don't really become wealthier by consuming. You become wealthier by making things you can sell to others--at a profit. The point is obvious but, at this stage of imperial finance, it was inconvenient." - Empire of Debt, page 224.
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Quote from sabotage:
Isn't the point of accumulating a deficit to invest it in productive resources that would one at one cycle of the wave turn that deficit into a surplus (the economy would be booming then and the rates high) and use that surplus to pay debt?
From the introduction of the PACT America report:
"There are acceptable times for the accumulation of debt. Businesses often take loans in order to finance growth. This debt can help a business to gain increased profits, and a profitable business will be able to pay back its debts. Therefore, when used properly, debt is a powerful tool. However, when a business borrows money for the purpose of expansion, it always has a plan in place to pay this money back. If no acceptable plan is in place to repay the loan, the bank views this business as a poor investment risk. Therefore, debt may be either a powerful tool or a dangerous weapon, and those who are uneducated in firearm safety often end up shooting themselves.
"There have been times in American history when debt played an instrumental role in the growth of our economy. Before World War II, our country was in the midst of the Great Depression. As part of the war effort, many bonds were sold to the public, and American citizens helped to finance our victory. The national debt allowed our country to escape the Great Depression and fully capitalize on the post war opportunities. Not only were we able to export weapons during the war, but our goods and services also helped many European countries rebuild afterwards. America was a net exporter, and large amounts of wealth flowed into our collective treasuries. Therefore, the national debt was a terrific investment in both freedom and capitalism.
"However, recently America has shifted its focus from being a net exporter to a net importer. Since America is now a net importer, more money flows out of this country each year than flows into it. The national debt has increased at alarming rates, but this debt is no longer an investment in the future of America. Instead, it has become a line of credit to help us live an unsustainable lifestyle. The sons of Lady Liberty are prodigal indeed; they are wasting their inheritances on fleeting pleasures."