What did the US use for collateral when we borrowed money from other countries?
We know that the US government has borrowed billions of dollars from China, Japan and other countries. But what did we use for collateral? I've been told that the United States is actually a corporation. When a corporation goes belly up, it's assets are used to pay its debts, thus protecting the personal profits of its executives. So when they say "of the people, by the people and for the people" does that mean that WE are the collateral? Is this why the wealthy are trying to get as much money as they can so they can pay cash if this nation goes under, while the rest of us become slaves?
The US is not a corporation. It is a National Gov't. The US treasury backs it's debt by the "Full Faith & Credit" of the US Gov't. This means essentially the taxing power of the gov't to extract revenue from the private sector. Essentially the gov't doesn't actually go bankrupt. Technically bankruptcy is a legal reorganization of the finances of a company or an individual where debt obligations are wiped away. Since only the US gov't can mint it's own currency, there is an unlimited amount of currency it could create. The risk is not bankruptcy as much as it is the devaluation of the currency. The larger the debt burden, the weaker the currency will get. This in turn will weaken the purchasing power of the dollar further and reduce what you can buy with a dollar.
It is possible for the US to default on a debt payment, however that is unlikely. That does not necessarily mean a bankruptcy. It just means your credit doesn't carry the same weight. The US has historically enjoyed certain perks as a result of it's strong currency, such as the dollar holding "reserve status". If we were to loose that, items such as oil which are priced in dollars globally may no longer be. In which case the price of oil to the US consumer would rise dramatically. If the problem is serious enough you can have hyperinflation like the Weimar Republic. Hopefully the US will get it's Federal spending under control long before that.
Landmark, I apologize for not being clear. I did not say JFK took us off the gold standard. I said he tried to take the power to print currency from the Federal Reserve and give it back to the government.
I'd have to look further into that. However the Federal reserve is a branch of the Gov't. It's leaders are presidential appointments approved by congress.
The government's taxing power is not necessary for paying off the debts in these securities. The Fed can create unlimited new money out of nothing in crediting the reserves of banks surrendering their securities to it in return for this money.
Bank Reserves are not used to pay off gov't debt. They are used a multiple of lending in the fractional reserve lending system. Reserves stay on deposit and are not even actually lent out.
The full faith and credit of the US govt also means that the govt can create the money out of nothing to pay its debts. Taxes are not needed to cover deficit spending debts.
Yes...the gov't can create as much currency as it wishes, and technically doesn't even have to issue debt at all to begin with. But that comes with potentially great consequence as the era of John Law taught us.
Everything comes with potentially great consequences. Not spending enough can lead to contraction and even deflation. We don't advocate unlimited spending at all.
US deficits (Increased Spending) have exploded since the late 60's early 70's. And capacity utilization has steadily declined during that time. And the purchasing power of the dollar has been eroded. We're already feeling the consequences.
Hyperinflation occurs in certain specific circumstances, like owing debts in a currency you cannot create, so you try to beat the international exchanges in creating more and more money. But not if you can create the money and float on the exchanges
I am not necessarily talking about hyperinflation. The US hasn't had hyperinflation. It has a slow but consistently increasing erosion to purchasing that effects those on the lowest end of the economic spectrum more than anyone else.
Loans made by the United States, in the form of bond sales, are backed by the full faith and credit of the United States. Our problem is that as we print more money, the value of the dollar becomes less, and the interest payments on the loans that the government has made increases. When and if the value of the dollar increases, the debt that people keep talking about will decrease significantly, because interest payments will decrease and the value of the loans will increase causing some entities that have made loans to the United States to sell them to other entities at a discount, just like the private sector does. Finally, a lot of the debt is owned to people in the United States who buy savings bonds and treasury notes.
Merely creating new money does not necessarily cause devaluing of currency. It depends on how much is actually in circulation chasing goods and services. Imports, taxes drain the money from circulation and new money may simply replace that.
Thanks for your answers Landmark and Larry.
Full Faith and Credit. I can look that up to further my understanding. Based on what the two of you have said, my question now concerns the value of the dollar. My understanding is that with neither gold nor silver behind it, the value of the dollar is fiat. Is this raising and lowering the value of the dollar anything more than a game? I know that the Federal Reserve prints our money. The two presidents who tried to take back the power for the government to print its own money, Lincoln and Kennedy, are also the two who were assassinated. Not saying there's a connection. Just an interesting coincidence.
The U.S. has been on the gold and silver standards. We have assets in Fort Knox--not enough to cover the debt. Tthe strength of the dollar, which are basically promissory notes, is strong enough for most investors. We do need to limit spending.
I think your timeline is off on the Presidents. We were on the Gold standard already when JFK was killed. It was Nixons adm that took us off the standard.
@Larry Wall: It's generally thought the US has a large stock of gold bullion in Fort Knox. No one has been allowed to see it for decades now. That includes congressmen who have asked to. We don't know if it's still there.
I heard a speech by the Treasurer of the United States, who has seen the gold. Ron Paul has doubts--therefore I do not. It would be very difficult to get that volume of Gold out of Ft. Know with no one knowing about it.
The value of the dollar is not affected by the printing of new money, unless and until so much new money is printed that the economy cannot keep up with the increased demand. We are nowhere near that point. New money leads to increased production.
New money doesn't necessarily increase production. We have the most expansive monetary policy in US history for 5 years...and capacity utilization is still well below average levels seen over the last 2 decades.
New money *that gets spent* will increase production, as long as production is capable of going up - which you seem to acknowledge when you say our cap. utilization is down. (Pouring money into banks' reserve balances does not count as spending.)
Correct...because the creation of money does not mean an increase in velocity. There must be some incentive to put the money to work. Without Cap Ex...there is no increase in production. Hence corporate balance sheets remain at record cash levels.
Diminishing value of dollars only occurs when new dollars cannot be matched up to new materials at the same prices, or to new workers to hire at the same wages, which would occur with full employment in effect.
Diminishing value of dollars happens when the currency increases without regard for productivity. It is happening right now.
http://www.shadowstats.com/article/no-4 … rement.pdf
The dollar has not been backed by, exchangeable for gold since 1971.
It is fiat money, meaning it can be created out of nothing. That doesn't mean the government will endlessly create it, but it can pay off any debt in dollars that way.
But they do create too much of it for unproductive spending already. And then when inflation kicks in they just alter the way we calculate it to hide the true cost. CPI measures are now dramatically different as a result since the 1970's
@LW - what, exactly, is "unproductive spending"? There are LOTS of "unproductive" things in our economy - tanning booths, luxury items, entertainment, etc., that don't serve to increase productivity. But by the very nature of money changing hands,
Entitlements are a great example. They do a great job of destroying price discovery and driving up costs. See the last GDP report. Consumer spending is at 14 year high. Capital expenditures still nowhere to be found. Incentives are still all wrong
It is not correct to say that the value of the dollar is diminished when more is created. Dollars get their value from things they can buy. As long as more things can be made at same prices value not changed.
Correct...more dollars without a corresponding increase in productivity will hurt purchasing power. Unfortunately, there has been an awful low of that over the years.
It's a good thing that those new dollars elicit an increase in productivity, then. That's what happens when the government SPENDS dollars into the economy.
No those dollars when directed to often by the gov't illicit price distortions. Which why when a Dr opts out of Medicare the cost of care drops by 50%. When the gov't stops trying to dictate outcomes we get proper price discovery.
We need to limit spending only if to do so would be seriously inflationary. Right now, in a recession, it would not be inflationary.
Spending needs to be limited only to things than can't be plausibly provided privately. Deficits and surplus will happen organically based on increases and decreases to consumption and spending. Gov't dictated outcomes distort markets.
The best US collateral for borrowing is the well-being of the US economy itself. Strong US economy means strong world economy. That is why investors would rather provide funds to the US rather than put their home economies at risk. Also, a firs US Dollar is in need for international transactions between all countries.
Consumers and tax payers keep the economy moving, but we buy things and pay taxes with the dollar that is not real money because it has no gold or silver backing it. How can the gov't use fiat money as collateral?
Your assumption is wrong. It is the creation of new capital that keeps the economy moving. That is the strength the taxing power is based upon. Consumers can only consume that which is first created through innovation.
@LW, I think you put too much emphasis (faith?) in capital and not enough in deficit spending. Companies remove money from the economy when they save up profits, and they won't invest those unless they think they can accumulate even more profits.
Deficit spending requires every dollar put into the economy eventually comes out somewhere else with only transient income. Capital investment is about incentive. If we don't want cash hoarding we need proper incentives to cap ex.
Deficit spending is the source of all dollars. If that dried up, hoarding of dollars would be the endgame. No rich person or company would part with their money without an expectation of earning a net profit. Money does not originate with the rich
Disagree entirely. 1920-21 policy responses saw no monetary expansion or deficit spending. The recovery was one of the fastest and robust in response to the biggest deflationary pressures in history and the largest contraction of the monetary base.
But consumers can only consume what is first created if they have money to do so. Money is the medium of exchange. Capital would not exist without money to represent its value in exchanges. Consumers without money cause capitalism to falter.
I am not saying we should revert to a barter system. I am saying that there are times when there is more than enough currency in circulation and what we need is incentives for capital formation, not gov't increasing spending to dictate outcomes.
The U.S. does not "borrow" dollars from anyone and we have not done so since we were on the gold standard. The Chinese, owing to our large trade deficits, collect a surplus of dollars. (Same story for Japan, Saudi Arabia, and most of our other trading partners.) Since they have chosen not to buy American goods with those dollars (that's why it's a trade deficit), they have three choices: sit on those dollars, trade them on the FOREX market for other currencies, or exchange them for U.S. bonds. As bonds are 100% safe (save for political stupidity) and earn a bit of interest, this is the option usually taken. (U.S. bonds are also widely used as the currency of international transactions, which is why there is such an uproar about the possibility of us defaulting.) The only thing bonds can be redeemed for is more dollars, and as long as Congress raises the debt ceiling, we can print as many dollars as we need to pay off any obligation. There is zero chance of America "going under." Even if the Republicans forced us to default, there is nothing for bondholders to collect except paper.
I have a couple of hubs on this very topic, if you are interested.
I'd be careful with the term 100% safe. If you bought a 10 year treasury on January first you've lost money when yields jumped nearly 100%. There is no such thing as a riskless investment. Treasuries carry interest rate and inflationary risk.
They are 100% safe in that they will always be redeemed. I wasn't speaking about tsys as an investment.
I mean be careful...because someone might read this and put money into a treasury based on that comment without understanding the definition of risk.
I agree on the point concerning foreign and private individuals buying our government's securities. Of course, the Treasury is required by a law passed in 1917 to borrow money instead of simply create it when it tries to cover deficit spending.
The risk is no just in gov't securities. It's any investment grade fixed income security that is correlated inversely to rates. Most treasuries are not bought by individuals anyway. Most are held by central banks and other gov't agencies
John, Landmark is thinking in absolutes. Sure there is a logical possibility that the US will go under, but a very low probability in actuality. T securities are very low risk as long as there is a govt of the US paying debts in money it creates.
There is no risk of going under in terms of maturity repayment....there is a risk to the market to market value of treasuries and all fixed income assets. The 20 year treasury index declined nearly -14% in 2013. That is real interest rate risk
To begin with we have not borrowed billions of dollars from China. They have amassed billions in dollars from importing into our country, like all those goods made in China at WalMart. Where are they going to safely store that pile of dollars? If they want minimal risk, they will buy Treasury bonds or securities. It is very low risk and earns a bit of interest. It's like your buying a CD from a bank. The Chinese know that we can always pay back their investment. None of that money deposited in our Federal Reserve Bank (which sells these securities and bonds) goes into funding deficit spending. That is done independently by the Treasury selling securities to banks and other large institutions at public auction for that specific purpose. Our government does not go to foreign countries to ask for loans. They come to us for a safe place to store their dollars. The Fed eventually will buy back these mature securities for deficit spending from the banks with new money it creates on the spot by crediting the value of the securities to the banks' reserves. It's a digital entry into a spreadsheet. That will redeem the debt to the banks since the banks no longer hold the securities and the Fed is a governmental agency when it buys them. The securities still are "live" in the sense that, if the Fed gave them to some other nongovernmental entity, by holding them, that entity could claim the face value of the securities. That also frees up the debt the Treasury (for the government) had with the banks for deficit spending. So, it would be the same as if the Treasury issued its own notes, as pure credit.
The banks in 1917 required the Treasury to borrow rather than create its own money as needed. Lincoln had instituted the use of Treasury Notes to fight the civil war. He had gone to the banks and they would only lend at usurious rates of 25% - 36% (they didn't think the Union would win). So he said, "Sorry, I'll print my own." That worked very well and did not produce hyperinflation. But the banks were upset because they could not earn interest on loaning money to the Treasury. So they had the law passed in 1917 saying the Treasury had to borrow and not create its own money. But in the long run, the government still gets to spend credit rather than debt. People are not aware of the implications of the Fed's buying securities from banks. And I think the Fed may not want to directly make that know because Congress might take that power away from them.
The risk of devaluation of the currency does not come from just printing more money. Values of monetary units are negotiated between parties in exchanges of goods and services in setting prices. Until then more money cannot itself devalue money.
More money if it is placed into public circulation eventually translates into more velocity. If that is not accompanied by a corresponding increase in productivity It will mean inflation.
LandmarkWealth: You say "more money if it is placed into public circulation eventually translates into more velocity." That is closer to what I am saying. So let us be precise. Money in circulation concerns exchanges of goods and services.
Yes..but amount of goods and services which can be bought in a transaction declines when productivity doesn't keep up with new dollars in circulation. Prices don't rise just because a product is scare. Sellers raise the price because they can.
You are both right and wrong. Yes WE are the collateral whenever the government borrows or prints money. However not because the US is a corporation. They promise to pay this money back in dollars they collect from our taxes. Dollars they take from what we earn through our labor, without our consent and through force or threat of force. So essentially yes we are slaves.
The more they spend, the more enslaved we become. And it is actually worse. The more money they spend, the more money the Fed has to print into existence and the less purchasing power the dollar has so you need to work harder just to maintain your current quality of life.
They get away with this for several reasons. People don't notice the devaluation of the dollar because it happens gradually over time. The government needs to continue spending more money then they take in to create the illusion that they are giving you more for your money so they can keep taxing you. They borrow this money because there is a limit to how much taxation people will accept before they reach a breaking point and resist. It is deceptive, dishonest and despicable and we have allowed it to get to this point through our apathy and ignorance and I'm not really sure there is a whole lot we can do about it at this point accept wait for the entire system to come crashing down under its own weight.
Does that answer your question?
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And what does it mean for us?
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