Deficit Spending By The American Government

[NeenerNeener]

I finally decided to start my own thread. This one is intended to be a discussion of the impacts of deficit spending on the dollar (inflation), foreign policy, the middle class and below.

It is my understanding that deficit spending is covered by the issuing of government bonds and the printing of more money by the treasury.

Some of these bonds are bought by U.S. citizens, others (perhaps many more now) are bought by foreigners.

When these bonds (or "worthless IOU's" as our president likes to call them) come due, the government pays out by printing more money or issuing more bonds.

Common sense tells me that this is a major source of inflation in our country. An insidious one, considering those in power that spend so much won't likely be in power when the debt comes due.

My hypothesis is that inflation hurts the middle class and helps the upper class, causing a deeper division between the classes. History tells us that if this division grows too great, the working class seeks revolution. For instance, Karl Marx's "workers of the world unite", or Hitler's appeal to the proletariat, or perhaps the French Revolution.

This is something that most of us don't want to happen in the states. How do we prevent it though? Economics is a complex issue with many more variables than the ones above. Even friends I have that I consider "very intelligent" many times become resigned when trying to discuss issues of the american economy. So what do we do?

 

[NeenerNeener]

Also, I get a sense that these bonds that are owed to those outside our country will greatly affect our ability to negotiate public policy with our allies.

Or even further, couldn't all these IOU's be a way for other governments to leverage economic power over our country in the future, a sort of economic warfare if you will?

 

[charrison]

Originally posted by: NeenerNeener
Also, I get a sense that these bonds that are owed to those outside our country will greatly affect our ability to negotiate public policy with our allies.

Or even further, couldn't all these IOU's be a way for other governments to leverage economic power over our country in the future, a sort of economic warfare if you will?

Most of our debt is owed to the american public. Greenspan has been raising interest rates, yet the 10 year bond has been dropping. I dont think we have anything to worry about at this point.

 

[NeenerNeener]

Practically speaking, most things seem to cost more than they did five years ago. So it's apparent that inflation is occuring. Can anybody tell me why?

 

[rahvin]

Originally posted by: charrison
Most of our debt is owed to the american public. Greenspan has been raising interest rates, yet the 10 year bond has been dropping. I dont think we have anything to worry about at this point.

Most of our debt is owed to social security, not individual americans.

Originally posted by: NeenerNeener
Practically speaking, most things seem to cost more than they did five years ago. So it's apparent that inflation is occuring. Can anybody tell me why?

Inflation is a fact, the goal of the Fed isn't to eliminate inflation, it's to control it.

 

[Zebo]

No they roll-over the debt. They don't "print more money" to pay it off, in fact we never have to pay it off.

 

[ntdz]

The government doesn't pay it's debt by printing more money, afaik. That'd just be idiotic. If you check our inflation, it's extremely low as well. As of now, our deficit spending isn't hurting us much, if any.

 

[NeenerNeener]

I still don't see an explanation of WHY inflation occurs. Also, ntdz, when you "check our inflation", where do you get that number and what does that number represent. We're not on a gold standard, so, what do they compare the value of the the dollar to, to determine inflation-rate?

Zebo, don't we have to borrow more money to pay the interest on this debt?

 

[rahvin]

Originally posted by: NeenerNeener
I still don't see an explanation of WHY inflation occurs. Also, ntdz, when you "check our inflation", where do you get that number and what does that number represent. We're not on a gold standard, so, what do they compare the value of the the dollar to, to determine inflation-rate?

Zebo, don't we have to borrow more money to pay the interest on this debt?

The CPI and other metrics determine "inflation".

Inflation causes tax revenues to rise. If you can sit on a debt for 30 years its like you got the money for free. As long as there are willing buyers of our bonds there won't be an issue with the debt being repaid.

 

[dullard]

Why inflation occurs is simple. Suppose NeenerNeener and I lived on an otherwise deserted island. Suppose I ran a buisness from that island - selling sand to tourists. Suppose I hired NeenerNeener to collect the sand.

Year 1: I pay NeenerNeener $1 per handful of sand. Then I sell that handful of sand for $2. Everyone is happy.

Year 2: NeenerNeener demands a raise due to his added experience and company loyalty. I now pay NeenerNeener $1.75 per handful of sand. I don't want to offend my customers so I keep the price at $2. Everyone is happy.

Year 3: NeenerNeener demands another yearly raise. I now pay him $2.50 per handful of sand. I sell it for $2. Guess what. I go out of buisiness, lose my private island and have to fire NeenerNeener from this wonderful job. Tourists have nowhere to buy sand. Everyone is far worse off.

Or,

Year 3: Neener gets a raise to $2.50. I raise my price to $3.00. Neener is happy with his raise. I still get a profit for doing next to nothing. Tourists still can buy their touristy sand. Everyone is happy. Inflation occured. Without that inflation everyone would have been unhappy.

Extend this silly example to the real world and you see that inflation is almost always a must. People want raises, raw materials are limited and rare so raw material prices must go up. Prices must go up eventually.

 

[NeenerNeener]

Sounds like a vicious cycle. People want raises cause prices go up. Prices go up because people want raises.

 

[dullard]

Originally posted by: NeenerNeener
My hypothesis is that inflation hurts the middle class and helps the upper class, causing a deeper division between the classes.

Not necessarilly. Time for another silly example.

Suppose NeenerNeener earns $40k a year - a middle class salary. Suppose NeenerNeener buys a house for $160k at today's 6% fixed interest rate. The house is 4 times his salary and he can barely afford payments even with eating nothing but ramen noodles and skipping all forms of entertainment and just about all shopping.

Suppose horrible inflation comes around tomorrow. The cost of everything (goods AND labor) goes up by 10 times (see history for examples of inflation nearly this fast). Suddenly tomorrow NeenerNeener earns $400k a year. But since NeenerNeener didn't buy many goods, his expenses don't change much. But, within a few months, NeenerNeener has his entire house paid off! He got a nearly free house. See how inflation helped the middle class?

Suppose a wealthy person was the lender. The wealthy person gave up quite a bit in order to loan NeenerNeener that money (sold some valuable stocks to get the instant cash). Now the inflation hits. The wealthy person gets the money back which can buy 1/10th of the stocks that were sold to raise the money in the first place. Inflation can hurt the wealthy.

Inflation helps those who owe money at fixed rates (the poor and middle class). Inflation hurts those who are owed money at fixed rates (you have to be somewhat wealthy to be owed significant amounts of money).

 

[LordMagnusKain]

actually most mortgages given to the poor in America are adjustable rate.

 

[Zebo]

There's lots of reasons for inflation quite simply can be thought of as: people want to make a profit off thier endevors. Weather labor, capital or even a home seller they want profit.

As far as the defict is concerned many economists believe that deficit spending drives up private interest rates, which in turn is passed off to the consumer though higher prices to cover that increased intrest expense for whatever venture you many be in.

And we already know deficit spending weakens our dollar against foreign currencies which raises it's inflationary head when purchasing foreign goods.

 

[chowderhead]

Originally posted by: charrison

Originally posted by: NeenerNeener
Also, I get a sense that these bonds that are owed to those outside our country will greatly affect our ability to negotiate public policy with our allies.

Or even further, couldn't all these IOU's be a way for other governments to leverage economic power over our country in the future, a sort of economic warfare if you will?

Most of our debt is owed to the american public. Greenspan has been raising interest rates, yet the 10 year bond has been dropping. I dont think we have anything to worry about at this point.

Foreign and International investors/banks control 2 trillion dollars of US debt Click on Ownership of Federal Securities. Private ownership is probably 4 trillion. What happens to our foreign policy if these foreign countries i.e. Japan and China increasingly become our bankers?

 

[Zebo]

The wealthy person gave up quite a bit in order to loan NeenerNeener that money (sold some valuable stocks to get the instant cash).

Not quite. Banks create money out of nothing, well not really nothing it represents an asset, when neeners house loan is issued. But they did give up thier leading power since it lessoned thier reserve.

 

[dullard]

Originally posted by: Zebo
Not quite. Banks create money out of nothing.

Who said anything about banks? I was just giving a simple example. When you owe money (especially at a fixed interest rate), inflation is good. When you are owed a fixed interest rate, inflation is bad.

 

[NeenerNeener]

" quote:
Originally posted by: NeenerNeener
My hypothesis is that inflation hurts the middle class and helps the upper class, causing a deeper division between the classes.

Not necessarilly. Time for another silly example.

Suppose NeenerNeener earns $40k a year - a middle class salary. Suppose NeenerNeener buys a house for $160k at today's 6% fixed interest rate. The house is 4 times his salary and he can barely afford payments even with eating nothing but ramen noodles and skipping all forms of entertainment and just about all shopping.

Suppose horrible inflation comes around tomorrow. The cost of everything (goods AND labor) goes up by 10 times (see history for examples of inflation nearly this fast). Suddenly tomorrow NeenerNeener earns $400k a year. But since NeenerNeener didn't buy many goods, his expenses don't change much. But, within a few months, NeenerNeener has his entire house paid off! He got a nearly free house. See how inflation helped the middle class?

Suppose a wealthy person was the lender. The wealthy person gave up quite a bit in order to loan NeenerNeener that money (sold some valuable stocks to get the instant cash). Now the inflation hits. The wealthy person gets the money back which can buy 1/10th of the stocks that were sold to raise the money in the first place. Inflation can hurt the wealthy.

Inflation helps those who owe money at fixed rates (the poor and middle class). Inflation hurts those who are owed money at fixed rates (you have to be somewhat wealthy to be owed significant amounts of money)."

Edited: 06/16/2005 at 07:49 PM by dullard

If I went from earning $40k to $400k, I would no longer be a member of the middle class! No matter though, this is the way I look at it. Let's say I own no property or stock and make minimum wage. Inflation hits and my wages don't go up because my boss's rent went up and he can't afford to pay me more. Now my food costs more and I make the same amount of money. Sucks to be me.

However, let's say I'm a member of the upper class, and I own property and stock. Prices go up, but so do the value of my assets. It's a wash, but since I make plenty of money, the inflation doesn't affect my standard of living.

This is how I believe the division occurs.

 

[NeenerNeener]

"Who said anything about banks? I was just giving a simple example. When you owe money (especially at a fixed interest rate), inflation is good. When you are owed a fixed interest rate, inflation is bad. "

Only if the interest rate is less than the inflation rate.

 

[dullard]

Originally posted by: NeenerNeener
If I went from earning $40k to $400k, I would no longer be a member of the middle class!

If EVERYTHING went up 10 x then, yes you would. The poor would make ~10 times more, the middle would make ~10 times more, the rich would make ~10 times more. Of course this is a silly number, but it really drives home the point clearly.

Inflation hits and my wages don't go up because my boss's rent went up and he can't afford to pay me more.

Since inflation hit, and all prices are rising, your boss can easilly raise his prices to match all the competition. Thus there is plenty of money to pay the added expenses (one of which is you). Whether he does it or not is another story. But he certainly can. And reread my post - I said IF you owe money at a fixed rate, then inflation CAN help.

 

[rchiu]

Originally posted by: dullard

Originally posted by: NeenerNeener
If I went from earning $40k to $400k, I would no longer be a member of the middle class!

If EVERYTHING went up 10 x then, yes you would. The poor would make ~10 times more, the middle would make ~10 times more, the rich would make ~10 times more. Of course this is a silly number, but it really drives home the point clearly.

Inflation hits and my wages don't go up because my boss's rent went up and he can't afford to pay me more.

Since inflation hit, and all prices are rising, your boss can easilly raise his prices to match all the competition. Thus there is plenty of money to pay the added expenses (one of which is you). Whether he does it or not is another story. But he certainly can. And reread my post - I said IF you owe money at a fixed rate, then inflation CAN help.

Heh, if inflation means everyone get PAID x times more, everyone will have no problem with inflation. The problem with inflation is that everything COST x times more, and when there is hyperinflation, wage never catches up that inflation.

 

[dullard]

Originally posted by: rchiu
Heh, if inflation means everyone get PAID x times more, everyone will have no problem with inflation. The problem with inflation is that everything COST x times more, and when there is hyperinflation, wage never catches up that inflation.

I'm just stating that inflation itself is not a major problem. A little inflation is actually desireable to many people. Inflation combined with other problems can be a bad thing.

 

[rahvin]

Originally posted by: dullard

Originally posted by: rchiu
Heh, if inflation means everyone get PAID x times more, everyone will have no problem with inflation. The problem with inflation is that everything COST x times more, and when there is hyperinflation, wage never catches up that inflation.

I'm just stating that inflation itself is not a major problem. A little inflation is actually desireable to many people. Inflation combined with other problems can be a bad thing.

The problem is banks and lenders don't like inflation because it acts as a wealth redistribution scheme for borrowers who invest in real property. There is always a tug of war between lenders and lendees on inflation. Ideally to avoid disrupting an economy excesively you want inflation to be a couple percent, this allows payments as a percentage of income to decrease over time for the middle class but yet still allows the lender to make a couple percentage of gain over the life of the loan.

 

[Jhhnn]

Meh. As we've discussed many times before, excess borrowing will ultimately catch up with the borrower, whether that's a person, a corporation, or a nation.

As for inflation favoring the borrower, that's only true if the rate of increase in the borrowers' income meets or exceeds the price of everything else they have to buy to survive. While that mortgage payment may shrink to insignificance, that's small consolation if the price of food, fuel, insurance, etc. more than makes up the difference. Inflation also strongly discourages saving, and obliterates the earnings and value of conventional investments, other than real estate.

Part of what current deficits do is to falsely maintain the high value of the dollar, encouraging offshoring and overseas investment. It soaks up and props up what would otherwise be excess dollars in international markets by providing a safe investment avenue for those dollars. Asian bankers are supporting the dollar and holding down interest rates buying US govt securities, plain and simple. So rather than a gradual adjustment in the marketplace, the greater imbalance created will ultimately lead to a more precipitous collapse. Which is just fine by American Investors moving their money offshore, investing in China, etc... They plan to have their money on the sunny side of any readjustment, and stand to benefit from using their overvalued dollars to buy bargain offshore investments today, then sit back and watch as the relative value skyrockets. The only catch is that emerging markets have to grow strongly to counteract the effects of collapsing American buying power...

This phenomenon hinges on illusion, on maintaining a false sense of security in the target population, and on the complicity of that nation's financial elite. Much the same happened in Argentina a few years ago- their financial elite was essentially skimming off the top of what the govt was borrowing, moving it out of the country as fast as they could. The average guys seemed to be doing fine, until the bottom fell out... Their own industry had been so eroded by foreign competition due the overvaluation of their currency that they didn't have domestic means of production to turn to. Basic domestic commodities also became scarce and expensive, simply because selling them in another country suddenly became more profitable... Everyday goods that were once cheap were rather suddenly very expensive, and the capital to rebuild is already gone, the political situation unstable, investment climate unfriendly... Basic government services, even roads, fire, and police degrade rapidly, simply because of reduced revenues and the now crushing burden of debt maintenance... Govt owned assets with money-making potential are also sold off in an effort to stave off default...

Can't happen here? That's exactly what you're supposed to believe... Our only saving grace is that the debt is, afaik, entirely in our own currency, mitigating the effects...

 

[NeenerNeener]

Thank you Jhhnn. Sorry for the repetition of the thread. I'm new here. I like your synopsis.