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Econ 101: A Bond Story

This article is one in a series intended to help people anticipate and prepare for the challenges and opportunities that would come with a major economic crisis in the US.
The 2001 economic collapse of Argentina created catastrophe in an advanced industrial society as middle-class people discovered they could not withdraw money from their banks. It also created an opportunity for worker-controlled production, neighborhood assemblies and other creative alternatives to corporate globalization. Princeton economist Paul Krugman, who specializes in global financial crises, tell us "If this [the US] was a Third World country, and you had the [economic] numbers we have, you would say, "Oh, my God, start stocking up on canned goods," because we look ... worse than places like Argentina or Indonesia."[1] This article is one in a series intended to help people anticipate and prepare for the challenges and opportunities that would come with a major economic crisis in the US.

Treasury Bonds? US budget debt? What's this all about? Where could this be headed?

The US government borrows money by selling Treasury Bonds at x% interest. This government debt is usually considered to be a "low risk" investment, because the government can repay it from taxes that it levies on its citizens. Some large business firms can borrow by issuing corporate bonds (commerical paper). They have to repay these loans from their business earnings, which are less certain and thus more "risky" than compulsory taxes. Since the government bond has traditionally been considered fail-safe, relative to the potential that a corporation could fail to pay its lenders, the government can attract investors with a lower rate of interest. Business debt is considered to be a less "safe" investment, therefore corporate bonds must pay a higher rate of interest to attract buyers. This difference in interest rates could become important.

Because a government can borrow money easily, it prefers to raise money through borrowing (issuing bonds) rather than through politically unpopular taxes. It borrows and borrows, until it needs to borrow just to repay interest and principle. If the US barrowing becomes excessive, foreign investors could conclude that the jobs leaving the US will never return, and the US government is going to have trouble raising enough taxes to pay off its debt. At that point, foreign lenders will become nervous wondering if the government can really pay off the bonds. The increased sense of "risk" makes investors hesitate to buy government bonds at the typical low rate of x%. The government then has to raise its interest rate to encourage investors to buy bonds, that is, to lend the US money. So the interest on government debt goes up a notch x+1%. In response, interest on business & domestic loans (mortgages), which tracks higher than government debt, goes up too. In addition to uncertainty about risk, as more and more bonds of all types flood the international market, as when the US runs large budget deficits each year, the huge supply of bonds begins to out pace the demand for bonds by investors. This also forces the bond interest rates to go up.

On and on it goes, and as economist Paul Krugman says, "the United States is running huge twin deficits. The federal government is borrowing $1 billion a day or so for the operations. The United States as a whole is borrowing $1.5 billion to pay for imports. Those can't go on forever. It's a law that says that things that cannot go on forever don't, and it appears that the world is finally looking at it and saying, "Gee, we don't see this changing."" [1]

When businesses & households find their interest rates go up in response to US Treasury bond rate increases, they may not have enough income to make their repayments. Then bankruptcies and foreclosures begin. People are thrown out of work, and cannot make their monthly mortgage payments. People have to sell their homes, but the prices have fallen, because the market is flooded with houses for sale. Sometimes the selling price is less than the mortgage debt owed to the bank, which must be paid, unless the person files for bankruptcy. Angry out-of-work people take to the streets. Police crack down on the people and send them to jail. Civil unrest increases. Politicians become nervous. What to do? Blame someone else. Start a war (a big one).

This scenario is predictable, as was the 2001 Enron debacle, and the Wall Street bubble burst of 2002. This predictability allows us to collectively act now to avert these anticipated pressures toward war. It might be too late for revising energy and tax policies to be of help, but we can advocate toning down the superficial China-bashing rhetoric that is becoming popular with both major political parties. Other articles in this series will delve into this further.


[1] December 21st, 2004 Paul Krugman on "Social Security, the Decline of the Dollar and Healthcare" DemocracyNow! <a href = " http://www.democracynow.org/article.pl?sid=04/12/21/1535228&mode=thread&tid=25"><b>CLICK for LINK</b></a>

Adapted from: Hells bells 5/18/04 contribution to <a href=
" http://www.iraq-war.ru/tiki-read_article.php?articleId=6170" <b>www.iraq-war.ru</b></a>
Let's see it! 06.Mar.2005 17:41

Democratic Troll

I know there are many viewers here at PIMC who don't have time for this kind of thing, but I, for one, am grateful for serious educational efforts, even if posted as a series. In fact, it's better in a series, so you can take it a chapter at a time.

True, but taking great strides with the theory... 06.Mar.2005 20:56

Professional Economist

You are making some huge leaps and judgements with your posting, though I've attended Krugman's lectures and respect his premises. There is an economic MAD (mutually assured destruction) in place at this time. To dump US treasuries right now would be drive China's own investments worthless. If the dollar tanks, the world economy tanks. So a slow evolution to a mixed basket of currencies is necessary. The problem is that the Bush Admin. seems ignorant of this and may take actions that would hasten the devaluation of the dollar (greater war expenses from fronts with Syria, Iran, etc.). Can the US afford it? Yes, but only by taking the advice of Nathan Rothschild to Prime Minister David Lloyd George in WWI: "Tax the rich and tax them hard." This wisdom of empire building seems to escape Bush and his chronies (unless you buy the Illuminati conspiracy theories that destruction of the US economy is the end game).

First of all, everybody should remember that many powerful interests see this as a fascism--so collapse of the logistics and purchasing power that enable people to shop at Wal-Mart, Safeway, etc. is contrary to their support for Bush. They either must be being mislead by the Bushies intentionally or they would take exception with any major disruption of commerce. This is one aspect where the velocity of money and capitalism works in the favor of a free society.

I do agree with the authors sequence of events, which has already started to happen as even now the dollar is not the world's currency (ironically, it was exactly the cause of maintaining the petro-dollar that led to the farce of the Iraq War II), but has been compromised for a basket of world currencies. However, total collapse of the dollar would trigger not just US calamity, but world-wide depression. For all its faults, free-trade does have some balast for democracy and human rights.

Fair Enough 07.Mar.2005 18:24

Jim George

Professional Economist is correct about the MAD situation.

China currently pegs their currency to the dollar; as the dollar goes up or down, so does the yuan. Europe does not; as the dollar looses value relative to the Euro, imports demoninated in Euros become more expensive in the US. The US imports less European goods, and US imports to Europe become more (they appear to be cheaper from the Eropean perspective). The logic suggests that the falling dollar will spur more production in the US, and help decrease the imbalance in trade.

If china un-pegs its currency from the dollar, the dollar value versus the yuan is predicted to fall. Chinese products would appear more expensive to the US and the US would import less chinese goods. It is possible that huge numbers of chinese workers would be laid off in china, causing instability. Thus, as Prof Economist suggests, the chiniese, and others, are making shifts slowly.