Thursday, July 28, 2011

What Could the World Do? (The US Debt Issue)

The current financial impasse in Washington has raised some very interesting political questions and some thought provoking financial questions as well.  One of the big questions is if the us does default, What are we gonna do?  The answer that makes the most sense to me is nothing.

Let me explain a little bit.  First the US has about $14.3 trillion in debt, (that is $14,300 billion just to lend some perspective to the number).  Well that is more sovereign debt than any other country in the world (The entire European Union has $13.7 trillion, per the world bank  - Wikipedia .  So the US is the 800 pound gorilla sitting not in the corner, but in the middle of the room.  Assuming the debt impasse and a technical default and downgrade, many institutional investors would be forced to sell based upon their investment policies, but where can you go?  The real answer is that there isn’t anywhere you can really go because there are not enough AAA rated securities to soak up all of the money that would be forced to move out of Treasuries and into something else. 

But for me the question is more basic, why would you need to move your money anyway.  Living in California there are building codes that must be adhered to when building anything in California given the high occurrence of earthquakes (makes sense).  So the biggest, recorded earthquake was in the 8 on the Richter Scale, a level that would cause massive destruction.  But earthquakes codes are not designed for buildings to survive a 10 or 11 earthquake (which also makes sense).  At some point you have to accept that at a certain level the cost, and likelihood of occurrence make certain steps “unreasonable”.  If we have a level 11 earthquake everything is falling down and at that point we are going to have to start over (Noah style).

The same issue exists for US debt.  There is no market that is capable of absorb the money currently in Treasuries, and despite the political wrangling current engulfing us, what is really safer than US debt?  All of our debt is in US dollars, which we alone print, so there is not a currency issue.  We have the largest economy in the world by far (take a look GDP by Country),  and although we all hate the IRS we have a very good means of collecting taxes from our citizenry.  So would you rather have a piece of the income of LeBron James the basketball player or LeBron the bus driver?...the answer is LeBron James the basketball player.  And the reality today is that the US is still LeBron James the basketball player, but we are just having an argument with our fiancĂ©/wife on how we are going pay for the new Bentley.

According to the World Bank roughly 2/3 of US debt is held by American institutions.  With Bond rates at their lowest levels in years, there is still a very deep market for US debt, and if the debt ceiling were not an issue we could easily just print up more bonds to handle our current fiscal situation.  And despite the fact that China is our largest foreign holder of US debt, they represent less than 10% of our total outstanding debt (US Debt Holders), and they also don’t have anywhere to dump a $1 trillion in US debt without dramatically effecting the value of their holdings (remember there is nowhere for the money to go).
So what will happen?  Politics matter, and our inability to manager our politics is going to cost us in the short run and the long run.  The US has been the center of the financial world for the past 60 years, not because we are cooler than everyone else in the world, it’s because we built the financial infrastructure, and London needed to focus on rebuilding falling the end of World War II.    So we might be opening the door for someone to supplant the US in terms of our world financial prowess, but think about like this - The UK was at one time the most powerful country in the world with one of the largest economies in the world, despite the fact that it is a relatively tiny island nation, with not that many people.  Today the US has the third largest population in the world (behind on China and India) which means we have a lot of people who will continue to innovate and expand our economy, and we have the largest economy in the world (something that won’t change any time soon) which means we are going to be here for a while….no matter what Washington does.

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