Music, Technology, Art, Economy

US Economic Analysis In A Blog Comment

To quickly answer the question where the $700 billion will come from, it will come from the sale of treasury bills: we’ll sell treasury bills at whatever they’re currently going for (10 year notes are getting around 3.6% AFAIK), and buy with that money the mortgage security notes. Effectively, we’re going to trade $700 billion of treasury notes for $700 billion in mortgage security notes, thus allowing banks to trade something whose overall economic value is not well understood and at a fairly high risk with something that has a lower face value but whose value is known and calculable.

So in theory the treasury’s exchange will be revenue neutral.

In the future, the treasury will then sell back the mortgage backed security notes, and in theory could make a profit or take a loss: it is at the point when the treasury sells the notes back that taxpayers will either be hit (because we’ll have to pay those T-Bills that came due with money out of our taxes), or we’ll make a profit. Our maximum exposure is $700 billion, though the actual amount will be a whole lot less: if we’re actually out $700 billion, it’s because the value of the houses behind those mortgage backed securities dropped to zero. (Now if Paulson is smart, he’ll issue a whole range of notes from short-term 3-month bills to long-term 30-year notes: this will allow him to spread whatever potential loss may be suffered over a 30-year period, and give him greater flexibility to sell the notes back when they have maximum value.)

As to the credit rating of the United States, the reality is the United States has never failed to pay back a treasury note or treasury bill. And in theory the United States can simply print more fiat money: a dollar bill is essentially a 0% t-bill. So the United States government is the only entity in our economy which can (in theory) hold an unlimited risk exposure because when it comes time to pay people back, we can just print the money.

The measure that the United States has overextended its credit worthiness, therefore, is not the credit rating of various agencies—the United States government, by its actions of creating fiat money and regulating the banking industry and taxing people has in essence created the modern fiat economy. Instead, the measure if the United States has “overextended” its credit worthiness is to look at the core (non-food, non-fuel) inflation rate: this would help determine if the United States has dumped so much fiat currency into circulation that it effectively drives the “worth” of a dollar down by creating high inflation. The combination of inflation and the percentage of GDP taken in by the United States determines the percentage of ‘worth’ that is being directed by the United States: high inflation suggests the United States is taking in more ‘worth’ than the tax rate would suggest.

So the real numbers to watch over the next year are not “credit worthiness” of the U.S. federal government—that is meaningless. No; the real numbers are the GDP growth/decline rate, the core CPI inflation rate (seasonally adjusted), and indirectly the TED spread and the unemployment indexes: each of these will give us a sense of how much damage the current crisis has caused, how much money the U.S. is “overprinting” to cover T-bills bought back to cover the mortgage backed securities, how “illiquid” the banking sector has become, and how sluggish the overall economy has become.