Thursday, November 18, 2010

Bond Market Crisis?

Conservatives wants to stop government spending, but the market needs demand.  The Fed responded with monetary stimulus, injecting 6 billion into the economy by printing money and buying our own bonds.  Now Greenspan, former head of the Fed, said publicly that increasing our deficit may drive investors away from the US bond market.

What does all of this mean?

First, does buying our own bonds increase our debt?  Yes.  We are basically borrowing from ourselves to pay ourselves back at a later date with interest. 

Increasing our money supply decreases the value of our dollar.  This is where the international community ties into our economy. 

Remember the gold standard?  That is gone, because the natural boom and bust cycle of economics needs some magic cheating power...that is monetary policy, the ability to raise or lower interest rates and control for inflation and deflation...HOPEFULLY preventing total economic collapse like the depression.  (Unfortunately, history has not proven any safety net for global economic security). 

The US has been lucky, because the rest of the world, since WWII, has thought of the US dollar as a universal safety net.  Most global economic dealings are in US currency, and most economies keep their investments in US dollars- THROUGH THE BOND MARKET, because they expect that they can depend on the safety of their investments-that the US economy will always be okay-that they will get a good return on their investment.  These countries are basically buying our debt and propping up our economy while we spend spend spend ourselves out of our wits.

Why is the US lucky again?  Because, other countries cannot accrue such debt, they don't have others propping them up like rich aunts and uncles; and because most other countries deal and invest in US dollars THEY DO NOT WANT THE VALUE OF THE US DOLLAR TO GO DOWN, which means they will most likely want to invest in our debt, to keep the value of their investments up.  Whew.  Oh the tangled webs we weave.

So, what are the dangers of our ever increasing debt and monetary policy that decreases the value of the dollar?  Simple- others won't want to invest in our bonds, and BOO! our economy collapses like a house of cards. 

This is why we have such an affection toward China, they are our dearest lending Uncle.  Woe to us if they decide to invest in the Euro. 


1 comment:

  1. Interesting topic, Kat, and well explained.

    China is already investing in the euro:

    and about 27% of the world's reserve currency is in euros:

    The map on this page is really interesting, showing which countries are attached to the dollar or euro: