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The National Debt is not a Monetary Problem

By       Message Seymour Patterson       (Page 1 of 1 pages)     Permalink    (# of views)   5 comments

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Donald Trump has tipped over the delegate count hump of 1237, putting him well on the road of presumptive Republican presidential nominee to their nominee. Without any aspersions or pejoratives towards his policy pronouncements, Mr. Trump has promised to perform some rather incredible deeds. One is to make America great again--the implication is that America not great. I suggest many Americans would beg to differ. Perhaps some of his pronouncements are intended to titillate the emotions and propel him to the presidency. Among them are statements concerning women, the wall the Mexicans would pay for, repealing the TPP, and barring all Muslims from entering the U.S. With a propensity to vacillate on issues with impunity, for the general elections, Mr. Trump could seamlessly tack to the middle--and win: stunning his detractors on both sides of the political divide.

Maybe the most fickle statement to come from Mr. Trump lips is the notion of buying back the U.S. debt at a discount. The debt is a fiscal policy problem not a monetary problem. True the debt is gargantuan--$19.3 trillion--and obviously needs to be managed. But that does not translate into imminent disaster for the U.S. economy. Further, managing the debt does not mean balancing the budget; or reneging on our obligations to lenders. Ironically, what Mr. Trump is saying by "buy back government debt at a discount" is recognition the government is not a business. The government can print money--businesses cannot.

There is a degree of dissonance in Mr. Trump's argument when he says, "First of all, you never have to default because you print the money, I hate to tell you, OK?" Further, "I said if we can buy back government debt at a discount, in other words, if interest rates go up and we can buy bonds back at a discount -- if we are liquid enough as a country, we should do that," Trump said." (See CNN Politics) As we'll see shortly, part of this argument is correct--the higher interest rate part. However, printing more money does not necessarily increase interest rates.

It is easy to understand that increasing the supply of something affects and its value. One way the government can increase the money supply is via the Federal Reserve Bank open market operations, which means selling government securities (bonds) on the open market. As the amount of money in circulation rises, there will be an impact on interest rate and price level behavior.

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With respect to the price level, if the economy is operating below full employment, more money in circulation could have positive effects on economic growth. If the economy is at full employment though, the impact of increasing the money supply will be purely inflationary: only prices will rise in as much as output cannot. Despite the anemic economic growth rate (2 percent), the U.S. economy has recorded since the Great Recession 2008, unemployment rate is falling and is 4.9 percent and inflation virtually nonexistent--i.e. 1.1 percent in April 2016.

Regarding interest rates: A rise in the money supply would increase the rate of interest. The effect works through two channels the price level and in the financial market for a given demand and supply for money. First, the implied money-stock growth under Trump means the value of money would fall. When that happens, you'll need more dollars to buy the same goods. Nominal interest rates are the sum of real interest rates and the rate of inflation. Thus, higher inflation translates into higher interest rates. Some financial instruments--namely, bonds lose value as interest rates rise. In other words, the price of the bond will fall in value with increasing inflation and the government can buy back its outstanding debt at a "discount".

In the financial market the demand and supply of money would determine the interest rate. Then for a given demand, when the Fed (i.e. the Federal Reserve Bank) increases the supply of money interest rates are pushed lower. The value of the debt would rise and it would sell at a "premium". A subsequent rise in the demand for money to due inflation would have a mitigating effect on the interest rate fall--the net effect, however, would be a lower rate of interest from the initial level.

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The Fed chairperson Janet Yellen likely will raise interest rates in the coming months. The cost of government debt would increase. People holding bonds in their retirement portfolio would welcome higher interest rates. Of course, investors would not. Ms. Yellen's actions are in response to her perception the American economy is doing well. Contrast that with Mr. Trump's pessimism that informs his presidential run and the basis (in part) for making "American Great again!"

Mr. Trump's utterances have the force of conviction even when they are not realizable. How does he make Mexico pay for the wall? How does he prevent all Muslims from entering the U.S.? How does he deport all illegal aliens? Well , perhaps he doesn't or doesn't really want to. These campaign promises are simply devices to propel Mr. Trump to the White House.

Among those promises that are not doable is the buying back to US debt at a discount through the means of printing more money. Mr. Trump is reputedly a smart man. Surely, he knows that the Federal Reserve Bank is semi-autonomous. It is independent of the whims of the president (and Congress). Monetary policy is the purview of the Fed, not the Congress; not the president. The Fed decides to increase (decrease) the money supply in response to economic conditions--easy money in a recession and tight money when they economy over-heats. Mr. Trump is not a foolish man and certainly he understandings the role of the Fed in the U.S. economy. President Obama cannot forward a letter to Ms. Yellen demanding changes in the money supply--he would be overstepping legal bounds. And unless Congress legislates core changes in the mandate of the Fed, neither will Mr. Trump be able to tell the Fed to increase the money supply were he to become president of the United States.

 

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 

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