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> What is so Bad about the Defict?!?!, And why is everyone afraid of it?
brinn
post Nov 5 2010, 02:41 AM
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It seems that the U.S. and much of Europe has become obsessed with deficits, debt reduction and austerity. The question for debate is simple:

What do you see as the negative economic effects of persistent deficits?
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Hobbes
post Nov 5 2010, 03:02 AM
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What do you see as the negative economic effects of persistent deficits?

That's easy. Eventual economic collapse. Governments are no different than any other entity..they can't keep spending more than they make forever. Eventually, the debt becomes large enough that financing it becomes problematic, and those purchasing the bonds start demanding higher rates, causing ever larger deficits, causing rates to go even higher--and the death spiral begins. The only way out of that spiral is to print enough money to pay off the debt to a manageable level, causing inflation to jump dramatically. Given that much of our debt resides overseas in China, and the Chinese won't much appreciate have so much of their investment depreciate in value, WWIII could potentially ensue. That 'negative' enough?
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akaCG
post Nov 5 2010, 03:05 AM
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What do you see as the negative economic effects of persistent deficits?

At some point, a nation (just like a household) reaches a point of indebtedness when its lender(s) will not only refuse yet another request for yet another "just to tide me over" loan, but will find it really, really difficult to resist bursting out into open laughter while doing so.

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Belshazzar
post Nov 5 2010, 03:11 AM
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In addition to what was said above, interest needs to be paid on the debt. As deficits (and in turn national debt) increase, interest goes up and will eventually reach the point where it will be more expensive than anything else on the budget. And we have to pay taxes on it.
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Hobbes
post Nov 5 2010, 05:30 AM
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QUOTE(Belshazzar @ Nov 4 2010, 10:11 PM) *
In addition to what was said above, interest needs to be paid on the debt. As deficits (and in turn national debt) increase, interest goes up and will eventually reach the point where it will be more expensive than anything else on the budget. And we have to pay taxes on it.


We had actually hit that point some time ago. It is only the artificially lowered interest rates since then that kept the interest on the debt from exploding the budget. Interest rates won't stay this low forever. Given that, and the projected $20 Trillion debt by 2020, interest on the debt is expected to $1 Trillion annually. Add that to the current $700 billion structural deficit (deficit we accrue based on past obligations with no new spending) and the deficit, with no additional or increased spending, will be $1.7 Trillion. That's about equal to current revenue. What do you think we'd call someone who's credit card payments equalled their income? Bankrupt...and then some.

QUOTE
At some point, a nation (just like a household) reaches a point of indebtedness when its lender(s) will not only refuse yet another request for yet another "just to tide me over" loan, but will find it really, really difficult to resist bursting out into open laughter while doing so.


That is the point that Greece et al were nearing earlier this year. If you look at the various metrics that were applied to them (debt to GDP, deficit to GDP, etc)...we are in the same place they are already. The only difference is that investors still had confidence in us, whereas they lost it for Greece. Note that there are already rumblings of lowering our credit rating, which is the beginning of the inevitable crash. What constantly amazes me is that this impending doom doesn't raise much of a blip on the radar screen, even though it completely dwarfs all the other problems that do. Everyone is complaining about the speedbump, while ignoring the bridge being out. We are going to get our comeuppance for this, and when it comes, since we've ignored it for sooooo many years, its going to be a beast.

FWIW...reports are out the debt commission (do we really need a commission to tell the numbskulls in Washington they're spending too much? If they can't figure that out for themselves, they should immediately resign as being too incompetent for their position) has already taken entitlements, the looming additional $70 Trillion in unfunded liabilities, off the table. To me, this calls into question their aptitude for the job assigned to them as well. We'll just get another whitewashing with steps deemed 'politically acceptable' which do nothing to actually address the problem. You heard it here first! smile.gif

This post has been edited by Hobbes: Nov 5 2010, 05:41 AM
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Dingo
post Nov 5 2010, 05:56 AM
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What do you see as the negative economic effects of persistent deficits?
Deficits would be less of a problem if we spent the borrowed money wisely. If the money were spent to become energy self-sufficient and ecologically sustainable and turned us toward a peace time locally based economy then inevitably the debt would diminish to zero. Our growing deficits are due to bad political decisions, which include bad economic and environmental ones. The deficits are only a symptom. It's the bad politics that are leading us to a debtor's crash.
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Hobbes
post Nov 5 2010, 06:39 AM
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I think that's very true, Dingo. Our structural deficit is due to politically expedient decisions made that had long term financial ramifications that were just completely ignored.

There is a very simple cure for this. Force the government to enact separate loans for each new expenditure--fund them like projects. That way the true cost of each program would have to be calculated with the legislation, or else no funding could be provided. Politicians don't do this for that very reason. Projects of the type you propose, which would essentially be investments, would be quite easy to both justify and fund using this method. 'Pork' projects would not. But when you roll them all up into some homogenous general fund, they all get lost--as does the actual money spent, which is why we have a $700 billion structural deficit.
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brinn
post Nov 5 2010, 11:19 AM
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What do you see as the negative economic effects of persistent deficits?

I hope some of you have an open mind and are at least willing to contemplate a different perspective. Let me explain why I, and many functional finance advocates, believe that the problem of the deficit is completely overblown:

Many of the concerns raised above are relics from when the US was on the gold standard. The US dollar is now a non-convertible, floating, fiat currency and because it is backed by nothing tangible, save for the ability of the currency to extinguish US tax liabilities, it is a completely different animal than any convertible currency.

The US government is the monopoly issuer of the US dollar and, because it has the ability to issue currency at will, there is functionally no solvency risk, nor can there be any solvency risk unless the US makes a political decision to default either through maintaining a hard and fixed debt ceiling or through some other act of congress. The only true restraint is inflation.

Chairman Greenspan made the following comments at the opening of the annual Economic Symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyo., on August 29, 1997.
Central banks can issue currency, a noninterest-bearing claim on the government, effectively without limit. They can discount loans and other assets of banks or other private depository institutions, thereby converting potentially illiquid private assets into riskless claims on the government in the form of deposits at the central bank.
That all of these claims on government are readily accepted reflects the fact that a government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit. To be sure, if a central bank produces too many, inflation will inexorably rise as will interest rates, and economic activity will inevitably be constrained by the misallocation of resources induced by inflation. If it produces too few, the economy's expansion also will presumably be constrained by a shortage of the necessary lubricant for transactions. Authorities must struggle continuously to find the proper balance.


Combine this fact with the fact that the US has no foreign denominated debt (all US debt is denominated in US Dollars) and I’m assuming that no one will disagree that the US can effectively “print” as much currency as is needed to service any debt it currently possesses.

With just this single simple observation we are already moving away from the common view that government finance is analogous to financing a household. The key difference is that households (and states) are users of the currency and as such are constrained by revenues. A household or state must generate income through wages, taxation, debt issuance or other means before it can spend. The sovereign issuer of a currency, like the federal government, is not revenue constrained and must actually spend before it can tax. Without the issuance of US dollars (federal government spending) there would be no US dollars to tax. Again, please understand that I’m not claiming that the US can print $1,000,000 for each and every citizen without consequence (inflation is ultimately the only meaningful consequence) but only attempting to establish some basic terms where we can agree before continuing the conversation. I’ve got to go to work but I’ll try to add more later.
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AuthorMusician
post Nov 5 2010, 01:24 PM
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What do you see as the negative economic effects of persistent deficits?

I don't. It's a number game that gets linked to production. Conservatives seem okay with deficits when Republicans are in charge and become all in a tizzie about deficits when Democrats are in charge. That's a political game linked to the number game.

Another part of the number game is investing. We just went through what a mess that can become, and we'll probably go through it again.

What's wrong with comparing this number game to a household budget is that the household cannot make the rules for the number game. It's either play the game or drop out altogether. The government can change the rules.

Several variations on rule changes have been tried. I don't think that all the variations have been tried, but I'm not smart enough to come up with something else. It's the difference between driving a car and inventing another mode of transportation. I am sure that there are other ways to get from point A to point B, but I don't know what they are.
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lederuvdapac
post Nov 5 2010, 01:30 PM
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QUOTE(brinn)
The US government is the monopoly issuer of the US dollar and, because it has the ability to issue currency at will, there is functionally no solvency risk, nor can there be any solvency risk unless the US makes a political decision to default either through maintaining a hard and fixed debt ceiling or through some other act of congress. The only true restraint is inflation.


Technically, this is correct. But inflating away the debt is essentially admitting that you are insolvent anyway. The choice for the United States is quite clear. Either we admit that we made mistakes, that the federal government made promises it cannot possibly keep and default - or - we will inflate away to devalue our debt and simultaneously destroy our currency and economy. We are definitely going for the latter option. Paying off the debt is impossible. Paying for future entitlements is impossible. Inflation is the stated and intended policy. People need to get this through your heads. I don't care if you are Republican, Democrat, or whatever. You need to understand that it is the expressed and explicit policy of the central bank and the Congress to create inflation and steal your money. Not literally of course. They can steal your money without ever having to reach into your pocket. They just steal your money's value and bring down the economy around us.

QUOTE(brinn)
With just this single simple observation we are already moving away from the common view that government finance is analogous to financing a household. The key difference is that households (and states) are users of the currency and as such are constrained by revenues. A household or state must generate income through wages, taxation, debt issuance or other means before it can spend. The sovereign issuer of a currency, like the federal government, is not revenue constrained and must actually spend before it can tax. Without the issuance of US dollars (federal government spending) there would be no US dollars to tax.


While again, technically correct, there is a nuance I would like to address. The US government isn't the sovereign issuer of currency, the Federal Reserve is. There is the appearance of an independent central bank that holds a monopoly on the currency and they can issue the currency via their discount window. So although the Federal Government spends $4 trillion, the actual money supply is much higher than that.
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brinn
post Nov 6 2010, 12:02 AM
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Leder,

For my purposes I am simplifying things by consolidating Central Bank and Treasury operations and referring to them as the Fed. The distinction between the two makes no difference to my arguments. Also I’m assuming that you agree that solvency is not an issue but that inflation is.

What I want to do first is establish that the national debt (the sum of the cumulative annual deficits) is merely the accounting offset for private sector savings and that can be done with a simple analogy that is originally attributed to Warren Mosler. I first encountered this analogy on Prof. Bill Mitchell’s Website “Billy Blog”.

Imagine the economy is a household which is comprised of you (the parent) and your kids. You the parent are analogous to “government” and the kids comprise the non-government or private sector. As the government you decree that you will offer 100 of your business cards per week to the kids if they agree to tend the garden on a weekly basis.

Naturally, the kids resist as they have no use for worthless business cards so you create demand for your “currency” (the business cards) by establishing a tax that can only be extinguished by remitting them. You declare that the kids will need to pay you 100 business cards per week to remain living in your household.

Immediately, by imposing a tax obligation in the currency of issue (the business cards) you have created a demand for the currency and created the conditions to allow you to transfer private resources (the kid’s labor) to the public sector (your garden). However, also note that you must spend the 100 cards each week before the kids can pay the tax of 100 cards. This illustrates that government spending must precede taxation and that taxation is not a revenue source for the government (i.e. taxing or taking your business cards from your kids does not allow you to spend your cards in the first place). You are the monopoly issuer of your cards and you are never financially constrained in your business cards (the currency).

This arrangement is analogous to a fiat currency like the US dollar. You can then extend this analogy and begin to track your currency transactions via a spreadsheet. This eliminates the need to “print” more business cards. Your spreadsheet represents “bank entries” which record all the outflows (spending) and inflows (taxation). If you make an error and add an extra zero to your spending one week, you wouldn’t have to “print” 900 new cards but your kids would be better off by 900 cards because it would show up as a deposit in their account.

Under the conditions above, the household budget would be balanced each week: You spend 100 cards and the kids pay you 100 cards to extinguish their tax liability. Note that the kids will be unable to accumulate any cards (that is, save) because they can only get access to the volume of cards that you make available via spending.

If you want to teach your kids to save you will either need to increase the business card wage for their labor while leaving your tax unchanged, ask them to do more labor each week and thus increase their wages while leaving your tax unchanged or keep paying them the same amount for the same labor and lower your tax. Let say you provide them with 120 cards per week as wages (government spending) but keep the tax at only 100 cards. Your budget will now be running a deficit of 20 cards per week but the kids can now save 20 cards per week because your spending (the government spending) has provided the “finance” for the savings. As the weeks go by the kids could accumulate more and more savings (numbers in the spreadsheet would increase) and you would soon see that the non-government saving over time is the exact record of the cumulative deficits being run by you (the government). Same as the US economy.

Extend the analogy further; Your kids now want to make more money (cards) and earn a return on their savings. As it stands, the only way they will be able to do that is if you decide to pay interest on their savings. This is equivalent to you offering them a government bond (a bit of paper saying that if they deposit their savings with you each week that you will pay them back at some future time plus some interest paid, of course, in business cards). Your issuance of debt establishes a non-zero rate of interest in your household and increases the kid’s wealth. Note that you were not forced to issue the bond to enable you to continue to run a deficit. The bond simply replaced non-interest bearing savings (reserves in our “banking” system) with an interest-earning asset (the bond).

Work the analogy backward and you can see how a federal surplus reduces private sector savings. Any surplus must be met by either:

a) A demand for more work to earn the shortfall – noting that the household has now reduced employment levels (in hours) and there is some underemployment creeping in. If you chose to reduce your deficit by not employing one of your kids you would have generated unemployment.

cool.gif A sale of private possessions to get some cards. In this simple case, It is likely that the kids would offer your bonds (the bits of paper) for sale to get the funds. So the surplus begins to eat away at your kids wealth.

or

c) A reduction in savings that are not being stored in bonds.

Regardless of the response, the budget surplus strains your kid’s liquidity and forces them to reduce wealth. If you kept running budget surpluses, your kids would eventually run out of assets and their labor would be underutilized.

If you are at all interested in learning more yourself, I would recommend you google Bill Mitchell (Billy Blog), or Warren Mosler (The Center of the Universe). Both are at the forefront of functional finance or Modern Monetary Theory as it is commonly known (although it’s really neither modern nor theoretical). Also check out New Economic Perspectives which is the website of the University of Missouri, Kansas City’s economics department.

If this discussion gains any traction I’ll address inflation concerns later.
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Hobbes
post Nov 6 2010, 01:18 AM
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QUOTE(brinn @ Nov 5 2010, 06:19 AM) *
What do you see as the negative economic effects of persistent deficits?

I hope some of you have an open mind and are at least willing to contemplate a different perspective. Let me explain why I, and many functional finance advocates, believe that the problem of the deficit is completely overblown:


Your analysis doesn't indicate why it is overblown. No one has said that the U.S. will default on its debt (although that is an option).

QUOTE
The US government is the monopoly issuer of the US dollar and, because it has the ability to issue currency at will, there is functionally no solvency risk, nor can there be any solvency risk unless the US makes a political decision to default either through maintaining a hard and fixed debt ceiling or through some other act of congress. The only true restraint is inflationhation


Exactly. What level of inflation are you comfortable with? What level of inflation will those foreign entities holding our debt be happy with? The concept of carrying wheelbarrows full of money to buy a loaf of bread is not that far fetched--it has happened both here and elsewhere around the world before. Does the accompanying devaluation of savings (already something Americans don't do enough of) a good thing? I agree that the government can do this. However, one shouldn't neglect the fact that there are very large negative consequences of doing so--including, as I mentioned, heightened potential of WWIII ensuing.

QUOTE
The sovereign issuer of a currency, like the federal government, is not revenue constrained


Which is EXACTLY the problem.

QUOTE
and must actually spend before it can tax.


Not true. Sufficient currency exists for the economy to function, and therefore for activities to happen which can be taxed, without any additional government spending. Further, money can be injected into the economy through the Fed (we've been doing this the last couple of years already), again without the government having to spend anything.

Here's the real problem I have with those advocating the deficit is no big deal. It just encourages more deficits. Eventually, as you state, rampant inflation will be the result. We've seen what impact that can have in the Weimar Republic in Germany after WW I. Note the woman shoveling money into the fire to keep warm...and tell me--is that image really 'overblown'?

QUOTE(AuthorMusician)
What's wrong with comparing this number game to a household budget is that the household cannot make the rules for the number game. It's either play the game or drop out altogether. The government can change the rules.


No, not really, they can't. They can shuffle the shells around alot, but reality will always catch up with them in the end. Again, we've seen this start to happen already, in Greece, Spain, etc. Near chaos resulted, only mitigated when other countries stepped up and fixed it. They could do this because Greece has a relatively small economy. We're in about the same position as Greece. Who's the big brother out there that's going to save us? That entity doesn't exist.

QUOTE
What I want to do first is establish that the national debt (the sum of the cumulative annual deficits) is merely the accounting offset for private sector savings


Disagree. Rather, it is the running sum total of governmental fiscal incompetence.

The word 'merely' doesn't even belong in a sentence with something totalling tens of trillions of dollars of an obligation. It just doesn't. You think that woman shoveling money into her furnace felt this was 'merely the accounting offset for private sector savings'? I would suspect anyone telling her that then would have been roundly slapped, and rightfully so. This, in fact, is a perfect example of why we should never (never never never never) let those in the ivory tower make decisions for those of us who aren't. Reality gets ignored in the ivory tower, where they can play with numbers and formulas, and just ignore the nasty realities that get in the way of their cozy mathematical manipulations.

This post has been edited by Hobbes: Nov 6 2010, 01:32 AM
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Dingo
post Nov 6 2010, 01:22 AM
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My first comment added for clarification.

QUOTE(Hobbes @ Nov 4 2010, 11:39 PM) *
QUOTE(Dingo)
What do you see as the negative economic effects of persistent deficits?

Deficits would be less of a problem if we spent the borrowed money wisely. If the money were spent to become energy self-sufficient and ecologically sustainable and turned us toward a peace time locally based economy then inevitably the debt would diminish to zero. Our growing deficits are due to bad political decisions, which include bad economic and environmental ones. The deficits are only a symptom. It's the bad politics that are leading us to a debtor's crash.

I think that's very true, Dingo. Our structural deficit is due to politically expedient decisions made that had long term financial ramifications that were just completely ignored.

There is a very simple cure for this. Force the government to enact separate loans for each new expenditure--fund them like projects. That way the true cost of each program would have to be calculated with the legislation, or else no funding could be provided. Politicians don't do this for that very reason. Projects of the type you propose, which would essentially be investments, would be quite easy to both justify and fund using this method. 'Pork' projects would not. But when you roll them all up into some homogenous general fund, they all get lost--as does the actual money spent, which is why we have a $700 billion structural deficit.

"Force the government to enact separate loans for each new expenditure-". How do you pay off a military project or a school? A road I could see because you could apply tolls. One problem is in determining the real public cost of the project. Depending on what cost basis you apply you could determine say gasoline generating $15 dollar a gallon or more in public costs. That would include military, environmental and health costs projected into the future. I have no problem with the principle of treating each public outlay as a loan that needs to be paid back. I just don't see how to make it practical.

This post has been edited by Dingo: Nov 6 2010, 01:29 AM
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brinn
post Nov 6 2010, 03:13 AM
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QUOTE(”Hobbes”)
Your analysis doesn't indicate why it is overblown. No one has said that the U.S. will default on its debt (although that is an option).
It is overblown because it is necessary for private sector liquidity. If the government begins to run a surplus when aggregate demand is collapsing it will exacerbate the situation and likely result in deflation.


QUOTE(”Hobbes”)
What level of inflation are you comfortable with? What level of inflation will those foreign entities holding our debt be happy with? The concept of carrying wheelbarrows full of money to buy a loaf of bread is not that far fetched--it has happened both here and elsewhere around the world before. Does the accompanying devaluation of savings (already something Americans don't do enough of) a good thing? I agree that the government can do this. However, one shouldn't neglect the fact that there are very large negative consequences of doing so--including, as I mentioned, heightened potential of WWIII ensuing.
Are you truly concerned with hyperinflation in the US? Hyperinflation is largely a result of a collapse of supply. Inflation is very well understood and can be managed via taxation, and monetary and fiscal policy. What is our rate of inflation currently? What is Japan’s rate of inflation?


QUOTE(”Hobbes”)
Not true. Sufficient currency exists for the economy to function, and therefore for activities to happen which can be taxed, without any additional government spending.
Sure, the government can run temporary surpluses but a consistent surplus will result in a collapse of demand as private sector wealth is eroded. It’s an accounting identity and can’t be debated.

QUOTE(”Hobbes”)
Further, money can be injected into the economy through the Fed (we've been doing this the last couple of years already), again without the government having to spend anything.
Can you clarify how the fed injects money into the system without spending?

QUOTE(Hobbes”)
Here's the real problem I have with those advocating the deficit is no big deal. It just encourages more deficits. Eventually, as you state, rampant inflation will be the result.
in a sense I agree but it’s much too simplistic to state that the deficit is all bad. In our current environment we need a larger deficit (either through targeted spending designed to create jobs or through drastic reductions in taxes) but as soon as private sector demand is restored and unemployment is drastically reduced, spending can be reduced and taxation levels can be raised to limit inflation.

QUOTE
We've seen what impact that can have in the Weimar Republic in Germany after WW I. Note the woman shoveling money into the fire to keep warm...and tell me--is that image really 'overblown'?
It’s not overblown, just not applicable. Weimar Germany’s hyperinflation was due primarily to three things: The requirement to pay reparations in a foreign currency, A positive feedback mechanism in the wage/price index that was negotiated by the strong labor union in Germany resulting in spiraling wages, and the occupation of the Ruhr region which was the manufacturing heart of germany which effectively shut down production. None of these conditions are present in the US. Again, what is our inflation rate?

QUOTE(”Hobbes”)
Again, we've seen this start to happen already, in Greece, Spain, etc. Near chaos resulted, only mitigated when other countries stepped up and fixed it. They could do this because Greece has a relatively small economy. We're in about the same position as Greece. Who's the big brother out there that's going to save us? That entity doesn't exist.
We are in no way shape or form analogous to Greece. Greece is part of the European currency union and is therefore not sovereign in their own currency. They are revenue constrained and need to tax or borrow to spend. All economies in the ECU share this risk. It is a flawed system. Other countries did not step in and fix Greece. The European Central Bank began buying their debt which supported them. It is analogous to the US federal government providing funding to a state.




QUOTE(”Hobbes”)
The word 'merely' doesn't even belong in a sentence with something totalling tens of trillions of dollars of an obligation. It just doesn't.
Hobbes, You do realize that the trillion dollar debt that you reference is really the sum total of all savings held by the private sector, no? You do realize that the "deficit could be repaid tomorow by moving the funds held in Bond accounts at the fed back to reserve accounts at the fed. Voila, Debt paid!

With the massive stimulus and two rounds of QE where’s the inflation you’re so concerned about? Do you think it’s a coincidence that our last budget surplus ended in 2001, and was reported as the longest surplus since 1927-1930. Do those dates ring a bell? Is it a mere coincidence that the first six US depressions followed the first six sustained budget surpluses? Is it a coincidence that in 1836, President Jackson actually paid off the federal debt and the worst depression on record followed.
It’s time to rethink your position. The situation isn’t what you think it is, despite how much the “logic” may appeal.
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Belshazzar
post Nov 6 2010, 03:18 AM
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QUOTE(Hobbes @ Nov 5 2010, 09:18 PM) *
Here's the real problem I have with those advocating the deficit is no big deal. It just encourages more deficits. Eventually, as you state, rampant inflation will be the result. We've seen what impact that can have in the Weimar Republic in Germany after WW I. Note the woman shoveling money into the fire to keep warm...and tell me--is that image really 'overblown'?


Yes, you can only devalue your currency so much before something like that happens. My grandfather grew up in the Weimar Republic and he used to say that people would joke about papering their walls with marks because it was cheaper to do that than to buy wallpaper. Of course, we haven't gotten to that level yet, but if we ever do, hopefully China will consider us "too big to fail" and we'll get a bailout. laugh.gif
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Curmudgeon
post Nov 6 2010, 05:03 AM
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What do you see as the economic effects of persistent deficits?

I have an image in my mind. Was it John F. Kennedy that pointed to Richard Nixon and said, "Would you buy a used car from this man?"

Whenever I have purchased a car, it always seemed that the salesman had to get the sales manager's approval. As I never met the sales manager, I always took it as a euphemism for, "Yes! Time for a cup of coffee!"

Lately, I hear that China and other foreign governments are picking up our debts. (In History class in High School, we were told that it was the Rockefellers and the like who financed the nation through the world wars.) Foreign corporations are funding the Republican political campaigns. Somewhere in the back room, I have an image of Karl Rove having no interest in politics, government, or power. I have a vision of him as the sales manager who is approving the deals and pocketing a commission. If he felt any ownership for this country, he might be concerned; but I think that he just sees his bank balance growing. It doesn't occur to him that if the Chinese foreclose on our mortgage, he won't have a country to live in...

Let's propose an alternative that we can sell to the wealthiest 2% of the American population. If they invest in Savings Bonds, T-Bills, Republicoins, or whatever; we'll pay them a higher interest rate than we pay foreign investors, and the interest earned will be tax free if the loans are held in America by American citizens or corporations that can prove 90% or better American ownership. They can hold onto the notes, and use them as collateral for borrowing the money they need from American banks, etc., to finance factories, payrolls, etc. The nation will still be in debt to the wealthiest Americans. That's already how we finance our cars, our homes, our educations. As a society, we are accustomed to being in debt. It is only the wealthiest that really fear that their granchildren will actually have to pay off the national debt. If they're holding the notes, they'll want to collect the interest and discourage the government from prepaying the balance.
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brinn
post Nov 6 2010, 02:49 PM
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QUOTE("Curmudgeon")
Lately, I hear that China and other foreign governments are picking up our debts. (In History class in High School, we were told that it was the Rockefellers and the like who financed the nation through the world wars.)...

...If he felt any ownership for this country, he might be concerned; but I think that he just sees his bank balance growing. It doesn't occur to him that if the Chinese foreclose on our mortgage, he won't have a country to live in.

...It is only the wealthiest that really fear that their granchildren will actually have to pay off the national debt. If they're holding the notes, they'll want to collect the interest and discourage the government from prepaying the balance.


Curmudgeon,

China does not fund the US. Sale of treasuries to China, or any other entity for that matter, are not done as a source of funding but rather as a reserve drain allowing the fed to maintain control of short tem interest rates. Without bond sales the overnight rate would be pushed to zero. Keep in mind that the US has no foreign denominated debt but does have foreign holders of our currency. Let me explain further and keep in mind that this description is not theoretical but strictly operational. It's not how the system should work or how people say it works but rather, how it does work.

To understand the accounting behind treasury sales one must first understand that all foreign holdings of US currency are held at US reserve banks. When China sells goods to the US, the dollars that they receive in exchange are held in the US at a US reserve bank. This is a crucial point; the dollars never leave the US banking system. Once the Chinese have these dollars they can buy US dollar denominated goods and services, sell the currency to a willing buyer for another currency, hold the currency in the reserve account (earning 0%) or buy a treasury note or bill which will give them a small interest return on their deposit. If they buy a treasury note the reserve bank essentially moves the money from the reserve account at the Fed (the reserve account can be thought of as a checking account as the owner of the account can remove funds whenever they want. In banking terms a checking account is known as a demand deposit account or DDA as the owner can demand payment of funds at any time) to a T-Bill which functions just like a savings account or a certificate of deposit. A certificate of deposit (CD) is a deposit with a bank that earns interest but that can’t be taken out prior to the agreed upon maturity date, just like a T-Bill.

So the analogy is that the Reserve bank takes these dollars that are held in China’s US reserve checking account and places them in a T-Bill which, for all intents and purposes, is a certificate of deposit. When a regular bank takes $1,000 from your checking account and puts it into a CD the bank has no more nor less funds than it had a moment ago. The difference is that your funds have gone from being available upon demand to being available (with interest) at a set point in the future. Your liquidity has been exchanged for the ability to earn interest. The same dynamic is occurring with the sale of bonds.

So what happens when the bonds are ready to be redeemed? In effect, at the maturity of the T-Bill, the reserve bank takes the balance from the “CD” and transfers it back to the “checking account” of the owner with a small amount of interest added. Debt paid. The fact that the balances never leave the banking system but are simply transferred from one account to the next is the key to understanding that repayment of bonds is not an onerous task that requires the US to collect the funds to make the payment but nothing more than an accounting entry.

Given that explanation, thinking of foreign held treasuries as debt is not entirely accurate as it should be clear that treasuries more closely resemble savings rather than debt. As long as our economy remains healthy and US innovation continues, there will be a demand for our currency as it is the only currency that can purchase US assets. Theoretically, it is possible to inflate our way to the point that our currency becomes undesireable but that would presume that we have no control over inflation which is clearly not true.

Additionally, if China decides to stop buying treauries what will they do with the US dollar reserves they've built up? They can buy US dollar denominated assets, provided they can find a willing seller, or they can sit on them and earn nothing. If they buy US assets, products or services it will do nothing but increase demand in the US economy which is exactly what the US economy currently needs. If they continue to buy treasuries, the act of purchasing treasuries drains liquidity from the system and acts as a necessary offset to inflationary pressures.



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Hobbes
post Nov 6 2010, 03:35 PM
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QUOTE(brinn @ Nov 5 2010, 10:13 PM) *
QUOTE(”Hobbes”)
Not true. Sufficient currency exists for the economy to function, and therefore for activities to happen which can be taxed, without any additional government spending.
Sure, the government can run temporary surpluses but a consistent surplus will result in a collapse of demand as private sector wealth is eroded. It’s an accounting identity and can’t be debated.


The private sector can generate wealth all on its own--it doesn't need the government for that. That is the myth that government operates under, though--witness the recent stimulus programs, none of which can be economically justified or achieved their indicated result.

It is an accounting identity, though--it is an accounting of exactly how fiscally inept our government is.

Let me ask a very simple question: If deficits are so good, then why, with our constant stream of deficits, don't we have an increasing governmental revenue stream which makes deficits unnecessary?

QUOTE
QUOTE(”Hobbes”)
Further, money can be injected into the economy through the Fed (we've been doing this the last couple of years already), again without the government having to spend anything.
Can you clarify how the fed injects money into the system without spending?


Through loans from banks. What does the Fed EVER spend anything on? It's not a spending entity.

QUOTE
QUOTE(Hobbes”)
Here's the real problem I have with those advocating the deficit is no big deal. It just encourages more deficits. Eventually, as you state, rampant inflation will be the result.
in a sense I agree but it’s much too simplistic to state that the deficit is all bad. In our current environment we need a larger deficit (either through targeted spending designed to create jobs or through drastic reductions in taxes) but as soon as private sector demand is restored and unemployment is drastically reduced, spending can be reduced and taxation levels can be raised to limit inflation.


I'm not stating the deficit itself is all bad--I'm stating that HUGE deficits lead to economic problems. Eventually, an enending stream of even modest deficits will cause problems too. It's unavoidable. Again, consider interest rates. They are artificially low right now, and even with those, we have a $700 billion structural deficit. Interest rates WILL return to normal, and probably even higher, and this will add about another trillion dollars to that. That will put us at close to a $2 Trillion deficit, with no new spending at all, and not considering the impact of all our future unfunded liabilities. Rampant inflation, which you have stated (and I agree) is the 'limiting factor', WILL result.

As for the last part of your statement, spending CAN be reduced...but it never IS. Further, how do you solve the problem when the spending amount you need to reduce is greater than your budget? You can't eliminate more than all government spending. Nor can you tax all money away (which is why comparisons of our debt and deficit to GDP is a singularly ridiculous and meaningless number--it assumes the government can tax at 100%, which of course can never happen.) Hence, you will have an unsolvable problem using only those two levers---again leading to rampant inflation as the only possible result.
QUOTE
QUOTE
We've seen what impact that can have in the Weimar Republic in Germany after WW I. Note the woman shoveling money into the fire to keep warm...and tell me--is that image really 'overblown'?
It’s not overblown, just not applicable. Weimar Germany’s hyperinflation was due primarily to three things: The requirement to pay reparations in a foreign currency, A positive feedback mechanism in the wage/price index that was negotiated by the strong labor union in Germany resulting in spiraling wages, and the occupation of the Ruhr region which was the manufacturing heart of germany which effectively shut down production. None of these conditions are present in the US. Again, what is our inflation rate?


I'm not concernecd with what our inflation rate is, I'm concerned with what it will be. The situation we have would be akin to telling someone on the beach a tidal wave is coming, and having him reply that the water is fine right now. Our inflation rate is low because our economy is weak, and demand is limited. Hardly the go forward position we'd want to maintain, right?

QUOTE
QUOTE(”Hobbes”)
Again, we've seen this start to happen already, in Greece, Spain, etc. Near chaos resulted, only mitigated when other countries stepped up and fixed it. They could do this because Greece has a relatively small economy. We're in about the same position as Greece. Who's the big brother out there that's going to save us? That entity doesn't exist.
We are in no way shape or form analogous to Greece. Greece is part of the European currency union and is therefore not sovereign in their own currency. They are revenue constrained and need to tax or borrow to spend. All economies in the ECU share this risk. It is a flawed system. Other countries did not step in and fix Greece. The European Central Bank began buying their debt which supported them. It is analogous to the US federal government providing funding to a state.


Absolutely we are. Look at all the metrics used to indicate how bad their governmental finances were, and we are on par on all of them.


QUOTE
QUOTE(”Hobbes”)
The word 'merely' doesn't even belong in a sentence with something totalling tens of trillions of dollars of an obligation. It just doesn't.
Hobbes, You do realize that the trillion dollar debt that you reference is really the sum total of all savings held by the private sector, no? You do realize that the "deficit could be repaid tomorow by moving the funds held in Bond accounts at the fed back to reserve accounts at the fed. Voila, Debt paid!


What funds held in Bond accounts? There are no funds there...the money from the bonds is collected to cover current expenses--there isn't any money in Bond accounts. That's why the bonds are issued, because the government doesn't have the money. If the funds were there...why do they need to keep issuing bonds?

QUOTE
With the massive stimulus and two rounds of QE where’s the inflation you’re so concerned about? Do you think it’s a coincidence that our last budget surplus ended in 2001, and was reported as the longest surplus since 1927-1930. Do those dates ring a bell? Is it a mere coincidence that the first six US depressions followed the first six sustained budget surpluses? Is it a coincidence that in 1836, President Jackson actually paid off the federal debt and the worst depression on record followed.
It’s time to rethink your position. The situation isn’t what you think it is, despite how much the “logic” may appeal.


No, I don't think it is. Flip your logic around. We are currently undergoing the largest deficits we ever have, with the government spending more than twice what it takes in. Is our economy surging ahead? Hardly. If this worked as you say it does...we do we EVER have recessions? We doesn't Japan just spend its way back into prosperity? Do you really think they're undergoing decades of stagnation on purpose?

This post has been edited by Hobbes: Nov 6 2010, 04:13 PM
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brinn
post Nov 6 2010, 06:36 PM
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QUOTE("Hobbes")
The private sector can generate wealth all on its own--it doesn't need the government for that. That is the myth that government operates under, though--witness the recent stimulus programs, none of which can be economically justified or achieved their indicated result.
Of course private sector can generate goods and services on its own. I haven't claimed otherwise. However, currency is not wealth but is rather and accounting of wealth. It is the score of wealth , not the wealth itself.

QUOTE("Hobbes")
Let me ask a very simple question: If deficits are so good, then why, with our constant stream of deficits, don't we have an increasing governmental revenue stream which makes deficits unnecessary?
Let me answer this question with a question of my own and if you feel it doesn't clarify enough I'll try to expand further. What would happen if the government, in an attempt to pay off the national debt, instituted a 100% tax on all privately owned assets?

QUOTE("Hobbes")
Through loans from banks. What does the Fed EVER spend anything on? It's not a spending entity.
So congress does not enact spending programs? Where did the stimulus come from? Scott Pelley of 60 Minutes asked Bernanke this specific question in March of 2009. The question and repsonse is transcribed below:

QUOTE
PELLEY: Is that tax money that the Fed is spending?

BERNANKE: It's not tax money. the banks have-- accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. so it's much more akin to printing money than it is to borrowing.


QUOTE("Hobbes")
I'm not stating the deficit itself is all bad--I'm stating that HUGE deficits lead to economic problems. Eventually, an enending stream of even modest deficits will cause problems too. It's unavoidable. Again, consider interest rates. They are artificially low right now, and even with those, we have a $700 billion structural deficit. Interest rates WILL return to normal, and probably even higher, and this will add about another trillion dollars to that.
Hobbes, what is the natural rate of interest? I'm assuming since you believe that they are "artificially" low right now that you have an idea of what the natural rate should be. Additionally, reality does not support your thesis. For example, the 30 year treasury as of today it sits at 3.875%. Historically the 30 year was 13.45% in 1981 and has been decreasing ever since. Unless my data is incorrect, the national debt has increased from about $900 Billion in 1980 to over $13 trillion in 2010. But how could this be? How do long term rates decline while the deficit increases? Have rates been held "artificially" low for the last 30 years? Shouldn't the market be punishing the US for our fiscal recklessness by now? It seems that the market has given the US a vote of confidence in complete contradiction to prevailing wisdom on deficits. Odd isn't it? additionally, japan has one of the highest debt to GDP ratios of any developed country on the face of the earth. debt was 170.4% of GDP according to Visual Economics website. A look at Bloomberg today shows me that the 30 year japanese bond is currently 2.00%. Is Japan an exception to the rule as well? I'm honestly not trying to be snarky or sarcastic. I'm just frustrated that the conventional economic wisdom has been dead wrong since nixon took us off the gold standard. The forecasts of high rates and increasing inflation that were predicted have been dead wrong. Rates and inflation have done precisely the opposite of what many conventional economists thought would happen. At some point, if the theories consistently produce incorrect predictions, the theories must be questioned. If every economic forecast must be revised due to "artificial" situations or exceptions to the rule, then what good are the rules in the first place?


QUOTE("Hobbes")
I'm not concernecd with what our inflation rate is, I'm concerned with what it will be. The situation we have would be akin to telling someone on the beach a tidal wave is coming, and having him reply that the water is fine right now. Our inflation rate is low because our economy is weak, and demand is limited. Hardly the go forward position we'd want to maintain, right?
Actually your concerned with what it MIGHT be if we do not control inflation once aggregate demand is restored. Once again, inflation is well understood and is an economic condition that the fed is well equipped to deal with.

QUOTE
[Regarding the similarity between Greece and the US] Absolutely we are. Look at all the metrics used to indicate how bad their governmental finances were, and we are on par on all of them.
The metrics are not comparable as Greece is part of a monetary union and is thus not a sovereign issuer of their own currency whereas the US is. Do you truly not understand that greece is effectively a user of the euro and not an issuer? Can Greece inflate their way out of their debt even if they wanted to? Could Greece allow the euro to depreciate until foreign trade begins to pick up some of their demand? Of course the answers to both questions are no because Greece isn't the only country that uses the Euro. Do you think Germany and Greece share the same desires for the strength of the Euro? Of course not. Joining the european currency has forced the fiscal policies of the member nations into a "beggar thy neighbor" approach.

QUOTE("Hobbes")
That's why the bonds are issued, because the government doesn't have the money. If the funds were there...why do they need to keep issuing bonds?
Incorrect. Bond proceeds fund nothing but rather serve as a reserve drain and allow the fed to maintain control over short term rates. Let me explain.

As you know, banks have to maintain a reserve ratio that is set by the Fed. The reserve ratio limits the amount of deposits that that the bank can lend. For example, if the reserve ratio is set at 10% the banks must maintain 10% of all (not actually all deposits but I’m simplifying for understandability) their deposits on hand. So, for example, a bank has $100 dollars in deposits. If the reserve ratio is 10% the bank must maintain 10% of $100 or $10 in reserves and can lend out $90.

Because deposit and loan levels are changing from day-to-day and minute-to-minute, the calculation of the amount that a bank needs to legally hold for a reserve is a moving target. In effect, the government solved this problem by allowing banks to calculate their reserve requirement based upon a date that had already passed. For example, the bank would calculate the amount of deposits it had on Monday’s date and that would be the reserve requirement for Wednesday. This effectively creates a two day lag as the bank knows two days in advance what the legal reserve requirement should be.

In reality, banks don’t pay much attention to the legal reserve requirement when making loans as banks know they can borrow the money to increase their reserve position should they lend out too much or should deposit levels drop precipitously. As long as the interest rate the bank charges on loans is higher than the rate they have to pay when borrowing money, it makes sense to make every loan that they can. In effect, bank lending decisions are affected by the price of reserves, not by reserve positions. If the spread between the rate of return a bank can get from making a loan and the interbank rate is wide enough, even a bank deficient in reserves will make the loan and cover the cash needed by purchasing (borrowing) money in the funds market. This fact is clearly demonstrated by many large banks when they consistently purchase (borrow) more money than their entire level of required reserves.

So where does the money that banks borrow come from? The first place they can get the money from is other banks that have excess deposits but not enough loans. Going back to our first example, if a bank has $100 in deposits it can legally lend $90 of the money assuming a 10% reserve requirement. If it lends anything less than $90 it will have excess reserves. Banks don’t like to have excess reserves as the excess money does not earn anything for the bank. So instead of letting the excess reserve do nothing, banks will lend these funds to other banks who need cash to meet their legal reserve requirement. The rate that banks charge each other on these loans is strangely called the Fed Funds Rate but it's less confusing to think of this as the interbank rate. When you think logically about this rate you will soon realize that if the banking system as a whole does not have enough reserves to meet legal requirements than, regardless of how the reserves are divvied up via interbank loans, at least one bank will fail to meet the reserve requirement. Given this reality, the interbank loan rate would be bid up to infinity as the banks who don’t hold enough reserves bid against each other to attract money from the banks who have excess reserves knowing that at least one bank will be left short. The opposite is also true. If there are excess reserves in the banking system as a whole the rate offered will be pushed to zero as the banks with excess reserves will continue to offer their excess reserves at lower and lower rates in an effort to make even the smallest return on their excess reserves (which would otherwise earn 0%).

Now, with a rudimentary understanding of how bank reserves work we can begin to talk about Bonds. If the government spends money by buying hammers from the private sector, than the account of the company who made those hammers will increase by the price of the hammers. This also means that the bank that holds that company’s account now has more reserves as its deposit balances have increased. If, through a combination of high government spending, high savings rates (increases deposits and thus reserves) and/or low loan demand, the banking system ends up with reserves in excess of required reserves we now know that the interbank rate will be driven to zero. In order for the Fed to be able to spend AND maintain control over the short term interest rate the fed will need to drain the excess reserves to maintain the funds rate above zero. They do this by draining the liquidity (excess reserves) from the system via sales of T-bills. The sale of t-bills gives the bank a place to park excess reserves and sets a minimum rate for interbank loans. If a bank holds excess reserves the lowest rate that it will be willing to accept if it lends the excess to another bank is the rate that the government will pay on a T-Bill as the bank knows that if it doesn’t lend the funds to another bank in the interbank market it can just place those funds with the government and earn the T-Bill rate.

Voila, the Fed now has the ability to spend any amount without having to worry about the banks having excess reserves and thus driving the interbank rate to zero. The government can now spend any amount while still maintaining a positive overnight lending rate (known as the target rate). So, if the government wants to lower liquidity (reserves) it can either increase taxes (thus lowering bank reserves) or it can sell T-bills. If it wants to add liquidity to the system it can spend (run a deficit) or buy T-bills from the private sector (thus giving the private sector money in exchange for their existing T-bill savings). The mechanism works both ways.

I know this is a long post and I hope you stuck with me through this as I've attempted to make it as simple and understable as possible. To summarize, if the central bank (the fed in the US) has a positive target for the overnight lending rate, it formerly needed to provide an interest-bearing alternative to, what were then, non-interest-bearing bank reserve accounts. This was typically done by offering securities for sale in the open market to drain the excess reserves. Central Bank officials and traders recognize this as "offsetting operating factors" since the sales are intended to offset the impact of fiscal policy that would cause the Fed funds rate to move away from the Fed’s target rate. In nations like the US, Japan, and others, where interest was not paid directly on central bank reserves, the penalty for deficit spending and not issuing securities was not (apart from various self-imposed constraints) bounced government checks but a zero percent interbank rate, as is the case in Japan today. The overnight lending rate is the most important benchmark interest rate for many other important rates, including banks’ prime rates, mortgage rates, and consumer loan rates, and therefore the interbank rate (known as the Fed Funds rate) serves as the base rate of interest in the economy.

It is also interesting to note that the fed began paying interest on reserves in 2008 thus bonds don't even effectively serve the purpose of establishing an overnight rate anymore as the interest rate on reserves accomplishes the same thing.

I know this all sounds heretical but it is completely and 100% operationally consistent with how our monetary system functions. Are you open minded enough to at least consider that what you think you know may be inaccurate? If you are, check out the following PDF from Warren Mosler. The Seven Deadly Innocent Frauds of Economic Policy. It's a long read but a very important one.

P.S.
Thanks for the interesting discussion Hobbes. I appreciate the lively interaction.

This post has been edited by brinn: Nov 6 2010, 06:44 PM
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Maybe Maybe Not
post Nov 6 2010, 10:04 PM
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QUOTE(brinn @ Nov 6 2010, 09:49 AM) *
When China sells goods to the US, the dollars that they receive in exchange are held in the US at a US reserve bank. This is a crucial point; the dollars never leave the US banking system. Once the Chinese have these dollars they can buy US dollar denominated goods and services, sell the currency to a willing buyer for another currency, hold the currency in the reserve account (earning 0%) or buy a treasury note or bill which will give them a small interest return on their deposit.
Even though the "dollars" remain in the U.S., held at a U.S. reserve bank, do the Chinese not expect that a certain value adheres to those dollars? I mean, we can't just decide the dollars they "have" are worth less than they were when the Chinese obtained them and expect no protest? Can we?
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