Ever wonder how the Government is able to fund all the bailout and rescue efforts, including President Obama's proposed $800 billion stimulus package? Especially given the fact that the US is the biggest debtor nation with over 10 trillion dollars in national debt! The answer is simple, we just print more money or sell more treasuries.

Because of the US’ safe haven status and the dollar's global benchmark status (since the gold standard was abolished), the world keeps on investing in America and thereby buying more dollars. A recent NY times article delved into this issue and it was eye opening to see the magnitude of the US money supply growth and the potential consequences to the nation in the years ahead.

The Federal Reserve, who oversees the nations money supply has the authority to print dollars at will. Since August 2008, the Federal Reserve has expanded its balance sheet from about $900 billion to more than $2.2 trillion, creating $1.3 trillion that did not exist to replace some of the billions wiped out in the financial crisis. In the case of the Treasury, the money comes from the same wellspring that has been financing American debt for decades: Investors in the United States and around the world — not least, the central banks of China, Japan and Saudi Arabia, which have parked most of their national savings in the safety of American government bonds. The value of outstanding American Treasury bills now reaches $10.6 trillion, a number sure to increase as dollars are spent under Obama’s economic rescue plan, saving auto jobs and preventing the collapse of government-backed mortgage giants.

Is there an end to sight and what are the long term consequences?

As the financial crisis deepens, the government’s only option seems to be to spend our way out of the current mess in an attempt to boost consumer demand and sustain business investment to create jobs. The mantra seems to be “Print money today, fret about the consequences tomorrow. Otherwise, invite a loss of jobs and business failures that could cripple the nation for years”. The incoming Obama administration already announced a massive stimulus package, so it is unlikely in the next few years that government spending (and hence printing more money/selling more treasuries) will stop.

But what it foreign investors start doubting the American wherewithal to pay back such an extraordinary sum, prompting them to stop — or at least slow — their deposits of savings into the United States? That could send the dollar plummeting, making imported goods more expensive for American consumers and businesses. It would force the Treasury to pay higher returns to find takers for its debt, increasing interest rates for home- and auto-buyers, for businesses and credit-card holders. It could potentially send the American economy into a depression for years to come.

Some argue that the moment for sobriety is long overdue, and postponing it further only increases the ultimate costs. “Our government doesn’t have enough spare cash to bail out a lemonade stand,” declared Peter Schiff president of Euro Pacific Capital. “Our standard of living must decline to reflect years of reckless consumption and the disintegration of our industrial base. Only by swallowing this tough medicine now will our sick economy ever recover.”

In Conclusion:

I think the issue of printing more money or taking on more debt needs to be looked at from a short and long term term perspective. From a short term perspective there is little else the government can do. Monetary policy is almost useless as interest rates approach zero percent. So Fiscal policy, driven by government spending, is the only real option left to quicken the recovery. Doing nothing would be political suicide and could also lead to a severe depression, as opposed to a severe recession.

Long term though the consequences are more grave as discussed above. Eventually the American and global economy will recover and all the old issues like high oil, inflation and investing bubbles will return. However, I do think the US dollar will be pummelled due to the massive amount of national debt. As a nation, America will be much poorer and foreign investing will become a must for all of us. Future administrations will have to focus on cutting government spending to reign in the deficit, which could cause massive job losses in the public sector. Also one thing this crisis will have shown is that the US financial system is as brittle as anywhere else in the world and foreign governments and investors will be less likely to invest or support US debt as they have been in the past. America will always be the land of the free, but it may no longer be the land of the rich.

What do you think? Will America emerge stronger and wealthier in the long term, or is the nation in for a long term decline?

Picture : Darren Hester