Borrowing and spending beyond ordinary limits largely explains how Americans got into such economic trouble. For decades, businesses and consumers feasted relentlessly, as if gravity, arithmetic and the tyranny of debt had been defanged by financial engineering.
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Printing Money – and its Price
By Peter S. Goodman
28 December 2008
Borrowing and spending beyond ordinary limits largely explains how Americans got into such economic trouble. For decades, businesses and consumers feasted relentlessly, as if gravity, arithmetic and the tyranny of debt had been defanged by financial engineering.
Armed with credit cards and belief in a bountiful future, Americans brought home ceaseless volumes of iPods and cashmere sweaters, and never mind their declining incomes and winnowing savings. Banks lent staggering sums of money to homeowners with dubious credit, convinced that real estate prices could only go up. Government spent as it saw fit, secure that foreigners could always be counted on to finance American debt.
So it may seem perverse that in this new era of reckoning — with consumers finally tapped out, government coffers lean and banks paralyzed by fear — many economists have concluded that the appropriate medicine is a fresh dose of the very course that delivered the disarray: Spend without limit. Print money today, fret about the consequences tomorrow. Otherwise, invite a loss of jobs and business failures that could cripple the nation for years.
Such thinking carries the moment as President-elect Barack Obama puts together plans to spend more than $700 billion on projects like building roads and classrooms to put people back to work. It is the philosophy behind the Federal Reserve’s decision to drop interest rates near zero — meaning that banks can essentially borrow money for free — while lending directly to financial institutions. This is the mentality that has propelled the Treasury to promise up to $950 billion to aid Wall Street, Detroit and perhaps other recipients.
But where does all this money come from? And how can a country that got itself in peril by borrowing and spending without limit now borrow and spend its way back to safety?
In the case of the Fed, the money comes from its authority to print dollars from thin air. Since late August, the Fed 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 trillions wiped out by falling house prices and vengeful stock markets. The Fed has taken troublesome assets off the hands of banks and simply credited them with having reserves they previously lacked.
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 national savings in the safety of American government bonds.
Americans have gotten accustomed to treating this well as bottomless, even as anxiety grows that it could one day run dry with potentially devastating consequences.
The value of outstanding American Treasury bills now reaches $10.6 trillion, a number sure to increase as dollars are spent building bridges, saving auto jobs and preventing the collapse of government-backed mortgage giants. Worry centers on the possibility that foreigners could come to doubt 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.
“We got into this mess to a considerable extent by overborrowing,” said Martin Baily, a chairman of the Council of Economic Advisers under President Bill Clinton and now a fellow at the Brookings Institution. “Now, we’re saying, ‘Well, O.K., let’s just borrow a bunch more, and that will help us get out of this mess.’ It’s like a drunk who says, ‘Give me a bottle of Scotch, and then I’ll be O.K. and I won’t have to drink anymore.’ Eventually, we have to get off this binge of borrowing.”
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, a Connecticut-based trading house. “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.”
But most economists cast such thinking as recklessly extreme, akin to putting an obese person on a painful diet in the name of long-term health just as they are fighting off a potentially lethal infection. In the dominant view, now is no time for austerity — not with paychecks disappearing from the economy and gyrating markets wiping out retirement savings. Not with the financial system in virtual lockdown, and much of the world in a similar state of retrenchment, shrinking demand for American goods and services.
Since the Great Depression, the conventional prescription for such times is to have the government step in and create demand by cycling its dollars through the economy, generating jobs and business opportunities. That such dollars must be borrowed is hardly ideal, adding to the long-term strains on the nation. But the immediate risks of not spending them could be grave.
“This is a dangerous situation,” says Baily, essentially arguing that the drunk must be kept in Scotch a while longer, lest he burn down the neighborhood in the midst of a crisis. “The risks of things actually getting worse and us going into a really severe recession are high. We need to get more money out there now.”
Had the government worried more about limiting spending than about the potential collapse of the mortgage giants, Fannie Mae and Freddie Mac, it might have triggered precisely the dark scenario that consumes those who worry most about growing American debt, argues Brad Setser, an economist at the Council on Foreign Relations.
China purchased a lot of Fannie and Freddie bonds with the understanding that they were backed by the American government. No bailout “would have been portrayed in China as defaulting on the Chinese people,” Setser said. That would have increased the likelihood that China would start parking its savings somewhere other than the United States.
The most frequently voiced worry about the bailouts is that the Fed, by sending so much money sloshing through the system, risks generating a bad case of rising prices later on. That puts the onus on the Fed to reverse course and crimp economic activity by lifting interest rates and selling assets back to banks once growth resumes.
But finding the appropriate point to act tends to be more art than science. The Fed might move too early and send the economy back into a tailspin. It might wait too long and let too much money generate inflation.
“It’s a tricky business,” says Allan Meltzer, an economist at Carnegie Mellon University, and a former economic adviser to President Ronald Reagan. “There’s no math model that tells us when to do it or how.”
But that, as most economists see it, is a worry for another day. Some policy makers are focused on staving off the opposite problem — deflation, or falling prices, as demand weakens to the point that goods pile up without buyers, sending prices down and reducing the incentive for businesses to invest. That could shrink demand further and perhaps even deliver the sort of downward spiral that pinned Japan in the weeds of stagnant growth during the 1990s.
“Those who claim that sharp increases in federal borrowing and the national debt would be ill advised at the present time, when the economy is weakening while deflation threatens, have failed to study Japan’s history,” declared the economist John H. Makin in a report published by the conservative American Enterprise Institute — ordinarily, a staunch advocate for lean government.
So back to the well Americans go, putting aside worries about debt, unleashing another wave of synthesized money in an effort to prevent deeper misery.
“Right now,” Setser says, “the risk is not doing enough.”
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