Interesting commentary from supposed interest rate guru Jim Grant here. He was on Bloomberg yesterday discussing the credit worthiness and his credit downgrade of the U.S. He makes the classic mistake of comparing the U.S. government to a household, but conveniently bases his “downgrade” of U.S. credit on a faulty model:
“(the downgrade was made) as if (the U.S. government) were an issuer (of debt) that didn’t have a printing press.”
First of all, let’s repeat this once again. The United States cannot “run out of money”. We do not need to sell debt to China and Japan in order to finance our spending. The US government, through its unique relationship with the Fed and the banking system can never “run out of money”. Therefore, the whole insolvency debate is a non-starter. The true constraint is always inflation. Whether we are a good steward of the currency is entirely based on how well the U.S. government controls the rate of inflation (of which there is none right now which provides a significant buffer in terms of “printing money” – please reference the wild spending in Japan, low inflation and ability to run very high deficits for 20 years in case you’re looking for historical precedence). High inflation is controlled primarily via taxation (debiting private sector bank accounts). Inflation is low right now and should remain relatively low based on lending trends, capacity utilization, output gap, high unemployment, etc. Therefore, we should all hope that taxes will remain low (the UK’s recent tax hike is a clear sign that they don’t understand how their own non-convertible floating currency system actually works).
Getting back to Grant’s comments, however….The fact that the U.S. has a printing press is exactly why it is entirely different from a household or a state government. Households and states must compete for dollars that the U.S. government “prints”. They are revenue constrained. The U.S. government, however, is never revenue constrained in the same sense that a household it. They can simply spend at will and will never be at risk of defaulting (barring economic collapse or unforeseen catastrophe that inhibits the government’s ability to tax and enforce taxation on the public). Ignoring the fact that the U.S. has a printing press is a fatal flaw in understanding how the monetary system works in the United States. This is akin to writing up a credit rating for an alchemist while ignoring the fact that his primary line of work involves the creation of gold! Can an alchemist become late on his house payments? Sure, but only if he decides he doesn’t want to make any more gold. The alchemist, by definition, never cannot meet his obligations. Can he dilute the value of gold? Sure, but that is an entirely different story and in a world of low inflation (see here), dilution is not a primary concern.
Based on the idea that we just print paper that is backed by nothing, Grant goes on to describe our monetary system as:
“A great suspension of disbelief”
I am not certain if Grant is a believer in the gold standard, but his comments imply such. As I’ve thoroughly covered, the gold standard doesn’t exist today because there are inherent flaws in a commodity linked currency system. The primary weakness is that it inhibits spending and wrongly weakens trade deficit nations. Of course, the natural argument against such comments is that, the inhibition of spending is exactly the point. But the Austrians and deficit hawks never seem to complain about deficit spending when it involves printing up dollars to go to war or defend the nation. In other words, not all spending is bad spending. Sending checks to bankers who should have failed? Bad spending. Spending on healthcare with record high unemployment. Bad spending. You catch my drift. The world is not as black and white as most politicians and economists would like to believe.
In trying to define what a dollar is, Mr. Grant goes on to say that a dollar is:
“An assertion that the treasury will be good on something”
But again, this implies that our alchemist can somehow be “bad” on something. In order for the United States, which is never revenue constrained, to go “bad” on our payments we would have to let inflation get wildly out of control, stop producing goods which are in high demand, stop producing work which is in high demand, stop being a great economic engine or somehow lose the ability to tax and enforce taxation on the citizens of the nation. While the economy remains weak and China is nipping at our heels as the world’s dominant economic engine there is no reason to assume that the United States cannot meet its obligations (of which there are technically none). It is not the public sector whose credit rating is in peril, but the private sector’s credit rating which is in peril. Mr. Grant can downgrade the U.S. credit rating until the cows come home (and I will short the subsequent spike in U.S. sovereign CDS), but that won’t change the fact that we are our own banker, the most powerful alchemist on the planet and never ever revenue constrained.
Full video attached:
Source: Bloomberg TV
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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