Here’s a common question I get via email:
“Can you explain why you don’t think the USA is going to have a Greek style debt crisis?”
Good question! This is one of those things that really confuse people because they understand how their own lives and businesses work as revenue constrained entities. But the currency issuer to household or business analogy doesn’t hold true. The reasoning is actually quite simple.
The USA has an institutional arrangement in which it is a contingent currency issuer. That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it has the extraordinary power to tax and issue risk free bonds that the public will always desire to hold so long as inflation is not extraordinarily high. Additionally, in a worst case scenario, the US Treasury can always rely on the Federal Reserve to supply the funds necessary to fund its spending. Imagine having your own bank that would always lend to you. This makes the government quite different from a household.
The key here is that there’s no solvency constraint as in, “running out of money”. Greece doesn’t have this arrangement. Since the ECB is essentially a foreign central bank there is a real solvency constraint and once Greece’s emergency funding line was cut off from the ECB it was forced to default on its IMF loan. So banks and private investors have become hesitant to buy Greek bonds because of this flawed institutional arrangement and the lack of an implicit guarantee. This is not comparable to the USA where the government has a domestic Central Bank which it harnesses.
This doesn’t mean the US government couldn’t one day run out of willing creditors due to economic weakness. In theory, the US government could find itself in a situation where financial markets do not want to hold US government bonds or US dollars. The key point here is that the US government can always “fund” its spending by selling bonds to the Central Bank and essentially printing its own currency. So the government isn’t going to default on itself, but could cause a foreign currency or inflation crisis.
Lastly, it’s crucial to understand that reserve currency issuers operate with a certain degree of flexibility that other countries do not. This is because their currencies are in very high demand since they produce valuable quantities of goods and services. This is primarily due to the strength of the country’s private sector. So if a currency crisis were to materialize in the form of inflation or foreign currency it would be due to a collapse in private output leading to reduced demand in the currency. The government is still “solvent” in that it can fund its spending via the central bank, but this form of crisis is quite different from a traditional solvency and tends to have very different causes from the way a household or business becomes insolvent.
I would highly recommend reading the links at this page for more info:
Understanding the Modern Monetary System
Households and Governments go Bankrupt in Very Different Ways
Can a Sovereign Currency Issuer Default?
NB – It’s also worth mentioning that these conversations about the USA being “bankrupt” rarely focus on the entire balance sheet of the USA. For instance, we consistently hear fears about the USA’s “national debt” levels, but we never hear about the US government’s asset levels. As of Q1 2018 the Federal Government had $18.5T in liabilities according to the Fed’s Z.1 report. Total assets are listed at $5.6T, but this does not include the estimated $150T in recoverable fossil fuel assets or the $2T+ in federally owned lands. Given these vast “off balance sheet” assets it is safe to assume that the US government has a massively positive net wealth and is perhaps the most valuable entity on the planet.
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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