Thursday, September 17, 2009

National debt

Does it seem weird that the federal reserve owns 40% of the national debt? I'm trying to wrap my mind around the implications of that. Our government has borrowed ten trillion dollars (10,000,000,000,000) in the last few decades, and 40% percent of that (4,000,000,000,000) has been lent to the government by the government.

What I'm struggling to understand is when the money that must be created by the federal reserve in order to buy the debt gets spent. Is it when the debt is issued or paid off?
Lets walk through this.
1. Congress spends a bunch of money and issues debt in order to finance the payments.
2. The federal reserve buys 40% of it, which means that congress promises to pay the federal
reserve back later.
3. In order to give congress the money, the federal reserve has to make it. Since its the only entity that can legally do this, it doesn't have to produce value, just money.
So the new money (and the inflation) must be pushed into the economy at the time of the debt's issuance.
4. When the debt comes due, if congress has the money to spare it pays the federal reserve.
5. The federal reserve can then refrain from creating new dollars by re-issuing the dollars that congress paid it.

The problem with step four and five is that as long as congress continues to run deficits, it will not have the dollars to pay the federal reserve, and the federal reserve will not be able to remove the dollars it created from the market, so the inflation it causes will be permanent. In order to cover the old debt (40% of which are held by the federal reserve), congress will have to issue new debt (some 40% of which will be purchased by the federal reserve).

Its Kafkaesque. I'd say its Hoffstedterian, but its less a "strange" loop and more of a "clearly unstable feedback loop" (aka: stupid loop). The fact that the total national debt follows an exponential curve with this setup (with the interesting and notable exception of the Clinton years) should be the furthest thing from surprising, and the closest thing to absolutely horrifying. Remember that "government debt" means "money that every citizen has to pay later."

I imagine that Ray Kurzweil might jump in and suggest that the explosion in our future liabilities isn't such a big deal, because the amount of value we create will outpace our liabilities because technological progress is proceeding at a double exponential rate. I see the merit in that argument, but I worry that the damage done by inflation might derail the technological growth. The collapse of the economic system would be one of those catastrophes that could very well prevent the singularity from happening.

Though, I suppose, if the US collapses, another nation will become the central driver.