Thursday, February 2, 2006

US Debt

As a relative size comparison note, the Federal Reserve has issued $755B of paper money called Federal Reserve notes. If this currency were backed by gold at 100%, the gold price would be $2,892. From the above we see that the US is in no position to return to a gold standard anytime soon, despite protestations by many of us that we need a more reliable store of value than Fed paper.

We need to understand how this new system has worked so well for the US. The counter parties to our trade deficit have managed the system to allow this extreme condition to continue. At the risk of oversimplification, what they are doing is providing a massive Vendor Finance program for their exports. They literally loan us the money to buy their goods. They have been doing this for decades, but have expanded greatly as we have expanded our high living by purchasing so much with our paper currency.

This is patently “unsustainable” because at some point foreigners may decide they have enough of our dollars, forcing the whole system to fall apart. The dollar would devalue, and then we wouldn’t be able to buy as many things as we want from foreigners, like energy to drive our cars. But this feared calamity has not occurred. The US dollar has dropped some but stabilized, and US interest rates are not soaring. The system may appear stretched, but nothing has broken, so we have been lulled into believing that it may not really be a problem.

I found this article explaining the US debt situation and recent trends tonight when I got curious about how this all works exactly. Interesting article.

Or see here for another.