Another, more helpful way of looking at what is happening is to see it as a change in perception of where risk lies. Of course, there is risk in equities – how could there not be with the prospect of the once-mighty General Motors filing for bankruptcy? But there is also risk in bonds, including dollar bonds issued by AAA governments. So, as you can see in the graphs, the dollar/sterling rate has come sharply back, reflecting a change in the relative perception of risk between the two countries. More significant still has been the rise in the interest rate on 10-year bonds issued by the US, the UK and eurozone governments. As you can see, the interest rate on 10-year US bonds spun down from about 4 per cent in the middle of last year, to close to 2 per cent at the turn of the year. Now it is heading back to 4 per cent again. Those are astounding swings. If you have bought at the right moment last summer, and then sold at the right moment, you could just about have doubled your money. December buyers would now be facing a large loss.

Now look ahead. What will happen over the next decade, particularly in the US? Tax revenues have collapsed, while spending has soared, as the third graph shows. The US federal government is raising only about 55 cents in taxation for every dollar it spends. The rest has to be borrowed, either from foreign countries such as China and Japan, or by artificially creating the stuff by borrowing from the US Federal Reserve system. In the latter case the debt is being "monetised", the practice that normally happens only in wartime or in Latin America and which threatens massive inflation (the US mechanism for monetising debt is slightly different from our own "quantitative easing", but the effect is pretty much the same).

This cannot go on, as President Barack Obama acknowledges. "We are," as he puts it, "out of money." So what will happen?

It is very hard to know because there are no obvious precedents.

Read it carefully and read it all.

Filed under: * Economics, Politics • Economy • Credit Markets • The Credit Freeze Crisis of Fall 2008/The Recession of 2007-- • The U.S. Government • Budget • Federal Reserve • The National Deficit • The United States Currency (Dollar etc) • Politics in General • Office of the President • President Barack Obama

1. John Wilkins wrote: Why is “the crowding out theory” (is that say’s law?) true?  And isn’t the issue not the fixed amount of money that is spent, but how fast the money changes hands. The point is that we want institutions and people to spend, and to keep the money moving.  Inflation will go up, but if the feds allow for targeted inflation - as the Japanese finally did (kicking and screaming) - this will just seem like apocalyptic thinking. May 30, 11:43 am | [comment link]

2. Jeffersonian wrote: It is very hard to know because there are no obvious precedents. Of course there are, we just don’t want to admit what they are: Weimar, Argentina, Brazil, Zimbabwe and now Obama’s pal Hugo Chavez’s Venezuela.  Only the repercussions of an America monetizing its debt in this way will be catastrophic for the world economy until a new reserve currency can be established as we sink into the role of a third-rate socialist backwater. Change!! May 30, 4:52 pm | [comment link]

3. John Wilkins wrote: Jeffersonian, it seems that deflation is what we have to worry about now.  There is really little comparison between America and the countries you mention for a whole host of reasons, not least that lots of currencies are pegged to the dollar - which has plenty of people trading against it as well.  Capitalism has proven to be a bit more resilient recently in part because of the smart guys hedging their bets….  Inflation may happen - but we’re not quite there yet.  And if it does, will it be because of scarcity?  As long as people aren’t spending, prices will stay down. May 30, 5:35 pm | [comment link]

4. Jeffersonian wrote: Nations pegging their currencies to the dollar is one of the problems with us inflating our way out of debt, not a mitigating factor.  When countries realize their dollar holding are being diluted by American printing presses, they’ll dump those dollars in a New York minute.  Do you understand the consequences of that? May 30, 5:45 pm | [comment link]

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