Tuesday, July 22, 2008

Will the government go bankrupt?

Does the black cloud of a depression hang over the nation?

Recession blues got you down? Well, there is some good news; the United States government can't (and won't) go bankrupt. It says so right here:

The NYT has a good discussion of how the United States government has been out front in criticizing other governments for not allowing financial institutions to go bankrupt, but is now rushing to rescue Fannie Mae and Freddie Mac from failure.

One item the piece gets wrong is its discussion of the risk of bankruptcy by the U.S. government itself. This is essentially zero, since the U.S. debt is denominated in dollars. If the United States ever had difficulty paying off bonds held by foreign central banks, it could print as many dollars as necessary to make the payments.

The mass printing of dollars would of course be inflationary and would mean that foreign central banks would get paid off in dollars that are worth much less than the ones that they lent, but they have already been happy to take large losses on the money lent to the United States. For example, the dollar has fallen by almost 50 percent against the euro since 2002, yet foreign central banks are still willing to lend money to the U.S. government at interest rates that are well below the inflation rate in the United States.

The foreign central banks presumably are willing to absorb such large losses because they want to prop up the value of the dollar in order to maintain an export market for their goods. As long as foreign countries cannot figure out how to create domestic demand for their output (it actually is not very hard for those who have read Keynes), they may find it worthwhile to lose large amounts of money on their loans to the United States in order to maintain their export markets in the United States.
- Dean Baker at American Prospect

Of course, this doesn't mean that you won't go bankrupt.

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