RUNNING OUT OF MONEY / THE ECONOMIST ( VERY HIGHLY RECOMMENDED READING )

The debt ceiling crisis

Running out of money

Jul 29th 2011, 8:45

by Buttonwood

PERHAPS the oddest thing about the debt ceiling debate to an observer from the east side of the Atlantic is the process itself. In Britain (and in the rest of Europe, as far as I am aware), the government proposes a Budget, the opposition votes against it and that is it. If the government is defeated on a key issue of financing (which the debt ceiling surely represents), then the administration resigns, an election is held and a new government comes to power. Finance is so essential to the nature of government that the idea of separating the budgeting power from the executive branch seems no way to run a country. Yesterday's shenanigans, (http://www.bloomberg.com/news/2011-07-29/asia-stocks-decline-on-technology-forecasts-dollar-heads-for-weekly-slump.html) where the House spent all day trying and failing to pass a bill that faced automatic rejection in the Senate, resemble a Dickensian satire featuring the Circumlocution Office, a body designed to ensure that nothing gets done.


Anyway, it seems that US may soon have a problem that featured in a column (http://www.economist.com/node/18866863) a few weeks ago, running out of money. In the modern world, debt is money and money is debt; the ability to issue debt is essential to the state.


In the past, countries could run out of money in various ways. First, in a system backed by gold (or in the case of Argentina, a currency board), governments are constrained in their ability to create money. They need reserves, either physical (in the case of bullion) or foreign exchange. That requires the country to keep its trade in balance over an extended period. To maintain that trade balance, the government may have to constrain the choices of its citizens, as Britain did with post-war rationing.


Second, as we are now seeing in the euro-zone, countries can adopt an outside currency, and give up the money creation power. They still have the ability to borrow money, of course, but if they are perceived to abuse that right, financing becomes too expensive. Such is the case with Greece which has run out of money and depends on subsidised loans from its neighbours.


Third, a government could so abuse its money-creating power that hyperinflation sets in and the currency no longer becomes acceptable for commerce. Zimbabwe is the most recent example.


The US seems to be creating a fourth route, in the form of political resistance to the money creation process. Concerns about the long-term direction of US government finances are quite understandable; entitlements and interest are set to absorb the whole budget (http://www.economist.com/blogs/dailychart/2011/03/americas_budget) by 2025. But the debt ceiling needs to be raised to pay for policies that Congress has already voted for and approved. The answer, surely, is to campaign on the issue of restricting entitlements and win control of all branches of government on that platform in 2012.


From a historian's point of view, what is fascinating is that these problems are re-emerging after 40 years of a shift to fiat money, a change that seemed to remove all constraints on money creation. I have argued before (http://www.economist.com/blogs/buttonwood/2010/06/debt_markets_and_economy) that this shift drove most of the developments of the last 40 years from the rise of the finance sector to asset bubbles, and that the 2007/2008 crisis was a watershed moment (like the 1930s and 1970s) from which a new system will emerge. I assumed it would take a decade or so for the ramifications to work through, but the US Congress seems determined to accelerate the process.