A WEEK IN ECONOMICS (01/10/13 – 07/10/13) US GOVERNMENT SHUTDOWN, SLIMDOWN, OR DUMBDOWN?

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Week-in-Economics

It is difficult to explain the US government shutdown. For outsiders, the closing of government agencies, the furlough of 800,000 workers across the country and the bickering on Capitol Hill shows a country in deep crisis. Democratically elected leaders are supposed to run the country, not paralyse it, and yet this is precisely what is happening.

For an attempted explanation of the situation, click here. But the problem runs deeper than just Republicans expressing annoyance at the idea of the debt ceiling – the amount the US can borrow to pay its obligations like social security – being raised. It in fact begins at the time of the US independence in the 1770s when the Founding Fathers were determining the shape of governance of their new and free country.

The French philosopher Baron De Montesquieu proposed the idea of a separation of powers in which government would be divided into three branches : the Legislature (the branch which determines laws), the Executive (the branch which administers the country) and the Judiciary (the branch which determines if laws are followed). This creates checks and balances on the power of ruler. The newly formed United States adopted this idea, with the legislature being divided into two: the Senate and the House of Representatives. Currently, Democrats dominate the Senate; the Republicans dominate the House. Hence, the Republicans have a say in passing legislation.

The structure encourages debate and opinions to be articulated. It is reasoned that the congressman, by being part of Congress, is reflecting the opinions of the constituents of his State. Unfortunately, politicians have a tendency to aggrandize themselves or be rather partisan when holding the reins of power, an age old problem that even the Greeks, the father’s of democracy, were well aware of. It can ultimately ignore the needs of the people.

So, the Texas Showdown that is currently taking place is already having an impact of the lives of millions with the shutdown. Yet it continues. According to some commentators it could get worse after October 17th, the day when the US would reach its current debt ceiling. If it is not increased, the US would have to default on its obligations. The US would be seen as a bad debtor, unable to fulfil its obligations. Credit ratings go down, creditors start to worry and increase interest rates on repayments. The dollar weakens as investors are less willing to buy and the US is unable to borrow enough from other nations.

Now all this seems rather confusing given that the US is the largest economy. It dictates financial policy, it dictates global trade, it dictates military action. If the US default on its debt, or fails to pay, who exactly would be the bailiffs? Greece defaulted and shot the country into a mire. But this is because they could no longer borrow and could not increase their cash through quantitative easing. Countries did not want to trade with Greece. They had little to offer.

The US can increase their money supply, and have done with quantitative easing in which the Federal Reserve has been buying $85 billion of government assets per month. This money is predominately going to banks whose balance sheets have been shored up by this injection. If the government wishes to borrow money, it can go to the banks. (But that means increasing the debt ceiling.) The problem is that borrowing from foreign nations will become difficult if they default. Moreover, if the dollar weakens, this will have an impact on trade. More dollars would be needed to buy a foreign nation’s currency (particularly the renminbi) making it more expensive to buy goods. Then the US has a problem.

Republicans argue that increasing the debt ceiling is simply putting the country more into debt burdening future generations as they have to pay back. However, the debt ceiling has been increasing each year for the last 50 years. The country runs on being in debt. All the Republicans have to do is agree on the debt ceiling increasing, a simple case of consensual voting, and suddenly we do not have a default problem. Simple.

In fact, the financial system runs on two things: continuous money production, and debt. Economic theory states that when there is excessive amount of money in the system, inflation is likely to occur because too much money is chasing too few goods. If the money however is not in use, then this is less of a problem At the moment China has 60% of the world’s dollars in the reserves; US banks have the luxury of quantitative easing. Once not in the system, or hoarded by a few institutions, inflation is less of a problem. . Inflation will only be a problem for the US if there is a decrease in trade. But if the money is put into the system, it is typically lent out. What this means is that the borrower has to pay back the money incentivising him to not be extravagant. In summary, the way money is produced perpetuates the creation of creditors and debtors, and the cycle continues.

What does this all mean for the US? Economists are not sure the consequences of a default, but it is safe to say that if there is any adverse effect it will occur to either people who are highly indebted (most of us) or people who have little money. It is admirable that the Republicans are so concerned about the debt burden; the problem is that the US, and in fact the global system, is based on debt. In the end, the problem is not increasing debt; the problem is Republicans are attempting to diminish Obama, and the Democrats popularity. Debt is simply a smokescreen. The real desire is power.

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