4 ms·

Some loose threads: The main difference between bonds and cash is mostly based on the fact that cash is the means of settlement. But in fact what we call cash

by zby 6y ago

Some loose threads: The main difference between bonds and cash is mostly based on the fact that cash is the means of settlement. But in fact what we call cash can also have two main forms: federal reserves (debt of the feds) that can be dealt with only by banks and regular bank depositories (debt of the particular bank). And there is even a third layer of Euro Dollar which is debt of non-US banks who cannot hold federal reserves and who can only rely on deposits at 'correspondent banks' in the US who can hold federal reserves. The fed reserves is the most liquid form of money - but it cannot be held by individuals, only by US banks. Bank depositories are less liquid because there can be a bank run - in that respect US government bonds are in fact less risky even though they are not used as a settlement or accounting mechanism. They are less risky because the US government will always pay them back, because they are USD denominated and there is no gold parity any more. Non rhetorical question: are there any scenarios where the US defaults on their debts? It is only 50 years that we can a complete fiat based money - before that the system was based on gold (and silver and other resources like shells) - so the current USD based system is really incomparable with the past reserve currencies. Somehow Ray Dalio in his essays with historical comparisons completely misses that - but of course it only makes his thesis stronger. Non US bonds denominated in USD are completely different - because they can default. In gold based system all bonds used to be like that, because in the end no government could print gold. Maybe 50 years is not enough to have any full cycle and there is no way to extrapolate. The economists base their inflation and similar models mostly on the US economy and fiscal mechanisms - but because of globalisation the share of USD transactions outside of the US economy is probably growing. I would love to see stats on that.

neilwilson 6y ago
"Non rhetorical question: are there any scenarios where the US defaults on their debts?" No. Since it is just a bond swap. To anybody not in the US (like me), the US dollar is just a 0% permanent bearer bond. When a bond matures it is swapped for central bank reserves (floating debt). When one is sold it is swapped back (fixed rate term debt). The monetary system is reflexive. No financial institution is going to hold central bank reserves when there is a near identical government bond available paying a higher interest rate.
- zby 6y ago
  You make it sound as if that swap was something that happens automatically - but it is not. It is something easy to do and it has been done so far consistently - but there must be circumstances where they stop doing it at least temporarily (a stalemate in the Congress or something).
  - neilwilson 6y ago
    It may do in the US Congress due to interaction with the debt ceiling legislation and the like and, of course, it being the US it will no doubt end up in court. Here in the UK, by contrast, it is a 'standing service' on the Consolidated Fund that is governed by two acts of Parliament (The National Loans Act 1968 and the Exchequer and Audit Departments Act 1866). It is entirely automatic and mandated by statute. Nothing can stop it happening. Nothing can even delay it happening - short of a technical failure in the computer systems. Gilts will always be deleted, and the replacement bank reserves created by the Bank of England on the date of maturity.
- Gustomaximus 6y ago
  "Non rhetorical question: are there any scenarios where the US defaults on their debts?" 1) Technically they have defaulted in '79, though it was more of a delay. 2) See how divided politics has become. What happens if the US hits the debt ceiling and the other party decide enough is enough and wont approve appropriate borrowing capacity and all budget. Given divisive politics of recent does this seem that far fetched? 3) US debt is getting to 110% of GDP and growing fast. If this isn't controlled it will hit a point where it becomes to a point where people lose confide3nce. And sure the US govt can print money given own currency as is often touted, but currency need confidence. If people feel they are just a printing machine and decide to head for lower risk waters, they can print all they want but money will become increasingly worthless and they may beed to 'reset' which means possible default . 4) Interest rates. What if these go up? The government can influence but ultimately the market has to want to take on that risk too. If economic times get rocky its not unforeseeable the fed cant set interest rates as easily as they do today. This could flow into serious payment/cost issues on the budget. 5) Not to fear monger, but China hold a bunch of debt. What if they decide to drop a trillion onto the market while US has other crisis compounding value issues and currency runs? 6) On the flip side of foreign debt holders like china, what if some rouge president said "we are not paying you because you stole our IP" or whatever rationale. Unlikely but recent politics shows us extreme statements/positions like this can happen. Even to threaten this in an unthought statement could have serious consequence and flow-on. 7) What if we have another pandemic or natural disaster and the economy drops 30% and stays there... good luck serving the debt on a drastically shrunk economy without serious consequence. 8) What if the next generation decides they are sick of previous generations debt limiting their countries future and a movement starts 'not my debt' and some hard left/right politions take power on disgruntled citizens Etc And yes the US can always print money, but money can lose worth too if people dont want it because they feel too much is being printed. And to be clear, Im not saying the US will default, but there are many reasons that could trigger it to. Personally I think short term risk (sub 20 years?) is negligible, but if they stay on the current path we either need to find MMT works (whole other discussion), or there doesn't seem to be a positive end.

by zby 6y ago

neilwilson 6y ago

"Non rhetorical question: are there any scenarios where the US defaults on their debts?" No. Since it is just a bond swap. To anybody not in the US (like me), the US dollar is just a 0% permanent bearer bond. When a bond matures it is swapped for central bank reserves (floating debt). When one is sold it is swapped back (fixed rate term debt). The monetary system is reflexive. No financial institution is going to hold central bank reserves when there is a near identical government bond available paying a higher interest rate.

zby 6y ago
You make it sound as if that swap was something that happens automatically - but it is not. It is something easy to do and it has been done so far consistently - but there must be circumstances where they stop doing it at least temporarily (a stalemate in the Congress or something).
- neilwilson 6y ago
  It may do in the US Congress due to interaction with the debt ceiling legislation and the like and, of course, it being the US it will no doubt end up in court. Here in the UK, by contrast, it is a 'standing service' on the Consolidated Fund that is governed by two acts of Parliament (The National Loans Act 1968 and the Exchequer and Audit Departments Act 1866). It is entirely automatic and mandated by statute. Nothing can stop it happening. Nothing can even delay it happening - short of a technical failure in the computer systems. Gilts will always be deleted, and the replacement bank reserves created by the Bank of England on the date of maturity.
Gustomaximus 6y ago
"Non rhetorical question: are there any scenarios where the US defaults on their debts?" 1) Technically they have defaulted in '79, though it was more of a delay. 2) See how divided politics has become. What happens if the US hits the debt ceiling and the other party decide enough is enough and wont approve appropriate borrowing capacity and all budget. Given divisive politics of recent does this seem that far fetched? 3) US debt is getting to 110% of GDP and growing fast. If this isn't controlled it will hit a point where it becomes to a point where people lose confide3nce. And sure the US govt can print money given own currency as is often touted, but currency need confidence. If people feel they are just a printing machine and decide to head for lower risk waters, they can print all they want but money will become increasingly worthless and they may beed to 'reset' which means possible default . 4) Interest rates. What if these go up? The government can influence but ultimately the market has to want to take on that risk too. If economic times get rocky its not unforeseeable the fed cant set interest rates as easily as they do today. This could flow into serious payment/cost issues on the budget. 5) Not to fear monger, but China hold a bunch of debt. What if they decide to drop a trillion onto the market while US has other crisis compounding value issues and currency runs? 6) On the flip side of foreign debt holders like china, what if some rouge president said "we are not paying you because you stole our IP" or whatever rationale. Unlikely but recent politics shows us extreme statements/positions like this can happen. Even to threaten this in an unthought statement could have serious consequence and flow-on. 7) What if we have another pandemic or natural disaster and the economy drops 30% and stays there... good luck serving the debt on a drastically shrunk economy without serious consequence. 8) What if the next generation decides they are sick of previous generations debt limiting their countries future and a movement starts 'not my debt' and some hard left/right politions take power on disgruntled citizens Etc And yes the US can always print money, but money can lose worth too if people dont want it because they feel too much is being printed. And to be clear, Im not saying the US will default, but there are many reasons that could trigger it to. Personally I think short term risk (sub 20 years?) is negligible, but if they stay on the current path we either need to find MMT works (whole other discussion), or there doesn't seem to be a positive end.