Understanding the Economic Fallacies of U.S. Government Borrowing
The U.S. government's approach to financing through borrowing raises significant economic concerns. While theoretically borrowing money for capital investments can be justified, the current scenario in the U.S. does not align with this rationale. Instead, government borrowing exacerbates inflation, leading to a complex cycle of economic challenges.
Economic Justification for Borrowing
Government borrowing is economically viable when it is essential to fund resources for development that are currently lacking. For instance, during periods of infrastructure underdevelopment or technological advancement, borrowing can be a strategic move. However, when a country like the U.S. has abundant capital and is not hampered by a shortage of capital investments, borrowing becomes questionable. In the U.S., the situation is different; extra borrowing risks unnecessary inflation rather than advancing development.
The Role of the Federal Reserve
Surprisingly, much of the government borrowing is facilitated by the Federal Reserve. When the Treasury issues debt instruments such as 10-year notes, a group of banks or 'primary dealers' bid and purchase them. Subsequently, the Federal Reserve steps in to buy these notes, injecting liquidity into the financial system through the banks. This process appears logical; however, the catch lies in how the money is created.
The Fed creates money out of thin air to purchase these debt instruments. Since the 2008 financial crisis, the Federal Reserve has significantly increased its balance sheet. As of January 13, 2021, the Federal Reserve held a portfolio totaling 7.3 trillion in assets, an increase of about 2.7 trillion from the 4.7 trillion total on March 18, 2020. This money creation process raises critical questions about the sustainability and practical implications of such practices.
Consequences of Money Creation and Interest Collection
The mechanism by which the Federal Reserve creates money and collects interest from the same is inherently problematic. The process of selling debt instruments and collecting interest payments can lead to an unproductive cycle where the original capital is generated seemingly 'from nowhere'. Once the policy is reversed, the Federal Reserve should destroy the money created to avoid inflation, but this feudal tactic raises concerns about its feasibility and the long-term economic impact.
Challenges in Repaying Government Debt
Dealing with government debt repayment is a multifaceted challenge. Traditionally, there are three ways to repay loans. The first is through tax revenue, which has its limitations in a country like the U.S., where spending exceeds tax collections. There is also no political will to balance the budget or run a surplus. The second approach is refinancing, which extends the problem to future generations. The third and often used strategy is monetizing the debt, which involves creating more money to pay off existing debt. While this might seem like a temporary solution, it can lead to hyperinflation and economic collapse.
The cycle of borrowing, spending, and potentially inflating the economy through monetary policies can become unsustainable. The historical case studies of countries like Brazil, Argentina, and Venezuela illustrate the dire consequences of unchecked government borrowing and monetization of debt. These nations faced severe inflation, economic collapse, and societal unrest.
Given these considerations, it becomes imperative for the U.S. government to critically reassess its approach to borrowed funds. Balancing fiscal policy with sustainable growth, ensuring tax revenue investment in productive sectors, and exploring alternative financing mechanisms could prove to be more advantageous in the long run.