If most/all governments try to go into deficit all at once, where would the money come from?
November 28, 2008 1:59 AM   Subscribe

Keynesian economics calls for running deficits when times are bad and surpluses when times are good so as to smooth out the business cycle. Since the current economic downturn is worldwide, many governments are talking about running deficits so as to stimulate their economies. Here's what I'm wondering: who's going to be lending to all these would-be borrowers?

This old askMeFi thread tells us how the US borrows money under normal circumstances (mostly by selling Treasury securities, as I understand it).

Here are my worries:
1) Investors worldwide just got a lot poorer. Raising money through bonds bought by private citizens is going to be hard, especially in the US where consumers have had a negative savings rate for some time.
2) US debt is primarily owed to other governments, particularly China and Japan. Lender countries seem to be focusing on stimulating their own economies. China's stimulus plan is currently estimated to be to the tune of $1.5 trillion. If even countries which are traditionally lenders are shifting their resources to domestic stimulus, who is going to be lending to all of the governments who want to go into massive Keynesian deficit?

I'm not trying to be all gloom and doom about the economy. I'm just wondering where the money comes from if ever more countries want to run deficits and ever fewer want to lend. Maybe my sense of the economics involved is grotesquely oversimplified, but it seems to me that there's something fishy going on here, and I was hoping for an explanation.
posted by justsomebodythatyouusedtoknow to Law & Government (8 answers total) 5 users marked this as a favorite
Best answer: 1) The US saving rate will probably be rising as the adjustment continues.

2) China's current acct surplus, along with some others, may actually rise next year as their import costs (ie for oil) have fallen. This is partly offset by an increase in financing needs for oil importing deficit countries and reduced surplus dollars in oil exporters, but still.

3) Inflation. Seems to be a bit of competitive devaluation getting going, with the government of Canada for example saying they need to run a big deficit in order to "do our part", ie. keep up with the deficit spending going on all over the world presumably in part to help prevent the currency rising. Anyway, in many places currency intervention takes the form of selling local currency to buy US dollar assets, and for the moment the incentive to continue doing that seems stronger than ever.

4) "Gloom and Doom" talk is not entirely inappropriate; the astounding demand for Treasuries may not last forever.
posted by sfenders at 3:51 AM on November 28, 2008

an increase in financing needs for oil importing deficit countries

err no, sorry, guess I meant the opposite of that. So the lower oil price helps that much more.
posted by sfenders at 4:03 AM on November 28, 2008

Lending to governments, particularly in developed countries, is almost 100% safe...so in bad times people tend to shift their investments towards them. People can lend to the government via bonds, banks can lend via various means, other governments can lend, the IMF/World Bank can lend, etc.

Some governments (notably Iceland) are having a tough time because they've screwed themselves pretty hard and are going begging to the IMF and the EU, which will both impose some harsh medicine on them.

Governments can also print money at will, though this risks inflation. Typically inflation spurs spending (or your money loses value) and inflates your debt out. But if it gets out of control during a downturn, you get the 1970s.
posted by hylaride at 5:24 AM on November 28, 2008 [1 favorite]

I agree with the worries voiced by sfenders. And in answering your question, I would add one more item to the worry list, and that's the unsustainable run on the US buck.

After sinking slowly and steadily for several quarters, its value has shot back up by up to 20-25 points relative to key G8 currencies...and that's happened just over a matter of weeks. So what's behind that? Many suspect it's because of new demand for US T-bills, notes and bonds. America needs to borrow a lot of money and the markets (Japan, China et al) provide it through those three tools. The more demand you have for these, the higher the value of the dollar you use to purchase them.

There are potentially serious consequences consequences to this. US made goods become more expensive for buyers outside of America, and goods made outside of America become cheaper for US consumers. In other words, it's the last 10 years of macroeconomic policy all over again--precisely what had lead to America's already huge trade- and current-account deficits. When you're a debtor, you're essentially at the mercy of your creditors, such that at any time, a drop in confidence could trigger a large and rapid decline in the dollar's value. If that happens, what you get is a sharp, painful jump in inflation and interest rates, leading to stagflation on a scale that would make the 1970s seem like the good old days.

Sorry to be such a downer on a Friday, but hey that's why they call economics the gloomy science.
posted by runningdogofcapitalism at 7:38 AM on November 28, 2008

Response by poster: sfenders,

I find #1 and #2 consoling, but I'm worried about the scale of the problem. The US will be going from a deficit of $500 billion to what, $2 trillion after the bailouts? That's not to mention most of the rest of the Western world also planning to go deeply into deficit. It's not enough for China to be lending as previously -- a truly insane amount of new lending is needed to cover all the new projected borrowing.

"In many places currency intervention takes the form of selling local currency to buy US dollar assets, and for the moment the incentive to continue doing that seems stronger than ever." OK, so the US might be able to borrow enough to cover the bailouts. What about everyone else?

That leaves us with #3, which was the answer I was afraid of. Oh pretty please, somebody tell me that this isn't all going to end in hyperinflation and sovereign default.

(Actually, the Canadian is now saying it may try not to run a deficit, cutting spending instead to keep us in surplus. They're also trying to change election financing rules to benefit themselves. If the Conservatives do not back down, they're going to be thrown out of office just five weeks after being elected (their minority government will fall if the other parties unite against them in a vote of confidence). What I'd like to see is King-Byng 2; a change of government without an election, giving the three other elected parties and assorted independents the chance to form a grand coalition government.)
posted by justsomebodythatyouusedtoknow at 4:57 PM on November 28, 2008

Canadian is now saying it may try not to run a deficit

Yeah, sort of unfortunate timing that I mentioned that. Guess I was a day behind on the news there, but I don't buy it. The gov't may not be predicting a deficit, but those who are have a lot more credibility with me than Flaherty (who I remember all too well from his time as Finance minister in Ontario). Even without the "additional stimulus" they're still promising, and without such a big US recession to help, they'd probably have had a deficit fairly soon anyway at the rate things were going. It does look a bit less senseless to have some temporary deficit spending now that there is arguably a need for some of that stimulus, let's hope it turns out to be as temporary as they'd claim to expect.

What about everyone else?

Well, everyone worries about the USA: The deficit they are financing is an order of magnitude larger than all the others, the US Dollar is the world's primary reserve currency, and the situation looks potentially unstable for all the reasons you've heard about.

Canada for example is not going to start any trouble for the global financial order, and will have no difficulty with this sort of thing in the near future unless something really bad happens elsewhere. Actually that is probably true of a lot of places around the world; what happens to them depends in varying degrees on what happens to the US and the Dollar.

The UK could have some trouble I guess, with unpredictable international consequences. The picture in Europe seems somewhat mixed and complicated. Some countries are more risky than others as always, but so far I think it might be said that all around the world, anywhere that is still traditionally thought of as "safe", government bonds are doing fairly well right now as money flees from risk. So maybe that money could change its attitude and we get that "painful jump in inflation and interest rates" all over the place like we did before. But that is not hyperinflation, which I think could probably not happen all at once to so many currencies. Beyond that, although much of the world may share the same kind of situation economically, based on what little I know, financially each country is sufficiently different in strength that it's hard to say anything much about "everyone else" collectively.
posted by sfenders at 7:45 PM on November 28, 2008

Response by poster: Canada for example is not going to start any trouble. This is true of Canada in general.

It's hard to say anything much about "everyone else" collectively. True. I was making a rather vague statement about what I took to be a trend.

Failing economies (in eastern Europe, the Ukraine, the Baltic states, Iceland...) want aid and/or loans. Western Europe and especially the US want huge amounts of money for bank bailouts and for deficit spending deficits. I agree that some countries are in much stronger shape than others and that the devil is in the details. That leaves me saying that if there are many borrowers chasing fewer lenders, some countries are either going to be forced to cut back government spending or print money, either of which could be economically disastrous.

I think my original question was unhelpfully oversimplistic, and I'm glad to have had your help to straighten it out. As I'm reading things now, we're looking at a game of musical chairs. Those countries which look strong will likely be able to borrow whatever they need, though it is not clear that currently flailing countries will continue to be able to get the money they need, making bad situations there much worse. That's very bad, but not as bad as I originally feared.
posted by justsomebodythatyouusedtoknow at 4:04 AM on November 29, 2008

A few days too late for your original question - but very relevant: "The American Crisis and the Case for an Inflationary Depression" - article from Seeking Alpha:

"However, this crisis will not remain a deflationary recession forever. When the United States debt bubble finally collapses, the U.S. will be forced to default on its debt and devalue its Dollar, as the Fed pumps more and more liquidity into the system. The CDS price for 10 year US Treasury bonds has already increased by 2500% over the past year, and with more deficit spending ahead, the U.S. Dollar's perceived stability will diminish, as will its demand. Increased supply and decreased demand - characterizing rampant inflation. This will send our recession into a depression, and usher in America's first inflationary depression."

Cheery souls!
posted by rongorongo at 6:24 AM on December 3, 2008

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