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Edited on Fri Nov-28-08 10:26 AM by HamdenRice
I've read two contradictory kinds of posts on DU about where people think the money is coming from. Some people think the Treasury is just "printing it". Some people who say this understandably also predict that this has to lead to the eventual decline of the dollar and/or inflation, which traditional economic theory would indeed predict.
A second group believe that we are borrowing the money, which means that in the future we'll have to pay it back with interest, which will cripple our ability to accomplish other important goals, like providing universal health care or repairing our crumbling infrastructure.
Between the two, the second is closer to the truth -- but with a big proviso about the "paying back with interest" part.
Something extraordinary is going on in the financial markets, which is making this moment the perfect time for President Obama to launch a huge public works program while continuing and finishing the nationalization of the banking system: global investors are giving the federal government free money.
The reason that the scale of federal borrowing in a sense "doesn't matter" right now, and the reason that the usual concern about federal bond selling will mean that eventually taxes will need to cover the interest on those bonds no longer applies, is that the financial markets are so scared, and they are so desperate for a safe place to stash their money (federal treasury bonds being basically considered the only safe such place), investors are right now giving the federal government free money. To put it another way, when you calculate interest, maturity, and so on, the yield on federal bonds is effectively zero to the investor. They are saying, "here Uncle Sam, please take my money and hold it for me; I don't care if I don't earn interest, as long as I don't have to risk it on stocks and bonds, I'll be satisfied with your promise to return it in tact."
Right now, if you look at the coupon rate on 2 year treasury bonds, it's zero. That's right; institutional investors, foreign governments, pension funds, etc., are so scared, they are willing to give the government their money for two years with nothing in return. Longer term bonds are paying interest, but when you run orthodox calculations of yield, they are also near zero or at least historically low.
Even money borrowed at zero interest has to be paid back with tax dollars, right? If we were talking about, say, military spending, even with zero interest rates, the federal government would have to pay back its expenditures with future taxes. That's because once you spend a dollar on, for example, the military, you don't get it back.
But the federal government isn't making expenditures; it's making investments. Granted, those investments are very, very, risky, and at this point, and it seems to me that Paulson is so scared, scattered and incompetent, that he isn't doing the obviously necessary thing, which is to go further toward full nationalization of several banks. But because they are making these expenditures as an owner and investor, the stuff they are buying pays income.
For example, next year, the federal government will earn about $6 billion on $125 billion in preferred shares it purchased in one tranche of the bailout. But the interest it will pay on the money it borrowed to pay that $125 billion is much less than $6 billion in preferred dividends it will take in; after a few years those dividends will rise to $11 billion, but the feds will have locked in basically a zero interest cost to pay investors. If the bailout works (and if we want to survive, if we don't want to have the experience of Iceland, I think we have to hope it does) and the financial system eventually recovers, the banks will repurchase that preferred at face value for $125 billion, so the taxpayers will not have to pay for it.
Basically the federal government is becoming the biggest hedge fund in history (which didn't work so well for Iceland), but unlike any other hedge fund, it will have a massive amount of control over the economic conditions and interest rates it's betting on, and the money it's borrowing is being given to it for free.
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