US T-bills a concern for leaders at summit
- Source: Global Times
- [21:28 June 15 2009]
- Comments
By Jia Wen
Even before the opening of the first BRIC summit in Yekaterinburg, Russia, analysts around the globe had been focusing their attention on a hot issue that was destined to be high on the agenda there, namely the safety of the member countries’ investment in US treasury bills.
Some might be a little unhappy about the discussion of this issue, but the BRIC countries’ concern is absolutely a legitimate and justifiable one.
Its economic logic is so simple that even a layman can easily understand. If I’ve lent $100 to you at an annual interest rate of 3 percent, I need to get not just the nominal sum of 103 dollars when your debt is due, but also a reliable guarantee that the purchasing power of the 103 dollars is no less than before.
This guarantee, despite repeated assurances from American officials, is far from reliable, given the current fiscal and monetary situation in the US.
To save the domestic economy from recession, US President Barack Obama has launched a massive economic stimulus package and greatly increased government spending. This policy, though absolutely necessary in the face of the most serious crisis since the Great Depression, is destined to cause a rapid rise in the budget deficit.
The deficit, if not brought under effective control, could increase the likelihood of inflation, which will in turn devalue US dollars and cause losses to holders of dollar-denominated assets like US T-bills.
According to a report from the US Congressional Budget Office, the projected budget deficit for 2009 is $1.85 trillion, or 13.1 percent of the projected GDP for the same year, the largest deficit as a share of GDP since 1945. Although the report expects the deficit-GDP ratio to drop to single digits from next year, the average ratio for 2010-2014 is 5.4 percent, over two times the pre-crisis five-year (2004- 2008) average of 2.5 percent.
Inflation, as has been proved by economic theories and historical precedents, usually lags behind budget deficits. No inflation today doesn’t mean no inflation in following years. The above-mentioned deficits forecast naturally deserves concern from leaders of the BRIC countries.
Apart from huge budget deficits, what deserves even more concern is the irresponsible decision by the Federal Reserve in March to purchase US Treasury and mortgage bonds.
Such a measure, despite its short-term effect of pumping more money into the economy and boosting aggregate demand, is by no means different from printing more money to spend when you lack it.
Dollars printed without support from real economic growth may result in an enlarged money supply unmatched by an equally enlarged supply of goods and services, resulting in inflation.
Some analysts have ruled out this possibility by saying that inflation and recession cannot coexist. But looking back to the stagflation ensuing the oil crisis in the 1970s, this claim can hardly hold water.
Some US economists have pointed out the inappropriateness of the Fed’s choice. In a commentary titled Inflation Nation in the New York Times, Allan H. Meltzer, a professor of political economy at Carnegie Mellon University and the author of A History of the Federal Reserve, questioned the Fed’s decision in an in-depth analysis of the lessons from its past monetary policies.
The inflationary effect of the Fed’s policies is undoubtedly felt by every holder of US T-bills, including top decision-makers of the BRIC countries, which are now holding more than $1 trillion in US T-bills, nearly a third of the grand total.
If US dollars depreciate due to inflationary pressures, these countries will inevitably suffer great losses. Their concern for inflation and the value of US dollars is a reasonable one.
It is up to the US to take more concrete steps to ease their worries, the most important of which is an unambiguous pledge from Ben Bernanke, Federal Reserve chairman. Only his pledge to control the printing of dollars can strengthen previous assurances from President Obama and officials of his administration.
The author is an associate professor at the School of Economics, Sichuan University