Should US Borrow More Given Treasury 'Demand'?

♠ Posted by Emmanuel in ,, at 12/02/2011 11:53:00 AM
To make a long story short, the answer to the post title is "no" contrary to what some IPE and economist types believe [1, 2]. At worst it is financially ruinous to do so and at best it is a very parochial assertion that there is limitless demand for US Treasuries out there. For, not only are there countries with significantly lower borrowing costs than the US, but they also have strong currencies that indicate continuing demand for assets denominated in their currencies unlike the slumping dollar which is near all-time lows on any number of indices. Those who think of the US as a "safe haven" obviously paint a very partial picture. Treasuries are just one asset class among many $ denominated assets. Foreigners also need to exchange their monies into dollars to invest in Treasuries.

Switzerland, Hong Kong, Sweden and Singapore that have both lower borrowing costs and currencies that actually hold their value unlike that of a certain North American nation do not take it as a signal to run up their debts as a "global public good." Even the most disingenuous American politician isn't mad enough to say "we're doing the world a service by running massive deficits."

This being an international political economy blog not a domestic economics blog spewing out Amerocentric regurgitations, I hold myself to a higher standard of looking at others' performance in issuing sovereign debt. Even the most cursory glance reveals their story does not hold up. Moreover, it goes unexplained in their version of events in which the world is flocking to American Treasuries how the currency that it's denominated in is slumping. It is simply not good social science to cherry-pick cases (limit yourself to n=1 America) or completely ignore the fact that foreigners would first have to change their currencies to that which your sovereign debt is denominated in. A more holistic picture suggests this simplistic low yields = limitless Treasury demand story is unwarranted.

On the other hand, an empirically verifiable and non-contradictory assertion is that the frequency of financial crises has increased ever since Richard Nixon dealt away with the dollar-gold standard in 1971. In other words, when the US no longer had its debt issuance levels constrained by the Bretton Woods system, we've had more instead of fewer financial crises. (The linked paper does not suggest their severity has increased, but remember that it was written prior to 2008/09--I'll give the benefit of the doubt to be charitable.) From this point of view, it is perverse that some call for unlimited American bond issuance if the goal is to stabilize the world economy since America being freed from such reins coincides with our, ahem, age of turbulence.

To properly apply the thinking behind Kindleberger's hegemonic stability theory, the current period when the US has been either unwilling or unable to keep the dollar-gold standard intact is marked by more frequent incidences of financial crises. There is no hegemon out there "stabilizing" anything, least of all itself. Moreover, a stable system of exchange rates was one of the things the hegemon was supposed to provide according to Kindleberger, not the mishmash of freely floating ones we have today.

A more cogent, logically defensible argument is that the dollar is now a liability to the international monetary system rather than an asset. Has the US channelled its resulting capital account surpluses in productive ways? I do not think it's far fetched to answer in the negative after the subprime crisis. Did the chances of a European crisis occurring increase in the aftermath of the US subprime mess? I do not think it's far-fetched to answer in the affirmative. Trouble in core Western nations is more suggestive of systemic breakdown than systemic assurance.

But deficits don't matter since interest rates are so low, right?
Go buy Dick Cheney's autobiography if it maximizes your utility, but I for one prefer social science to Cheneynomics.