November 18, 2003



Donald R. Byrne, Ph.D.



Associate Editor 

Edward T. Derbin, MA, MBA



Note: To print a hard copy of this newsletter, click on the following link for a PDF download…

Newsletter Volume 2003 Issue 4 Complete.pdf









The U.S. National Debt is the arithmetic sum of all budget deficits and surpluses over the history of our nation.  When deficits occur, if a national debt exists, that debt increases.  Federal budget surpluses decrease our National Debt.  The U.S. National Debt was relatively insignificant until the Second World War, going from $43 Billion in 1940 to $269 Billion by 1946.  It currently is about $6.9 Trillion (with $4.0 Trillion held in the form of marketable debt - see the following for detail: this is your debt!).  Throughout much of the post World War II Era, federal deficits were usually the case.  This, of course, resulted in a more or less continual rise in national indebtedness.







A budget deficit occurs when government spending exceeds tax revenues.  The deficit necessitates borrowing, which increases the government’s debt. 






Federal Government borrowing in this country is of two types, non-marketable debt and marketable debt.  The latter consists of bills, notes and bonds.   Treasury Bills have a maturity of one year or less, usually in multiples of 3 months.  Treasury Notes range up to around 10 years, and Treasury Bonds as long as 30 years, with a few exceptions.  Recently the Treasury announced it would no longer issue new 30-year U.S. Treasury Bond maturities.



The shorter is the average maturity, the greater the amount of debt that has to be refinanced each year, along with the initial financing of new debt resulting from deficits.  For years 1998 through 2000, the U.S. Federal Government experienced budget surpluses and the marketable portion (see U.S. National Debt by Category) of the National Debt fell by some $435 billion.  But as mentioned above, it was short lived in that beginning with the 4th Quarter 1999 and continuing through the 2nd Quarter 2000, the GDP rate dropped 8%, from 8.9% to 0.9% in nominal terms (in real terms, the GDP drop was even more dramatic, going from 7.1% growth in the 4th Quarter 1999 to –1.6% in 2nd Quarter 2001…totaling an 8.7% decline)





Non-marketable debt is issued to the Trust Funds the Federal Government administers, such as the Social Security Fund and the Railroad Employees Trust Fund.  Other special issues occur often related to problems arising out of occurrences such as the oil shocks of the 1970s.   Also included in the non-marketable category are savings bonds.







The marketable issues can be purchased by anyone. They are usually sold at auctions by competitive bidding but smaller amounts can be acquired by non-competitive bids.  One of the major buyers is the Federal Reserve System, since it conducts its Open Market Operations in U.S. Government marketable securities and Federal Agency securities. 



It is important to note (and will be discussed further in future newsletters) that the FED operates almost exclusively in the secondary markets – it buys and sells securities in much the same manner as the ordinary trader would.  The FED currently owns around 10 percent of the marketable U.S. Federal Debt from this activity.





Since U.S. Federal Government spending resulting from the Great Depression and the Second World War, etc., has exceeded taxes for the most part, these deficits have accumulated and contributed to an awesome national debt.

In recent years, transfer payment spending has usually accounted for more than 60 percent of all Federal Government spending.  Transfer payments by the government results in receipts issued to the public that were not currently earned; that is no productive resource, such as labor, was currently supplied (and in many cases was never supplied).  In order to fund transfer payments, the government must tax others and or borrow as required. Transfer payments increase a household’s disposable income just as taxes decrease the same disposable income of households.  






Since government spending of either type increases aggregate demand, it then stimulates the economy to a higher level of activity.  Government spending on goods and services add directly to aggregate demand while transfer payments add to disposable income and thus also add to aggregate demand. 


On the other hand, taxes raised to finance government spending depress the level of economic activity by reducing the Disposable Income of the households paying the taxes.  The result of lower Disposable Income is a reduced aggregate demand for the nation’s goods and services.  If taxes are insufficient to fund all the spending of the government, borrowing occurs to fund the deficit.  This borrowing puts upward pressure on interest rates and reduces spending sensitive or responsive, in a negative way, to rising interest rates in the private sector such as in the demand for new housing.


This is why many argued that federal budgetary deficits stimulate economic activity to higher levels or if that activity is already pressing capacity (near full employment), inflationary pressures begin to appear.  Federal budgetary surpluses tend to depress the level of economic activity either in nominal or current dollar terms, resulting in disinflation or even deflation, or in real terms, a fall in real output to lower levels of growth of even negative rates, a recession.














In the first issue of this newsletter we argued that there were two major occurrences leading to recession:



(1) Significant rise in federal receipts as a percent of National Income…



 (2) …and the FED’s change to a monetary policy of restraint, leading to rising short-term interest rates.







The “twin policies” brought the nation’s economy to its knees: witness a positive growth of 7.1 percent to a three-quarter long recession, where the GDP collapse bottomed out at a negative 1.6 percent (real GDP). 



In other issues of this newsletter, it is argued that the increase in competition in a growing number of markets is providing anti-inflationary pressures and the role of fiscal and monetary policies to limit inflationary outbreaks is increasingly less needed now as compared to 20 or 30 years ago.







As we began discussing in the last newsletter, the U.S. Current Account Deficit is continuing to rise.  Focusing on the Trade Balance portion of the Current Account, it is currently at $41 Billion for the month of September.  While exports are picking up, imports are continuing to rise as well.   This phenomenon, where imports rise during recovery and expansion is known as the Locomotive Effect.


The Good…



The Bad…




                                                            The Ugly…







Japan and China: A Tale of Two Interventionists


An important point to revisit is illustrated in the following graphs, highlighting two very different approaches to intervening in the foreign exchange markets.


First, Japan…


At first glance it might not be obvious to the reader how Japan goes about controlling its foreign exchange rate.  If you keep in mind that deterioration in the Current Account (or Trade Balance) is tantamount to sacrilege in Japan, you will begin to understand the nature of their Ministry of Finance’s actions…


In a report by Reuters, November 6, 2003


“Japan's Ministry of Finance had publicly confirmed interventions after the fact, including the MOF's announcement that it sold 4.4573 trillion yen (around $38 Billion) between Aug. 28 and Sept. 26, representing a record monthly intervention, the report said.”  



Notice how at various times when the Yen has appreciated, or depreciated at a decreasing rate, it was in direct response to deterioration in the Current Account (actual or perceived)…








China, on the other hand, has evidently targeted ever-higher ratios of trade surpluses (Chinese Surplus equates to U.S. Deficit).  Where the Japanese have apparently targeted a roughly 2 to 1 ratio (2.4 to 1 for 2002) in its trade with the U.S., China has widened that gap on successive occasions to around $5.7 in Chinese exports to the U.S. for every $1 in Chinese imports from the U.S.  It causes one to wonder how undervalued the Yuan really is…









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