The US debt balloon - a simple explanation for non-economists

Sunday, April 10, 2005

I apologize for scaring away readers with headlines like the last one. To make up for it, an easy-to-comprehend explanation of the effects of the ballooning US federal debt follows here.
I have published this explanation before as it has proven very effective in educating non-economists about the geopolitical dangers of ever expanding debts. I am especially proud that this taught even my 12 year old daughter that the US is running a dangerous pyramid scheme that will come to a terrible end once creditors want their money back.
The story goes like that:

Let's assume, I borrow a 100 $ from you. In return for your cash you receive a piece of paper (a bond) that says, in one year I will settle my debt by paing you back 110 $ (includes interest). Next year you come to me and ask for your money. Now I say, "no problem, you can have your money, but may I ask you to lend it again to me plus a little more". As you made a decent profit by lending your saved money to me, you think that is not a bad idea and you happily leave me with another piece of paper (a new bond) that obliges me to pay you 110 $ plus 11 $ interest, altogether 121 $.
Now what do you think will happen a year later, when you come and want your money?
You already guessed it, I believe. I will say, "no problem, you can have your money, but may I ask you to lend it again to me plus a little more!" As this investment of your savings was profitable in the past you happily accept again a piece of paper (another new bond) that guarantees you a repayment of 133 $ (including interest) next year.
By now you know what will happen the year after, don't you!?
But now let's play this game to its bitter end. At some point in the future you will want your money back. After all it is your savings you have invested seemingly clever and now you want to reap the fruits of it.
As I am in dire need of your cash, I will politely ask you to lend it again to me. As you refuse because you need it for other purposes, I suddenly turn very angry, pull up my sleeves (point out the superior force of my weapons) and say, "listen, either you leave your money invested with me or I am gonna bully you and then beat you up as it never happened before to you!" On the international level this is called WAR.
Now you will argue that I cheated on you as I never intended to pay my debts in the first place. "Didn't you read the fine print", I will ask pointing a gun at you, "Section 25C of the Federal Reserve Act (adapted in 1994) explicitly says that I am exempted from repayment when we are in a fight (war) with each other!"
And suddenly two friends have turned into bitter enemies....
The bitter lesson of this story is that it will come true at a not too distant point of time. As the US Treasury department bluntly states on its website, "Federal Reserve notes are not redeemable in gold, silver or any other commodity, and receive no backing by anything. This has been the case since 1933. The notes have no value for themselves, but for what they will buy. "
Only problem there is: Greebacks buy less and less every day. Since 1913 they lost 95 percent of their value, according to official inflation figures - and we know how reliable (or not) they are from my previous posting.


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