On March 15th, Moody’s Investors Service fired a shot across the bow of the U.S. government warning the U.S. it might lose its AAA credit rating1, something that was once unthinkable for many Americans only a few years ago. The warning comes as the Government has run record, multi-billion dollar deficits and propelled the national debt to over $12 trillion, and this has many, like Moody’s, questioning whether or not the Government will be able to pay off what amounts to “$38,974.34 for every man, woman and child”. 2 In order to avoid the credit downgrade and escape higher interest payments on the debt it issues, the Government must either radically reduce its spending, raise taxes, or run the dollar printing presses to pay down the debt with devalued currency.
If the Government chooses option 1 and reduces its expenditures, then its risks widespread social unrest and rioting—something Greece is currently experiencing.3 The second choice, that is, raising tax rates to pay off the debt,is political suicide for many politicians. Raising taxes also means less money and purchasing power for the private sector to create more jobs with. Less jobs means less taxpayers and income for the Government. The third option is probably the easiest option for politicians politically. That is, print off more money to pay down the debt; this is what economists call the monetization of debt. Monetizing debt is accomplished when the Central Bank creates money to buy U.S. Treasuries. While this option is probably the easiest politically, it is also very dangerous.
The German Weimer Republic tried to pay off its debt from WW1 by monetization, and the result was hyperinflation to the point where the German currency became worthless. Another example of unsuccessful monetization, and a more recent one, is that of Zimbabwe. Zimbabwe was faced with the daunting task of paying off a mountain of obligations so it decided to monetize its debt. By November 2008, Zimbabwe’s inflation rate was an unfathomable 89.7 Sextillion (1021) percent.4 Weimer Republic Germany and Zimbabwe clearly illustrate the dangers of monetizing debt.
American politicians are faced with some very tough decisions that will affect the future of all Americans. The $12 trillion of debt represents a currency crisis in the making if politicians turn towards monetization to solve the debt problem.
1. brown, matthew. (2010, March 15). U.s., u.k. move closer to losing rating, moody’s says . Bloomberg.
2. Knoller, Mark. (2009, November 17). National debt now tops $12 trillion. CBS NEWS.
3. Mail Foreign Service. (2010, March 11). Greece rocked by riots as up to 60,000 take to the streets to protest against government. Mail Online.
4. Hanke, Steve. (2009, February 5). New hyperinflation index (hhiz) puts zimbabwe inflation at 89.7 sextillion percent. Cato Institute.