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Saturday Quiz – June 13, 2009

Welcome to the billy blog Saturday quiz. The quiz tests whether you have been paying attention over the last seven days.

See how you go with the following five questions. Your results are only known to you and no records are retained.

1. It is reported that large international buyers of US Government treasury bonds are getting worried that the US deficit is getting too large. If they stop buying the bonds then

2. The fact that the US dollar is the strongest international currency and is in high demand by international investors (including foreign governments) means that the US Government

3. If investors started to worry about the size of the Australian Government deficit and demand for federal public debt fell

4. Even if the government issues debt voluntarily in association with its deficits, the public debt is still

5. When the Australian government issues debt it logically

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    This Post Has 2 Comments
    1. My scores are going down. Going through the questions

      1. Obviously not a) the US govt can just print more $ and not b) because even though less demand for bonds drives up yields (yes) it will also drive down the value of the $US and since the US govt spending program must involve imports (eg oil) then a reduced US$ will reduce the capacity to service it’s spending program (if this means more than just ability to pay the interest. So I went with c) on the basis that the US$ will be reduced in value and that will lead to pressure to accept other currencies (which is happening)

      2. The fact that US$ is the reserve currency (and in demand during deflation since debts need to be settled in US$’s) also means that the US govt can appropriate more resources (outside the US) simply by printing more so it therefore has greater capacity to expand fiscally (until those that are accepting US$ don’t trust it anymore). So I went with b)

      3. Well. I picked not a) I know you say that the Govt doesn’t have to issue debt in equal amounts to it’s deficit and so therefore what it does issue is it’s (govt’s) choice and therefore it “chooses” how much to issue to drive the interest to where it want’s it. However, surely those bidding for the bonds have a rate that they can afford and therefore it’s a market, as far as the participants are concerned. Do they realise it’s rigged game then?


      Dear Fred

      Greetings from Amsterdam! I am sorry your scores are going down. I will have to try harder to explain things more clearly.

      Question 1: (a) is wrong obviously because the US government is sovereign and not revenue constrained. It can never run out of USD! I don’t encourage you to use to term “print more”. Spending does not involve printing money. (c) is clearly wrong because the USD stopped being a convertible currency years ago. It is now not a convertible currency! You cannot convert a USD into anything other than a USD. So we are left with (b) the correct answer – if the US Government insists on issuing bonds by auction then the yield (inverse to price) will rise if the auction price falls as investors require a higher yield to buy more. But this has no impact at all on the US Government’s capacity to spend because the bonds were not issued to finance spending in the first place. It might do all the things you say but the US Government can spend in USD whenever it likes. It can always service its spending program.

      Question 2: Pakistan or Turkey, as examples, have the same capacity to spend in its currency as the US Government has to spend in USD. It does not make any difference whether foreigners also want to hold USD and not Pakistan rupees. Any sovereign government can spend in its own currency. The point is that while USD are in demand for all sorts of reasons, a Pakistani, for example, has to get rupees to pay their tax obligations to the Pakistan government. They cannot pay taxes in USD. As an Australian, I can accumulate as many USD as I like but I still have to pay my taxes to my own government in AUD. Understanding that will allow you to see the point of the question.

      Question 3: (a) is correct as you now realise. (b) cannot be right because the funds to buy the bonds come from government spending anyway! There is no scarcity of saving constraining loans to private credit worthy borrowers. Loans create the deposits and reserves are then added. So to think there is a finite pool of funds out there and the government borrowing will squeeze other borrowers is the basis of the neo-liberal crowding out theory and it is just plain wrong as a desciription of how the modern monetary system we live in operates. (c) is plainly ridiculous. So (a) is correct and reflects the fact that yields may rise as in question (1) – see my point above. But the government chooses to issue the debt. It could simply stop issuing it and then there would be no issue. So it has to want the yields to rise as a matter of discretionary choice. The extent to which the bond yields rise is a market outcome clearly – depending on the strength of each auction. But it is ultimately the choice of government driving it.

      Hope that helps.
      best wishes

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