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Saturday, December 24, 2011

One Thing To Remember About The Federal Debt

Not all debt is bad.

This is so obvious, is it not? Without a house mortgage, a debt, we would be living in cradboard boxes, so not all debt is bad.

In the late 1990's and early 2000's the Federal Debt was shrinking due to the budget surpluses we were experiencing so much so as that some people began to discuss the scenario of "What Happens When the Federal Debt Disappears?"

And there were some immediate problems, one of which being that the main "Safe Asset" investment in the entire world - US Treasury Bonds - would disappear,  because the US government would no longer need to borrow money due to the surpluses being run.

Ask anyone right now when the entire world is looking for safe assets what would happen when 50% or more of the safe asset investments were to disappear. Off the top of my head, I think
(1) the prices of the remaining safe assets would jump - thereby removing safe assets from the portfolios of anyone not very wealthy, and
(2) since the rating agencies are the ones who assign AAA ratings and based on experience from 2008, I would expect that this price increase would lead to riskier assets being assigned AAA ratings, watering down the meaning of AAA rating itself and making investment decisions trickier and probably leading to another situation of banks holding "troubled assets".

In fact, there is some speculation that Troubled Assets were created as a low risk asset ( which actually carried high risk ) as an extended response to this very situation of government surplus!

So much for running a government like a business... or a home.


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