Thursday, December 3, 2009

Gold and The Golden Rule

The current high price of gold makes this an opportune time to remind ourselves of "The Golden Rule," namely, "he who has the gold rules."

The U.S. government is issuing enormous amounts of public debt to fund its trillion dollar budget deficits. Outstanding privately held public debt in September 2009 amounted to $6.783 trillion. (Federal Reserve and intergovernmental holdings, chiefly the Social Security and Medicare trust funds, of $5,127 trillion are non-marketable and cannot be traded). Foreign and international holdings amounted to 51.6 percent of privately held public debt in September 2009, up from less than 15 percent in 1986, about 18 percent in 1990, and 34.8 percent in 2000.

A good way to think about the public debt is to imagine that is the equity of a company, in this case the federal government. An investor’s share of a firm’s equity determines his share of seats on the board of directors, which selects and gives guidance to management in directing the operations of the firm. Until recently, U.S. debt was held by U.S. residents and institutions. Now a majority is held by foreign and international owners. The two largest are China (23.55 percent), which has rapidly increased its share, and Japan (21.13 percent). Next in line are the United Kingdom (6.42 percent), oil exporters (5.52 percent), and Caribbean banking centers, whose beneficial owners are not specified (5.64 percent).

Even as foreign ownership is rapidly increasing, treasury officials and other public and private economists insist that large fiscal deficits are not a problem so long as foreigners remain willing to buy our newly-issued debt. In the above model, this amounts to transferring ever-larger ownership of the firm’s equity (U.S. government debt) to non-U.S. residents.

In times of global anxiety, investors flee to safety, precious metals and U.S. treasuries. In normal times, investors pursue more risky investments that yield higher returns. However, applauding increasing foreign ownership of U.S. public debt as a sign of international confidence in the U.S. economy overlooks the golden rule, to wit, that those who own our debt can, if they choose, rule in proportion to that ownership. As the percentage continues to rise, foreign owners, not all of whom have our best interests at heart, can play havoc with the U.S. economy by announcing or undertaking actions to sell or diversify away from U.S. securities.

Cheering one’s increasing loss of financial control seems a strange way to congratulate ourselves and position the U.S. to remain the dominant global economic power.

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