I had originally planned to answer questions by Mike on exchange rates, which were partially taken up in my critique of an article by Dean Baker. While the factors that determine exchange rates are an important question in economics, especially for the theory of world trade, events over the last few weeks dictate that my reply to Mike’s questions be postponed.
These events include the threatened default of the U.S. government on its debt payments, the decision of the Obama administration to accept a compromise that includes no tax increases for the rich, a wave of panic selling on Wall Street and other world stock exchanges, a new plunge of the dollar against gold, the downgrading of the U.S. debt from AAA to AA+ by Standard and Poor’s, and a rare split vote by the Federal Reserve’s Open Market Committee on what to do next concerning the Federal Reserve’s monetary policy.
Any one of these events would probably have necessitated the decision to postpone the reply to Mike’s questions on exchange rates. However, the events of the last few weeks are closely intertwined with and relate to questions that this blog has been examining since its inception in the January following the late 2008 panic. In order to keep this reply within reasonable limits, I will concentrate on the question of the debt of the U.S. federal government and the threatened default by that government.
Debt default crisis a political and not a true financial crisis
Since World War I, the maximum debt that the U.S. government could carry has been determined by law. Every so often as the maximum debt limit was approached, Congress routinely voted to raise the debt limit. But this year the Republican-controlled House balked. The Republican majority threatened to refuse to raise the debt ceiling unless the Obama administration agreed not to raise taxes on the rich and corporations or even close tax loopholes that have often enabled the rich and corporations to pay no taxes at all.
The U.S. Treasury warned that if the debt limit was not raised by August 2, it would not have enough cash on hand to pay all its bills coming due, forcing it to default. The crisis was purely a legal and political one, since the U.S. government has been having no trouble recently selling its notes and bonds. Indeed, the federal government was able to sell them at prices that yielded some of the lowest interest rates it has ever had to pay. This would hardly be the case if there was a real threat of a federal default.
The media were taking the default threat seriously, but the markets—the capitalists in the know—were not. The markets were right. Over the weekend of July 30-August 1, the Democratic and Republican parties came up with a deal that raised the debt limit and averted the “danger” that the U.S. government would run out of money and default on payments on its huge debt.