Re: Crowding Out Hypothesis

[William F Hummel <wfhummel@xxxxxxxxxxx>]

Foreigners in the aggregate can buy US government debt only by having
previously earned US dollars through the sale of goods and services or
from investments in the US.  If the they choose to continue acquiring
US debt in exchange for their goods and services, they must deal with
the risk of a devaluation in the exchange value of their dollar
holdings.

In any case, I don't see any particular connection between the
interest payments on foreign-owned debt and future GDP of the US.
One should think of those interest payments as a part of the cost of
acquiring goods and services for the US.  They are paid in US dollars
which must ultimately be spent on US goods and services or assets.
Thus they don't represent a "burden" any more than the interest paid
to domestic owners of government debt, namely nothing.

William F Hummel

>There is no future debt burden when most of the debt is held domestically because it just amounts to a redistribution from taxpayers to bond holders.  However, there is a future domestic burden if interest payments are made to foreign debt holders--since future GDP is reduced.
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>Lonnie K. Stevans
>acslks@xxxxxxxxxxx
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>>>> William F Hummel <wfhummel@xxxxxxxxxxx> 08/13/03 01:06PM >>>
>Lonnie K. Stevans wrote:
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>>It seems that you are confusing "crowding-out" with another issue that deals with future debt burden.  "Crowding-out" occurs when government involvement in the debt market raises interest rates and thus "crowds-out" private spending.  From what I understand, there has not been much empirical evidence for this.  The issue of debt being held by foreign lenders becomes a problem in the future when resources must be sent externally to make interest payments.
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>I agree that there is no evidence to support the thesis that interest
>rates, real or nominal, automatically increase as a result of
>government deficit spending.  However I was using the expression
>"crowding out" in the context that is implicit in the quote by
>Volcker:
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>"The United States was running a budget deficit of more than 5 percent
>of the gross national product.  The American people were simply not
>saving enough money to buy all the Treasury bonds as well as to buy
>new homes and invest on their own.  So we were forced as a country to
>rely on foreign lenders, and to do that we had to maintain their
>confidence as a place to keep their money."
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>It seems to me that the issue is whether government deficit spending
>itself replenishes the loanable funds used to buy government bonds.
>If not, then there would clearly be a crowding out effect that would
>reduce private sector spending and investment.  My contention is that
>there is on average a reciprocal flow of funds between the government
>and the private sector due to deficit spending.  While there can be
>transient shortages in loanable funds, there is no secular component.
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>As for increasing interest payments to foreign buyers of government
>debt, I see no negative effect there.  The interest is paid in US
>dollars which can only be spent on dollar-denominated assets.  The
>purchase of that government debt represents an investment in the US
>that is balanced against the goods and services previously sold to the
>US.  The interest payments are simply a part of the present value of
>that investment.
>
>William F Hummel
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