Vivek Kaul
When it comes to movie endings, my favourite is the last scene of the classic western Butch Cassidy and the Sundance Kid. In this scene Butch Cassidy and the Sundance Kid have taken cover in a building which is surrounded by dozens of Bolivian policemen.
Both Butch and the Kid are seriously injured. Butch suggests to the Kid that after this they should move to Australia. And this is where the movie ends, in a freeze frame shot, in sepia tone, showing the pair charging out of the building they are hiding in, with all guns blazing. The Bolivian policemen are also repeatedly firing at them.
Earlier in the movie, Butch and the Kid are shown fleeing the United States where they are in trouble. They move to Bolivia because they believe that the country has a lot of gold and silver. Or as Butch says in the movie “You wouldn’t believe what they’re finding in the ground down there. They’re just fallin’ into it. Silver mines, gold mines, tin mines, payrolls so heavy we’d strain ourselves stealin’ ’em.”
But that is not how things turn out. As Duncan J Watts writes in Everything is Obvious – Once You Know the Answer “when they finally arrive (in Bolivia) after a long and glamorous journey abroad a steamer from New York, they are greeted by a dusty yard filled with pigs and chickens and a couple of run-down stone huts. The Sundance Kid is furious… “You get much more for your money in Bolivia,” claims Butch optimistically. “What could they possibly have that you could possibly want to buy?” replies the Kid in disgust.”
Things end badly for Butch and the Kid and in the last scene they are presumably killed. So was their decision to go to Bolivia a good one or a bad one? “Intuitively, it seems like the latter because it led inexorably to Butch and the Kid’s ultimate demise. But…that way of thinking suffers from creeping determinism – the assumption that because we know things ended badly, they had to have ended badly,” writes Watt.
Creeping determinism is also referred to as outcome bias. Nobel Prize winning psychologist Daniel Kahneman (he got the Nobel prize for economics) explain outcome bias in his book Thinking Fast and Slow. It is a situation in which “observers…asses the quality of a decision not by whether the process was sound but by whether its outcome was good or bad.”
Mahendra Singh Dhon, the captain of the Indian cricket team, i has become the most recent victim of the outcome bias. He has been criticized for asking Ishant Sharma to bowl the 48th over of the third one day international against Australia, which was played on October 19, 2013. Before Sharma bowled, Australia needed 44 runs to win of 18 balls. India was in the driver’s seat. In this over Sharma gave away 30 runs and India consequently lost the match.
Shashi Tharoor, the minister of state for human resources development, tweeted immediately after the match “Why Ishant & not Vinay for 48th over when VK(i.e. Vinay Kumar) had 2 left?” This is a clear case of sounding wise after something has happened or to put it more technically Tharoor was promulgating the outcome bias.
Michael Mauboussin and Daniel Callahan of Credit Suisse explain this brilliantly in a research paper titled Outcome Bias and the Interpreter – How Our Minds Confuse Skill and Luck released on October 15, 2013. They define outcome bias as a situation in which “people take outcomes into account in a way that is irrelevant to the true quality of the decision.”
This is exactly what Shashi Tharoor did when he questioned Dhoni’s decision of bowling Sharma in the 48th over. Lets look at some numbers. Ishant Sharma has played 68 matches and has conceded runs at the rate of 5.7 per over. Vinay Kumar has played 29 matches and has conceded runs at the rate of 5.7 per over (This takes into account their performance on October 19, 2013, I couldn’t find numbers for before that).
So as far as runs per over are concerned both Kumar and Sharma are on an equal footing. But what about their career averages? Sharma averages 31.36 runs per wicket whereas Kumar averages 36.25 per wicket. So I am not surprised that Dhoni went for Sharma even though Kumar also had two overs left. Given the choice he had at that point of time, bowling Sharma was a better bet than Kumar, numbers clearly show that.
Bhuvneshwar Kumar, the other fast bowler in the team, had already bowled his quota of ten. But assuming he had an over left, Sharma still would have been a better bet. A recent piece on Cricinfo pointed out that Sharma’s concedes runs at the rate of 7.38 runs per over in the last 10 overs. His average is at 24.22 per wicket. In contrast Bhuvneshwar concedes runs at the rate of 8.46 runs per over. While Bhuvneshwar is an excellent bowler during the initial overs, his bowling during the death overs, still needs to improve a lot.
This is not to defend Ishant Sharma. I personally feel he shouldn’t be in the team at all. All I am trying to say is that on October 19, 2013, Dhoni made the correct decision while bowling Ishant in the 48th over, even though India lost the match in the process.
Another factor that would have influenced Dhoni’s decision would be the fact that Sharma brought India back into the Champions Trophy final against England, by dismissing Eoin Morgan and Ravi Bopara of consecutive balls.
The moral here is that even good decisions can lead to bad outcomes. As Mauboussin and Callahan point out “Every day, people who make good decisions with bad short-term outcomes risk losing their jobs. This might include the head of a studio in Hollywood who failed to deliver a blockbuster, a chief executive officer who made a reasoned investment that soured, or a money manager with poor results for a quarter or two. The career risk in making better but bolder decisions can be too high for many professionals to handle.”
When such decisions go wrong, people who made them, are heavily criticised, as Dhoni has been And that’s because of the outcome bias. As Kahneman puts it “When the outcomes are bad, the clients often blame their agents for not seeing the handwriting on the wall – forgetting that it was written in invisible ink that became legible only afterward.”
In fact, Mauboussin and Callahan share a very interesting experiment which shows how human brains are tuned towards the “outcome bias”. This experiment was run by Jonathan Baron and John Hershey, two scholars of decision science.
In this experiment, the subjects of the experiment were told about a 25 year old man who was unmarried and had a steady job, and who had won a prize. The prize was essentially choice between winning $200 for sure or an 80% chance of winning $300 and a 20% chance of winning nothing.
The subjects were then told that the man selected the gamble. “The researchers then showed the subjects two different outcomes. In one the man won $300 and in the other he won nothing. They then asked the subjects to rate the quality of the man’s decision on a scale from 30 (clearly correct, the opposite decision would be unacceptable) to -30 (incorrect and inexcusable)…When the subjects were told that the man had won the money, they rated the quality of his decision a 7.5. When the researchers told the subjects that the man had earned nothing, they rated his decision a -6.5,” write Mauboussin and Callahan.
What does the result tell us? “These ratings are clear evidence that the outcomes deeply influenced how the subjects assessed the decision. Somehow, the subjects didn’t distinguish between two independent issues: the quality of the decision and the outcome from the decision,” explain Mauboussin and Callahan.
In fact, worse the consequence the greater is the outcome bias. The attacks carried out by al-Qaeda on the World Trade Centre on September 11, 2001, are a very good example. On July 10, 2001, the Central Intelligence Agency(CIA) came to know that al-Qaeda might be planning a big attack against the United States. “George Tenet, director of the CIA, brought the information not to President George W Bush but to National Security Advisor Condoleeza Rice. When the facts later emerged, Ben Bradlee, the legendary executive editor of The Washington Post, declared “It seems to me elementary that if you’ve got the story that’s going to dominate history you might as well go right to the president.” But on July 10, no one knew – or could have known- that this tidbit of intelligence would turn out to dominate history,” writes Kahneman.
Hence, it is always easier to be wise after the event and criticise people. But its worth remembering what Mauboussin and Callahan point out “We know that when we see an outcome and don’t know what information the decision maker had, our minds assume that good outcomes are associated with good decisions and bad outcomes are linked to poor skill.”
(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)
Month: October 2013
October 16, 2013 – The day 50 over cricket died
Vivek Kaul
A lot has been written on India’s fabulous win over Australia on October 16, 2013. The underlying message in almost all of these articles has been very positive. As one columnist put it in the Daily News and Analysis “Make no mistake, Jai Ho! Pur is no flash in the pan. It is a sign of the things to come.”
If what happened on October 16, 2013, is a sign of things to come, then I am really worried. And so should be you, if you are an average Indian cricket fan, like I have been.
I have followed the travails of the Indian cricket team, largely on television and radio, for more than 25 years now. I have watched games, where I knew from the very beginning that it’s a lost cause. I have religiously gone through scoreboards in the next day’s newspaper after having watched the full match on television, a day earlier. I have laughed my heart out while reading Hindi newspapers, which referred to leg before wicket as pagbadha.
I have prayed to God to ensure that there is an uninterrupted supply of electricity on days India was playing. I have spent hours trying to tune in to short wave radio to listen to commentary in the late 1980s and early 1990s, before the advent of cable television, when most international tours of the Indian cricket team were not broadcast live on television. And it was on radio I heard that a certain Sachin Ramesh Tendulkar, had scored his first century and helped India save a test match against England, in 1990.
I have spent time watching an ODI series between England and India, before my tenth standard exams, and am still paying the the price for it. I have prayed to God that the other God bats well and helps India win, a countless number of times.
I was depressed for almost one week when Sri Lanka beat India in the World Cup semi final at Calcutta (now Kolkata) in 1996, on an underprepared pitch which broke down and started turning like a top, in the second innings. I still hate Jagmohan Dalmiya for it.
Sachin Tendulkar’s straight drive and Venkatesh Prasad’s slow leg cutter are two things that I can watch over and over again. I almost jumped out of my seat in office, when Joginder Sharma dismissed Misbah-ul-Haq, and helped India win the first T20 world-cup in September 2007. And I wished that I was a part of the impromptu celebration that broke out at Firayal Chowk in Ranchi, after the city’s most famous son, hit a six at the Wankhede Stadium, to help India win the 2011 fifty over world cup.
Watching cricket has been a non-stop roller-coaster ride with emotions from fear to exhilaration to hope to defeat, built into it. But on October 16, 2013, I wondered whether all these years of watching cricket has really been worth the trouble?
I saw more or less the entire match on mute(to be honest I just can’t hear Ravi Shastri saying and that went like a tracer bullet one more time). And by the end of the match I wasn’t really sure if I was watching an international cricket match or a video game.
My Samsung phone has a cricket video game built into it. In this game, the batsman knows exactly where the bowler is going to pitch the ball. He also knows the likely speed at which the ball is going to come at him. Hence, he can decide in advance which shot to play. Typically, most balls can be hit for a four or a six. In short, the game is loaded totally in favour of the batsmen. The bowler is just an insignificant part of the game.
What I saw on October 16, 2013, was very similar. The wicket was dead. It did not have anything in it either for spinners or for fast bowlers. The worst of ODI cricket where the rules and the playing conditions are totally against the bowlers, was at work.
The power of heavy bats was at display, with even mis-hits crossing the boundary line. Cricket bats have become heavier over the years. Anyone who watches slow motion replays carefully, can easily figure out that even rank mis-hits go for a six these days.
Only, four players are now allowed outside the 15 yard circle at any point of time, making it even more difficult for bowlers specially spinners. Spinners rely a lot on mis-hits to take wickets. These mis-hits can be caught in and around the boundary line. But with only four fielders allowed outside circle, the chances of that happening are significantly lower. This has made it even more difficult for captains to bowl spinners in the final overs.
Also, two white balls are now used in a 50 over game. This has led to a situation where reverse swing that a fast bowler can get from an old ball, has been more or less taken out of the equation. It is rare to see toe crushing yorkers these days, which the likes of Waqar Younis, Wasim Akram and Brett Lee, had turned into an art form. This has also made it important for spinners to be able to bowl with the new ball. While it is important to adapt, it was very interesting to see the kind of turn that spinners used to get with the old ball earlier and fox the batsmen.
Over the years, boundary lines in cricket stadiums have been brought in. The cricket administrators seem to like the idea of batsmen hitting more sixes. Apparently that is what the crowds want I am told.
ODI cricket was never really meant for bowlers. The basic fact that a batsman can keep batting till he gets out, whereas a bowler cannot bowl more than 10 overs in a match, proves that. Over the years, limits were also placed on the number of bouncers that a bowler could bowl in one over. Thankfully this has been corrected, and bowlers are now allowed to bowl two bouncers in an over. This has ensured that batsmen can’t simply jump out of their creases after the one bouncer for the over has been bowled.
But even with this, ODI cricket is now loaded totally in favour of the batsmen. And what happened in Jaipur is a brilliant example of that. The era when a team could defend a low score is more or less over (that only happens when the pitch is really bad).
The days when the Indian cricket team could score 125 at Sharjah and win the match by bowling out Pakistan for 87, are gone. One of my favourite ODIs was at Perth in 1992, when India made 126 against the West Indies, and managed to tie the match, with Sachin Tendulkar taking the last wicket in the 41 st over, after the captain Mohammed Azharuddin had used up his four major bowlers.
Sachin on that occasion had bowled medium pace and got the last wicket with a beautiful outswinger. It’s been a while since I saw such a match in which the bowlers dominated from the very beginning. These days the only way to win a match is to out bat the other team. Bowlers rarely win matches any more.
The ICC has been trying to save 50 over cricket over the last few years. It has put an artificial cap on the number of international T20 matches that a team can play during the course of a year. It has also made changes favouring the batsmen, in order to liven up proceedings in 50 over cricket.
But anyone who watched the Jaipur match carefully enough on television, would have realised that large parts of the ground were empty (the BCCI commentators of course did not talk about it). This wasn’t the case with the T20 match that happened in Rajkot a few days earlier.
Why can’t ICC make a few changes in favour of the bowlers as well? Why limit the number of overs that a bowler can bowl in a match to ten? Why not allow, lets say, two bowlers per team, to bowl even 15 overs in a match? Why not even allow bowlers to tamper the ball in certain ways?
The ICC doesn’t stop batsmen from using heavier bats, where the wood is concentrated right at the bottom. As mentioned earlier a lot of mis-hits now cross the boundary line. Given this, I don’t see any harm even allowing bowlers to tamper with the ball. Let the batsmen figure out how to play them. Also, ICC needs to seriously look at the size of the boundaries. Cricket administrators need to stop bringing in boundary lines.
As a true cricket fan, I want to see a somewhat equal contest between bat and ball, which has gone out of the window, over the last few years. Maybe, I am getting a little too nostalgic here. Maybe, I am getting old. But for me, on October 16, 2013, 50 over ODI cricket, just died.
The article originally appeared on www.firstpost.com on October 19, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Debt ceiling: Why the Great American Ponzi scheme might just keep running
Vivek Kaul
Governments typically spend more than they earn. This difference is referred to as the fiscal deficit. The government of the United States (US) is no different on this front. It has been running fiscal deficits greater than a trillion dollars every year since 2009. It makes up for this deficit by borrowing. It borrows money by selling bonds on which it pays interest.
Currently, the US government has sold bonds close to $16.69 trillion. Of this, around $4.8 trillion worth of bonds have been bought by agencies of the US government which primarily run pension funds and retirement funds. The American households own around $1.2 trillion or around 7.2% of the total outstanding bonds of $16.69 trillion.
This is not surprising given that the savings rate in America has averaged at around 4.6% of the disposable income over the last 10 years. In July 2005, it had fallen to as low as 2% of disposable income. It has since recovered and since the beginning of 2013, it has averaged at 4.4% of the disposable income. The moral of the story is that the average American doesn’t save enough to be able to lend to his government.
So who are the other lenders to the US government? As I explained in detail yesterday the Federal Reserve of United States, the American central bank, is a major lender to the government. Currently it holds bonds worth $2.086 trillion or around 12.5% of the total outstanding bonds of $16.69 trillion.
This lending has gone up by 434% over the last five years. On September 17, 2008, two days after the investment bank Lehman Brothers went bankrupt, the Federal Reserve held US government bonds worth around $479.84 billion. As stated earlier currently it holds bonds worth $2.086 trillion.
The Federal Reserve doesn’t have any money of its own. It basically prints money and uses that money to buy government bonds. This money printing adds to the money supply. This excess money can ultimately lead to high inflation with excess money chasing the same amount of goods and services.
Hence, the Federal Reserve printing money to buy US government bonds is something that cannot continue forever. In fact, Ben Bernanke, had indicated in May-June 2013, that the Federal Reserve will go slow on money printing in the months to come. Since then, he has gone back on what he had said and indicated that the money printing will continue for the time being.
But even with that change in position, the US government cannot continue to rely on the Federal Reserve to finance a significant part of its fiscal deficit by buying its bonds. As I mentioned yesterday, between 2009 and 2012, the US government ran a fiscal deficit of $5.09 trillion. During the same period the Federal Reserve’s holdings of US government bonds went up from $475.92 billion (as on December 31, 2008) to $1.67 trillion (as on January 2, 2013). This increase, amounts to roughly $1.2 trillion. This amounts to around 23.6% of the total fiscal deficit of $5.09 trillion.
So the question is who will the US government have to ultimately borrow from? The answer is other countries.
As of the end of July 2013, foreign countries held a total of $5.59 trillion of US government bonds. Of this China was at the top, having invested $1.28 trillion. Japan came in a close second, with $1.14 trillion. How has this holding changed over the years? As of September 2008, the month in which the current financial crisis started with the investment bank Lehman Brothers going bust, the foreign countries held US government bonds of $2.8 trillion. Hence, between September 2008 and July 2013, their holdings have doubled (from $2.8 trillion to $5.59 trillion).
Given this, what it clearly tells us is that the foreign countries have helped by the US government run its trillion dollar fiscal deficits by buying its bonds.
Let us look at this data a little more closely. As of the end of December 2008, the foreign countries held US government bonds of $3.07 trillion. By December 2012, this had gone up to $5.57 trillion. This meant that during the period foreign government bought bonds worth $2.5 trillion. During the period the US government ran up a fiscal deficit of $5.09 trillion. The foreign governments financed around 49% of this, by buying bonds worth $2.5 trillion($2.5 trillion expressed as a % of $5.09 trillion).
During this period, some of the bonds that foreign countries had bought would have matured. The US government spends more than what it earns. Hence, it does not have the money to repay the maturing bonds from what it earns. Given this, it needs to sell new bonds in order to repay maturing bonds. A part of these new bonds being sold over the last five years have been bought by the Federal Reserve. The Federal Reserve has done this by printing money.
Hence, the US government has paid for a part of its maturing bonds by simply printing dollars. This is similar to running a Ponzi scheme, where the government is paying off old bonds by issuing new bonds. A Ponzi scheme is essentially a financial fraud where the money that is due to older investors is repaid by raising fresh money from newer investors. The scheme keeps running till the money brought in by the new investors is greater than the money that needs to repaid to older investors. The moment this reverses, the scheme collapses.
Despite this, foreign countries have been more than happy to buy US government bonds. As we saw a little earlier in this piece, they have doubled their holding of US government bonds between September 2008 and July 2013. In short, foreign countries along with the Federal Reserve have helped the US government to keep running its Ponzi scheme.
Why is that the case? The United States with nearly 25% of the world GDP is the biggest economy in the world. By virtue of that it is also the world’s biggest market where China, Japan and countries from South East Asia and South America, sell their goods and earn dollars in the process.
The way things have been evolved, the US imports and countries like China, Japan, Saudi Arabia etc earn dollars in the process. These dollars can either be kept in the vaults of central banks of these countries or be invested somewhere.
Hence, over the years, these dollars have made their way to be invested in US government bonds, deemed to be the safest financial security in the world. With so much money chasing them, the US government, has been able to offer low rates of interest on them.
This has helped keep overall interest rates low as well. It has allowed American citizens to borrow money at low interest rates and spend it on consuming imported goods. So the Americans could buy cars from Japan, apparel and electronics from China and countries in South East Asia and oil from Saudi Arabia. And so the cycle worked. The US shopped, China and other countries earned, they invested back in the US, the US borrowed, the US spent, China and the other countries earned again and lent money again.
The way this entire arrangement evolved had the structure of a Ponzi scheme. China and other countries invested money in various kinds of American financial securities including government bonds. This has helped keep interest rates low in the US. This helped Americans consume more. The money found its way back into China (like a return on a Ponzi scheme), and was invested again in various kinds of American financial securities, helping keep interest rates low and the consumption going. Like in a Ponzi scheme, the dollars earned by China and other countries has kept coming back to the US.
Hence, foreign countries have an incentive in keeping this Ponzi scheme going. Earlier, it was important for them to keep buying US government bonds to keep interest rates low and help American consume more. It was also important to keep buying these bonds to ensure that the US government had enough money to repay them. Now it has reached a stage, where the US government is repaying them by simply printing dollars.
But even with this foreign countries are likely to continue lending money to the US government by buying its bonds. Sanjiv Sanyal, global strategist, Deutsche Bank Market Research makes this point in a recent report titled Bretton Woods III and the Global Savings Glut.
As he writes “The basic idea is that, when people are young, they have little savings and may even need to borrow in order to spend on consumption and/or build assets. However, as they grow older, their net savings rise as they build up a stock of wealth that is later run down in very old age. The same dynamic can be said to broadly hold for countries as they experience demographic transitions although there are nuances that vary according to cultural context and fiscal incentives of individual countries.”
Basically what this means is that as a country ages (with the average age of its population rising) it tends to save more. Sanyal expects many developing countries to age at a very fast pace over the next two decades. As he writes “The link is even clearer if one considers the pace of aging by comparing the current median age with the expected median age in 2030. For instance, Japan will then have a median age of 51.6 years while China will go from being significantly younger than the US in 2010 to becoming significantly older after two decades. The aging of South Korea is even faster.” He expects these countries to have a median age of 40 by 2030.
Given this, it is likely that as countries age, they will keep generating excess savings. A lot of this money is likely to find its way into the United States, feels Sanyal. As he writes “we know that lenders do not just care about high returns but about policy risk, property rights, corporate governance and the overall ability/willingness to the borrower to return the money. Thus, aging current-account surplus countries may prefer to park their funds in safer countries even though returns are higher in certain emerging markets.”
And this will help the American government to continue borrowing. It will also keep interest rates low and help Americans keep their excess consumption going. “The next round of global economic expansion may require the US to revert to its role as the ultimate sink of global demand,” writes Sanyal.
And so the Great American Ponzi scheme might just continue for a while.
The article originally appeared on www.firstpost.com on October 18, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Debt ceiling absurdity: US Fed will now repay itself by printing money
Vivek Kaul
It was widely expected that the Democrats and the Republicans will finally strike a deal and extend the debt ceiling of the government of the United States(US). And that’s precisely what happened.
A few hours before the US government would have reached its debt ceiling, both the houses of the American Congress, passed a short term bill, allowing the government to suspend the debt ceiling until February 7, 2014. The Senate passed the bill, 81:18. The House of Representatives passed the bill 285:144. The bill will also end the government shut-down in the United States and allow it to operate till January 15, 2014.
Governments around the world spend more than they earn. They make up for the difference by borrowing money. The US government is no different on this front. The only trouble is that it is not allowed to borrow beyond a certain limit. This limit is referred to as the debt ceiling and till yesterday was set at $16.69 trillion.
If the bill suspending the debt ceiling had not been passed, the US government would not have been able to borrow more. And given that it would have become difficult for it to meet its expenditure from its income. Today, i.e. October 17, 2013, the US government will have around $28 billion of cash on hand. The treasury secretary Jack Lew had suggested in early October that expenditure of the US government on certain days could touch even $60 billion.
Given this, it would be able to meet only a part of its expenditure and hence, someone was not going to get paid.
The tricky question for the government would have been to decide who that someone would be. Would the government decide not to pay out the pension cheques? Or would it be unable to pay salaries of its employees? Would it default on the interest payments that are due on its bonds? Or would it be unable to repay maturing bonds? The American government like other governments around the world makes up for the difference between what it earns and what it spends, by selling bonds.
Interest payments of around $6 billion are due before the end of October. Also, bonds worth around $90-93 billion need to be repaid between October 24 and October 31. A default on this front would be catastrophic. The US government bonds (or treasuries as they are more commonly referred to as) are deemed to be the safest financial securities in the world. And if the security deemed to be the safest financial security in the world is not safe, what is?
But these are points that I have made before (you can read them here). The US government’s current debt stands at around $16.69 trillion. It has borrowed this money by selling bonds. Of this nearly $4.8 trillion is held by various agencies of the US government. Most of the US government agencies holding US government bonds are pension funds and retirement funds, which need to make payments in the years to come. To be able to make these payments, they need to invest now. Hence, they invest money in US government bonds deemed to be the safest financial security in the world.
The remaining US government debt of around $11.89 trillion ($16.69 trillion – $4.8trillion) is referred to as the debt held by the public. Of this, foreign nations hold around $5.7 trillion. China holds around $1.28 trillion and Japan $1.14 trillion.
What is interesting is that the Federal Reserve of United States, the American central bank, holds US government bonds worth $2.086 trillion. On the whole, this is only 12.5% of the total US government debt of $16.69 trillion. But what is interesting is that over the last five years the holding of the Federal Reserve has risen by 434%.
On September 17, 2008, two days after the investment bank Lehman Brothers went bankrupt, the Federal Reserve held US government bonds worth around $479.84 billion. As stated earlier currently it holds bonds worth $2.086 trillion. In comparison the debt held by foreign nations has gone up only marginally.
In the last one year, this holding has gone up by nearly $433 billion. What is happening here? The US government is spending substantially more than what it is earning. Since 2009, it has been running fiscal deficits of greater than a trillion dollars. Between 2009 and 2012 the US government ran a total fiscal deficit of $5.09 trillion. In 2013, it is expected to run a fiscal deficit of around a trillion dollars. Fiscal deficit is the difference between what a government earns and what it spends.
In a situation like this, if the US government would borrow all the money from the public, interest rates would shoot up, given that there is only so much amount of money that can be borrowed. And if the government borrows more, then there would be lesser amount of money for others(primarily the private sector) to borrow. This crowding out would lead to a situation where other institutions like banks would have had to offer a higher interest to borrow.
If a bank borrows money at a high rate of interest, it would have to lend it out at a still higher rate of interest, in order to make a profit. Higher interest rates would mean, higher EMIs. This would discourage the average American from borrowing and spending money, something which the US government believes is very important for reviving economic growth.
This is where the Federal Reserve stepped in. It has been buying the bonds being sold by the US government to finance its fiscal deficit. Where does the Federal Reserve get this money from? It simply prints it and hands it over to the government.
As we saw earlier, between 2009 and 2012, the US government has run a fiscal deficit of $5.09 trillion. During the same period the Federal Reserve’s holdings of US government bonds went up from $475.92 billion (as on December 31, 2008) to $1.67 trillion (as on January 2, 2013). This increase, amounts to roughly $1.2 trillion. This amounts to around 23.6% of the total fiscal deficit of $5.09 trillion.
Hence, the US government financed nearly 23.6% of its fiscal deficit by selling bonds to the Federal Reserve. Federal Reserve handed over this money to the US government by simply printing it. This has helped keep interest rates low in the United States.
And that is the real story. A lot of the US government borrowing over the last few years has been directly from the Federal Reserve. And now that the debt ceiling has been raised, this will continue.
The money that is borrowed by the US government from the Federal Reserve and other sources, is used to fund its expenditure. A substantial part of the expenditure is repayment of past debts as bonds mature, as well as payment of interest on these bonds.
In the year 2012, the US government paid a total interest of around $359.80 billion on its bonds. The fiscal deficit of the US government was around $1.08 trillion. Hence, nearly one third of the fiscal deficit was because of interest rate payments.
The US government does not earn enough to repay maturing bonds. Hence, it has to borrow money to repay bonds. This is a perfect Ponzi scheme where the government is paying off old debt by issuing new debt. A Ponzi scheme is essentially a financial fraud where the money that is due to older investors is repaid by raising fresh money from newer investors. The scheme keeps running till the money brought in by the new investors is greater than the money that needs to repaid to older investors. The moment this reverses, the scheme collapses.
In fact, as bonds being bought by the Federal Reserve from the US government, come up for maturity they will be repaid by getting the Federal Reserve to print money and buy new bonds. Hence, the Federal Reserve will be printing money to repay itself. If that isn’t absurd, I don’t know what is. The US Federal Reserve is currently helping the US government run its Ponzi scheme by printing money and buying bonds.
Having said that, increasing the debt ceiling was important given that even a whiff of a default would have caused a global financial crisis. First and foremost investors would have started selling out off US government bonds. This would have driven bond prices down and bond yields up, in the process pushing up interest rates first in the US and then globally. This would have put the entire plan of the US government to revive economic growth by maintaining low interest rates in a jeopardy. It would have also led to investors all over the world selling out of various financial markets. The logic would have been that if the security deemed to be the safest financial security in the world is not safe, what is?
Of course, the trouble is that the US government will breach its debt ceiling again in a few months time. What happens then? The debt ceiling has been in place in the US since 1939. Since 1960, the American Congress has increased the ceiling 79 times. So what stops it from doing it the 80th time as well? Nothing really. But till when can this Ponzi scheme go on? Ultimately all Ponzi schemes collapse. The only question is when. And for that I really do not have an answer.
The article originally appeared on www.firstpost.com on October 17, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
US govt reduced to live on borrowed time
Vivek Kaul
Governments spend more money than they earn and finance the difference through borrowing. The government of United States(US) is no different on this front. The trouble is that it cannot borrow beyond a certain limit. This limit, known as the debt ceiling, was set at $16.69 trillion.
This ceiling should have been breached in May 2013, a little earlier this year. Since then, Jack Lew, the American treasury secretary, has taken a number of extraordinary measures like delaying public employee pension fund payments, in order to ensure that the government expenditure remains under control. Lesser expenditure meant lesser borrowing and hence, the government managed to keep its total borrowing below $16.69 trillion.
Today i.e. October 17, 2013, the government would have run out of the extraordinary measures that it has been taking. Given this, the treasury department would have exhausted its borrowing authority.
Hours before this would have happened, the leaders of the Democratic Party and the Republican Party in the American Senate stuck a deal, suspending the debt ceiling. This will allow the US government to borrow beyond $16.69 trillion, till February 7, next year. The will also end the current government shut-down in the US and keep the government running along till January 15, 2014.
This is not the first time that the US government came close to its borrowing limit, given that the debt ceiling has been in place since 1939. Since 1960, the debt ceiling has been raised 78 times by the American Congress. But this time around the Democrats and the Republicans left it too late, each waiting for the other to blink first.
If the ceiling had not been extended the short-term repercussions would have been terrible. The treasury secretary Lew had said in early October that the US government “will be left…with only approximately $30bn” come October 17. This would not be enough to meet the expenditure of the government, which can be as high as $60 billion on some days, Lew had pointed out.
Interest payments of around $6 billion are due on US government bonds before the end of this month. Along with that, bonds worth between $90 to $93 billion need to be repaid between October 24 and October 31 (Source: www.thefinancialist.com) Governments issue bonds to borrow money.
The US government has reached a stage wherein it does not earn enough to repay the money it has already borrowed by issuing bonds. Hence, it has borrow more money by issuing fresh bonds to pay off the older bonds. If the debt ceiling had not been extended, it would have become very difficult for the US government to repay the money it had already borrowed.
More importantly, the US government bonds are deemed to be the safest financial security in the world. If the US government defaulted on paying interest on its bonds or repaying the principal, there would have been mayhem in financial markets, all over the world, including India. It has even been suggested that the crisis that could have unfolded would have been bigger than the crisis that followed the bankruptcy of Lehman Brothers in September 2008. Investors would have sold out of US government bonds driving up global interest rates.
The US government would also have had to prioritise its expenditure. Does it make pension payments? Does it pay its employees and contractors? Does it pay interest on its bonds? Does it repay maturing bonds? These are the questions it would have had to address. Also, there are no legal provisions guiding the government on who to pay first. Hence, any prioritisation of payments could have led to a slew of lawsuits against the US government.
Given the negative repercussions of the debt ceiling not being extended, the markets were positive that a deal reached would be reached. Stock and bond markets around the world have been stable. And gold, looked at as a safe haven, is quoting at levels of around $1280 per ounce (one troy ounce equals 31.1grams).
The trouble is that the US government will cross its debt ceiling level again in February, 2014. What happens then? How long can the American Congress keep increasing the debt ceiling? The basic problem is that the US government has borrowed too much money, and continues to do so, and if it doesn’t default today, it will default in the years to come.
The article originally appeared in the Daily News and Analysis dated October 17, 2013
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected])