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Sina, China

2013: The Year of
America’s Financial Collapse

By Jia Pu Jing

If Congress is unable to find a solution, the U.S. national credit rating will be compromised, which could possibly even result in a financial meltdown

Translated By Chase Coulson

5 February 2013

Edited by Kyrstie Lane

China - Sina - Original Article (Chinese)

In a recent motion to raise the short-term debt ceiling, Congress voted to allow the U.S. Treasury to continue issuing debt to maintain the federal government's operations until May 19. This marks the second time in a month that both parties of Congress have extended the time limit in which to solve the national debt crisis.

The issue of the U.S. debt ceiling has been around for a while. As early as May 2011, when the national debt was already nearing $14.3 trillion, there was serious debate about the debt ceiling crisis. From May 2011 to May 2013, the Democratic and Republican Parties have continued to quarrel over the debt problem. Why can't they be straightforward about the issue? Why can’t they either raise the debt ceiling to a very high level or simply do away with the ceiling altogether?

Because, in a nutshell, what they are arguing about is how to apply the tax collected to pay the debt owed. If Congress is unable to find a solution, the U.S. national credit rating will be compromised, which could possibly even result in a financial meltdown.

The U.S. currently issues currency through the Federal Reserve's purchase of government bonds from the Department of the Treasury. From this, the Department of the Treasury acquires U.S. dollars and then by way of a finance payment scheme takes the dollars and circulates them through the general economy. The guarantee of yields brought in by the Treasury for its purchase of bonds is future taxes. That is to say, the foundation of the U.S. dollar is U.S. government bonds, and the foundation of the government bonds is future tax revenue. To increase the money supply, the U.S. often issues more government bonds, and the issuance of government bonds implies that taxes will increase in the future.

After the eruption of the financial crisis, the Federal Reserve began two rounds of quantitative easing in an effort to buy up the toxic assets that were clogging the financial system. Approximately $2.6 trillion was spent to accomplish this end, exhausting the entirety of the bonds available to be issued at that point. So after the 2011 debt ceiling crisis began, the biggest problem the U.S. faced was this: Continuing to increase the money supply would mean increasing future taxation. But one might say that the space for tax increases is nearing its limit. So what the two parties are arguing over now is, specifically, the section of society upon which to impose new taxes.

However, of the current U.S. population of 315 million people, only 115 million are employed full time, while 127 million people currently depend on some form of welfare assistance. Yet taxes cannot be raised on all 115 million full-time workers, because the yearly income of 61 million of these workers falls below the $20,000 poverty line. Add to this the calculations of former U.S. Securities and Exchange Commission Chairman Chris Cox, which take into account future health care, Social Security and retirement expenses and show that the budget deficit will exceed $86.8 trillion. To go about repaying such a debt while relying on tax increases on 56 million individuals, how much tax would each person have to pay?

A year and a half has gone by, and the reason the U.S. has been able to make ends meet up to this point is because it has been relying on a system in which there is no additional debt issued, by selling Treasury bills (short-term government debt) to replace equal amounts of Treasury bonds (long-term government debt). But if there is no new debt in circulation, eventually all the Treasury bills will sell out, which is an unsustainable measure.

Every time the two parties force the debt ceiling upward, the decision to “temporarily and slightly raise future taxation” is made under somewhat strenuous circumstances. But at this point, additional large-scale money printing is not a possibility, because the space no longer exists to substantially increase taxes.

However, there is a double-edged sword of Damocles hanging precariously over America’s head, namely the acquisition of toxic assets from the previous two rounds of quantitative easing. For the most part, most of this bad debt is akin to collateralized debt obligation. The term limit on these kinds of derivatives contracts is usually five years. In 2008, the last time there was an explosion of toxic assets, it forced the Federal Reserve to print $1.7 trillion to rescue the market. If at some point in the coming months of 2013 the contractual expiration of these toxic assets reaches its peak and the U.S. government is powerless to print currency to rescue the market, a financial collapse will very possibly occur.

The author Jia Pu Jing is the project director at Renmin University of China, Center for Macroeconomic Research



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