Comments on Transcript of the Yahoo! Chat with Kevin (August 18 '98)

Page 2 of 2   << Previous Page   Add Comment   Original Item Submitted by: rzaogv KxoiKL , [url=http://krljqfcsvsqc.com/]krljqfcsvsqc[/url], [link=http://argclffxokps.com/]argclffxokps[/link], http://lugqsrlyxtfr.com/ Submitted by: Mounira With the news full of reports of poeittnal defaults of sovereign debt by Ireland and Greece – and poeittnally other EU members, many articles are being written asking the question of whether a similar fate may belong to the U.S.in the future; particularly in light of its massive increases in the national debt over the last couple of years. I believe the answer is a resounding NO due to a basic fundamental difference between the U.S. and members of the EU. Let’s examine what factors are relevant to avoiding default. An obvious factor is avoiding going into debt. However, avoiding issuing debt is not a reasonable policy for most nations as debts must be incurred to fund investments and cover periodic deficit spending. What conditions bring a risk of default for the sovereign debt of some nations but not others? One major factor is mandatory currency convertibility. If a nation’s currency is convertible to gold, another nation’s currency, or practically anything else, the risk of default is introduced. We live in a dynamic world and the relative value of currencies and commodities fluctuate wildly. For nations with convertible currencies, it may be simply a matter time before they get caught in an unfavorable position where holders of their currency exercise their convertibility option at a level that exceeds their ability to covert. This is the situation faced by Russia in 1998 when the ruble was convertible to the U.S. dollar and holders of rubles demanded dollars at rates above the Russians ability to provide them. The Russians had pegged the value of the ruble to the U.S dollar within a relative range (referred to as a fixed exchange rate.) A fixed exchange rate for sovereign currency can lead to a default and it did for Russia in 1998. Neither Ireland, Greece, or the U.S. have a fixed exchange rate into other currencies, precious metals or anything else, so we must look to another factor to explain the difference. The key difference is that Ireland, Greece, and the EU members gave up their sovereign currency while still maintaining liability for national debts. They surrendered the ability to issue and maintain their own currencies to the EU through the ECB. Importantly, however, they maintained national responsibility for their own debts as these were not ported to the EU/ECB. The U.S. has maintained its sovereign currency and this distinction makes all the difference. The U.S. is not at risk of default because it can simply issue sufficient dollars to satisfy its obligations. Yes, the difference is this simple. Each member of the EU has forfeited this option to satisfy its debts and it can certainly lead to default. By entering the EU ceasing to operate a national currency, these countries introduced the risk of default and will always pay increased rates of interest to accommodate risk premiums demanded by lenders. So, the EU created an international competitive disadvantage in the debt markets as compared to sovereign nations who operate their own fiat currencies, even with the risk of default appears to be remote.The concept of insolvency for a nation who operates a fiat currency with a floating exchange rate, such as the U.S. is not viable as the nation can always supply sufficient levels of its currency to satisfy its obligations. This is not to say that a nation can take on additional debt with impunity. In an environment of floating exchange rates, the exchange rates will surely adjust. This adjustment will have implications for imports and exports as for the indebted nation, the price of imports will increase and the price of exports will decrease. Increased foreign investment in the indebted nation should be expected also as a result of the adjusted exchange rates. Another possible outcome is that other nation’s will demand incentives, such as higher rates of interest for transactions in the nation’s currency, or may even resort to demanding payment by means other than the nation’s currency; Chinese Yuan or gold, for example. Submitted by: Edward Submitted by: Kelly Submitted by: Jennifer Submitted by: Dirk Submitted by: James Submitted by: Mary Page 2 of 2   << Previous Page   Add Comment   Original Item