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Wednesday, September 30, 2009

How Much Can We Borrow?

If your left hand borrows $1 billion from your right hand, would you, as a whole, be bankrupt?

Of course not.

You might wonder where your right hand got the money to loan your left hand. Assume that your left hand is able to create money, more or less like our central bank, the Federal Reserve. Your left hand, over time, gave the money to your right hand, which then lent it back to your left hand.

In this closed-system scenario, no matter how much your left hand borrows, no matter what the interest rate, you, as a whole, will never be bankrupt. Your left hand could choose to default on its debt, but it would never have to default.

Large debt and continued borrowing can potentially cause accelerating inflation. However, there is no inherent hard limit at which that occurs because the demand for consumption and investment in the private sector are equally important factors. Those factors will be the subject of another post.


Harry Eagar said...

You sound like you have been reading Greenspan's 'Age of Turbulence.'

Bret said...

No. I was trying to put together a series of short posts explaining why interests rates (even long term ones) are remaining low in the face of increased borrowing and money supply and this was the first snippet.

Unfortunately, I'm suffering from really severe writers block or something and everything else I've written is total junk so I haven't posted anything else.

Harry Eagar said...

Well, Greenspan agrees with you so far. More prosperity means more debt, according to him.

Of course, he's also a gold bug and expects fiat money to be worthless in the long run.

Hey Skipper said...

We can borrow as much as we are willing to print.

Whether what we print will retain any value will depend upon a combination of assets, future income, and outlays.

So, while my hands would never be bankrupt, they could be full of money fit only for burning.