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Wednesday, June 1, 2011

US Debt and Dollar Devaluation- a catch 22 situation

 On Tuesday, US house rejected a bill to increase the federal borrowing limit by $ 2.4 trillion.Republican made it clear they shall not allow increasing the debt limit without substantial government spending cuts and budgetary reforms.
Prima-facie republican stance seems justified.US debt is almost becoming equal to its GDP (almost 97% of GDP) and might even surpass it in time to come.
Government borrowing leads to higher demand for money which results in higher interest rates and reduced availability of loans to businesses better called clouding out.
So far USA has never failed to repay debt in the past. During the great depression president Roosevelt had devalued dollar by 41% against gold which helped out US banks from vicious cycle of failures.
Presently Japan is having debts more than 200% of its GDP but this debt is owned by mainly by Japanese and they are not willing to sell it. But this resulted in tattered credit rating of Japan.China and Japan being  major debt owners, US government is not that fortunate.
On the other hand China shall not easily let US devalue its dollar fearing erosion in chinese foreign reserves, and its catch 22 situation for USA.
Earlier World War II drove US debt to dreaded 109 % of the GDP which was brought down significantly by post war economic development.But it seems very difficult for USA to repeat the history amidst burgeoning clout of Asian countries like China and India.


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