“Be kind, for everyone you meet is fighting a hard battle” - Often attributed to Plato but likely from Ian McLaren (pseudonym of Reverend John Watson)

Sunday, April 05, 2009

Debt is a commodity too

I've been reviewing some of my posts (self-indulgent but, in a way, gratifying too) and they caused me to wonder. I've complained and I've listened to others complain that the United States is getting out of the business of producing things. We're running out of many natural resources (uranium, crude oil, iron ore, etc.) and we've decided to outsource much of our manufacturing. And yet we have the highest standard, or at least among the highest standards, of living in the world. Certainly we have, by far, the highest per capita rate of energy usage which is a reasonably good proxy for standard of living. The things comprising this standard aren't free, and since we aren't selling manufactured products or raw materials, what are we exchanging?

The answer is obvious, we're exchanging debt. But what is debt? It's the right to collect something of value from us at a future time or at future times. In that sense, it's a commodity. When I buy an "oil future" I exchange cash (not even the actual amount of the quantity of oil I'm committing to purchase times the unit price at which I'm committing to purchase it) for the right and the obligation to accept delivery of the oil at a fixed date and price. In this way, U.S. debt can be regarded as a "production future." China, for example, exchanges yuan for the right to receive dollars at or over a future period of time. The value of those dollars may rise and fall.

U.S. debt's value as a commodity is tied to our ability to, at some future time, produce or extract things of actual value. In this way, it's also like oil. We don't want oil to have it, we want oil to use to do things. The Chinese (and the various other governments, NGO's, pension funds, etc.) buyers of our debt want to use it to do things as well. Given that our ability to extract natural resources, manufacture durable and non-durable goods, etc. is declining, what would these holders like in exchange for the debt that they own?

One thing is intellectual property, but this is quite risky since any such property is easily copied. Ask Sony, the RIAA, any drug manufacturer, Microsoft, etc. One might say the holders of the U.S. debt could want dollars, but only if those dollars can be exchanged for things with some intrinsic utility.

For this reason, U.S. debt is a commodity whose value is dependent upon the perceived ability of the United States to produce a surplus of something of value. It's been amazingly resilient considering the amount of the commodity already produced and the trends for our ability to produce things of value. It's hard for me to see how perception of the ability to exchange U.S. debt for things of real value can withstand the facts on the ground.

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