Okay... imagine if you got a letter in the mail saying: "Dear sir, your credit has been downgraded and because of this downgrade, we will be dropping the interest rate on all your outstanding loans by 10%.  We'll also be happy to lend you as much money as you'd like."

Well, that's what happened over the last few days to the United States.  S&P reduced the rating on US debt from "wicked super duper secure" to "secure."  And as soon as the markets opened, investors from all over the world bought as much US debt as they could.  The interest rate on US debt went down by 10%... in one day.

There was also a corresponding drop in some major stock market indexes.  This means that investors were selling stocks and taking the money from the stock sales and putting them into US Treasuries.  The price of treasuries went up and thus the interest rate went down.  Why?  When you buy a bond, you pay some amount less than the face value of the bond and when the bond matures, the bond-holder pays you the face value.  That means, you pay $97.50 for a US Treasury bond that the US Treasury will pay you $100 for in 1 year.

Prices of Treasuries is going up and up which means that the percentage yields is going down and down.  The interest rates for treasuries is going down.  The cost of borrowing is going down.

If the market agreed that US debt was riskier, then investors would not be flocking to US debt, they'd be dumping it, the price would go down and the yield would go up.  Supply and Demand.

But it gets worse.  Many of the investors are investing non-US currencies in US debt.  That means that they are willing to take a risk on currency fluctuations.  If I have a Euro and I want to put it someplace "safe", I'd covert my 1€ to $1.40.  Then I'd buy a TBill.  When it matures in 1 year, I will get $1.44 and will then have to convert that back to Euros.  Now, it's likely that the Euro will appreciate versus the dollar given the US economy, so let's say the exchange rate is 1:1.5 in a year, so when I go to buy a Euro with my $1.44, I'll get 0.96€.  So, despite that a Euro-based investor may lose money by parking Euros in US TBills, they are still doing it.  Why?

Because US TBills are less risky than anything else in the world.  It's worth it to lose some money by parking the money in TBills because the losses are based on currency fluctuations and nothing else.

The Dow and other stock indexes reflect the likelihood of returns on investments.  Those returns come in the form of dividends and stock price appreciation.

A drop in the Dow means that investors think that sitting on cash/TBills is a safer bet than the businesses in the stock market.  Investors think that it's safer to invest in nothing and make no real returns (inflation protected TBills are running a negative interest rate) than to invest in businesses.

One may say, "gee, perhaps government borrowing is crowding investors out of business investment."  Crowding out means that investors get a better return putting money in TBills than in business investments.  That would be the case if TBills were paying any interest rate at all.  Back when TBills were paying 8% 10% interest (in the bad old early 80s), then, yes, there might be an argument that government borrowing is diverting money from business investing.  But at this point, investors think that publicly traded business on Asian, European, and US stock markets have a less than zero chance of returning any money on investments.  That's pretty bleak.

Now, why would it appear that businesses as a whole are so unlikely to be profitable that investors would rather park money in a losing investment where their losses are capped and predictable (TBills effectively paying negative interest), or in public companies?  If the issue were regional (e.g., the US markets doing poorly, but the Asia markets doing well), one would surmise that investors predict that US businesses will be less profitable than Asia businesses.  But it's a global thing.  Investors are selling stocks and putting their money into the one place they know they will get 99¢ or 0.96€ for every dollar they put in.

So, what can we conclude from this:

  • The stock market sell-off is not related to the S&P downgrade of US TBills and every financial reporter who blames the stock sell-off on the S&P downgrade should go back to school (supply and demand).
  • The world's investors is worries about the ability of businesses to make money.  Because businesses make money by selling stuff, we can conclude that investors think that businesses will be selling less stuff.
  • There is a very simple solution to the problem.
Okay... so, Mr. Smarty Pants, what's the solution?  Well, if someone is willing to loan you money at a negative interest rate and you could do something with that money that would increase your ability to pay the money back, would you do that?

Back in 1933, there was this wacky left-wing freak named FDR who promised an chicken in every pot and threatened the Supreme Court that if they didn't play ball with him, that he'd pack a whole lot more people on the court who agreed with his left-wing pinko ideas.

These ideas included borrowing money and spending it on paying people to build things that everyone needs or loves.  Some of those things included the sidewalk in front of my house when I was growing up, the school that my children attend, the Golden Gate bridge and the Hoover dam.  I can tell you for a fact that the $6B spent on all of the WPA projects in the 30s has benefited the country many times over.  In fact, the net present value of the cost of the Golden Gate bridge is likely less than the annual number of tourist dollars spent in San Francisco.

Here's what I'd spend interest free money on:

  • Teachers.  Get class sizes down by 25% in every state school in the country.  Hire teachers and commit budget money to keep them hired for 12 years.
  • Police and Fire.  Hire more and equip them well (with US made equipment.)
  • Pave every road in the country that hasn't been paved in 5 years or more and fix all the bridges, too.
  • Rebuild the air-traffic infrastructure including airports.  Make the US air infrastructure and airports the most modern in the world.
  • Build high speed regional train infrastructure.  That means east coast and west coast and Florida through Texas.  It also means sourcing the trains from domestic manufacturers.
  • Have a contest for "7 Wonders"... seven beautiful structures to be built around the country as a testament to the beauty and creativity of the country.
  • Build Internet infrastructure in every city that facilitates giga-bit Internet to every home and then rent that "dark fiber" out to commercial enterprises to supply the bits to the end consumers.
  • Supply US made computers to every single student in the country (imagine building the infrastructure in Michigan to compete with the $60B/yr Chinese computer assembly business.)
  • Start 2 "shoot the moon" science projects like the Apollo program that creates demand for people who think as solve problems.
How much would this cost?  Dunno... $8T over 8 years is a proctology guess.  What's the multiplier (dollars spent versus taxes collected), probably net cost of $4T over 8 years, but the total cost would be recovered over 20 years.

The big question is how to sell it.  It'd be easy to sell to the 14M unemployed.  "There'll be tons of jobs in your neighborhood next week."  You're not paying taxes now, so what do you care about the government borrowing... you care about, well, a chicken in your pot... and we'll give you a way to earn one.

But the Republicans... how to get about 60 House Republicans to defect.  To vote for a stimulus package the likes of which have not been seen since WWII?  This is were a pork in every barrel become a strategy.  Basically, for every representative that votes for the "Americans Pulling Together" act gets their name on every single project in their district and their name on every single paycheck for every single worker on the project.  "Your paycheck, brought you you by your local representative."  It's campaign advertising on every street corner, on most public buildings and in every paycheck.  That's something that even the Republican warchest could not match.

So, let's all be Americans about this.  It's time to pull together.  It's time to borrow money to invest in our future.  It's time to go all in and build the kind of infrastructure that led to the scientific and social advances of the 50s and 60s.  It's time to put people to work and to build an even greater America... and there are lots and lots of people lining up to invest in this idea at < 2% real interest on 30 year bonds.