The Deficit Battle

A battle between two sides, neither of which truly represents the interests of working people

The tension mounts as President Barack Obama and Speaker of the House John Boehner appear locked in a battle over how best to slash the federal deficit. The Treasury Department is scheduled to run out of borrowing authority on August 2 unless Congress agrees to raise the federal debt ceiling. No one is sure what will happen if there is no agreement but most analysts claim that the consequences will be severe. The U.S. government will not have enough money to pay bond holders what they are owed, leading to a downgrading of government debt and significantly higher future borrowing costs. The possibility of a flight from bonds could compound the problem, with a foreign-led sell off triggering a major dollar collapse.
Both President Obama and Speaker Boehner agree that Congress needs to see and approve a major deficit reduction plan before it will vote to raise the debt ceiling. They just cannot agree on a plan to present to Congress. According to media reports, President Obama has offered two different deficit reduction plans — one designed to achieve a $2 to 3-trillion reduction over ten years and the other a $4 to 5-trillion reduction.

Past Budget Deals

About the only thing we really know about either plan is the relative breakdown between spending cuts and revenue increases. And in both, most of the deficit reduction is to be secured by cutting spending. The chart on the right provides some perspective on how one sided this trade-off between spending cuts and tax increases has become.
As Ezra Klein explains:

“[Under Reagan, Bush, and Clinton] taxes were at least a third of the total, and in Reagan's case, his massive tax cuts were followed by deficit-reduction deals that actually relied on tax increases. . . .

“Bush also included taxes in his deal, and Clinton relied heavily on taxes in his first deficit-reduction bill, which passed without Republican votes. In 1997, when he was working with Republicans, he actually cut taxes slightly while passing spending cuts. But of course the economy was in much better shape then, and Clinton had already increased revenues substantially.

“The one-third rule doesn't break down until you get to the deal Obama reportedly offered Republicans in the first round of debt-ceiling talks: $2-trillion in spending cuts for $400-billion in taxes, or an 83:17 split. And that, if anything, understates how good of a deal Republicans are getting. Tax revenues and rates are much, much lower than they were under Reagan, Bush or Clinton.”

The ratio is said to be more balanced in President Obama's recently proposed $4 to 5-trillion deficit reduction plan: 75:25. However, since that plan apparently includes letting the Bush-era tax cuts for the rich expire in January 2013, Republicans have rejected it in favor of continued negotiations over the smaller deficit reduction plan.

Deficit Reduction: Through Spending Cuts or Tax Increases

Most of those who demand deficit reduction primarily through spending cuts have as their real goal a further weakening of the public sector and our social programs even though they claim that their only motivation is to do what is best for job creation. If we agree that drastic action must be taken to reduce the deficit (to be discussed more below), we face a basic choice: maintain taxes and cut government spending or maintain spending and raise taxes. Cutting public spending pulls money out of the economy, costing jobs. So does raising taxes. The question is whether we lose more jobs cutting spending or raising taxes.
The fact is that almost all studies of the economic impact of changes in government spending and taxes on employment find that changes in government spending have a larger impact on jobs than do tax changes. That means cuts in government spending will cost more jobs than an equivalent increase in taxes. Therefore, if we really care about jobs, deficit reduction efforts should emphasize tax increases over spending reductions. Sadly, both sides in the deficit battle are on the same wrong side as far as this choice is concerned.

Social Programs vs Wars and Tax Cuts

More troubling, both sides have also embraced the conventional wisdom that our debt crisis is real and caused by out-of-control spending on social programs. Therefore, they argue, we have no choice but to take the hard step of cutting spending on those programs.

It is true that our yearly federal deficits have grown large. For example, as Figure 1 shows, the deficit for fiscal year 2009 (October 2008 through September 2009) was $1.4-trillion, equal to 10 per cent of GDP. However, Figure 1 also makes clear that our future deficits are best explained by three drivers: the economic crisis, the Bush-era tax cuts, and the wars in Afghanistan and Iraq. According to the Center on Budget and Policy Priorities, these three drivers “explain virtually the entire federal budget deficit over the next ten years.” Said differently, our debt problems have little to do with runaway social programs. Rather they are caused by specific (tax and foreign) policies that can be reversed and an economic crisis that can only be overcome through public spending.
While Figure 1 focuses on our projected budget deficits, Figure 2 offers an important complementary perspective on our projected national debt. As the Center on Budget and Policy Priorities explains:

“[Figure 2] shows that the Bush-era tax cuts and the Iraq and Afghanistan wars—including their associated interest costs—account for almost half of the projected public debt in 2019 if we continue current policies. Taken together, the economic downturn, the measures enacted to combat it, and the financial rescue legislation play a significant—but considerabley smaller—role in the projected debt increase over the next decade. Public debt due to all other factors than those specifically indentified in Figure 2 falls from over 30 per cent of GDP in 2001 to 20 per cent of GDP in 2019.”

Figure 2 also makes clear that the projected total debt burden, measured by the total debt held by the public as a percentage of GDP, remains below 100% over the relevant period (and beyond according to the Congressional Budget Office), the level taken by most economists to indicate a potentially serious debt problem. In other words we really don't face an impending debt crisis.
Those who are eager to generate fears of such a crisis normally cite a different debt statistic, gross federal debt as a percentage of GDP. Gross federal debt is equal to the total federal debt held by the public plus the total federal debt the government owes to itself. Examples of the latter include Treasury debt held by the Federal Reserve and by the Social Security System. This gross federal debt figure has little to do with fiscal sustainability. In the words of the Congressional Budget Office:

“Gross federal debt is not a good indicator of the government's future obligations . . . those securities represent internal transactions of the government and thus have no direct effect on credit markets.”

Unfortunately, our national debt ceiling is defined in terms of gross federal debt rather than the more appropriate total debt held by the public. At the same time, this understanding of the debt problem leads to a relatively simple solution to our current deficit battle. As Dean Baker describes:

“Representative Ron Paul has hit upon a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6-trillion in government bonds it now holds. While at first blush this idea may seem crazy, on more careful thought it is actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget.

“The basic story is that the Fed has bought roughly $1.6-trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3-trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80-billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself.

“Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn't have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed's destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6-trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.”

In sum, we are witnessing a deficit battle between two sides, neither of which truly represents the interests of working people. No wonder, then, that the battle has done little to clarify the drivers of our rising national debt or encourage a productive national debate over appropriate policy responses. •

Martin Hart-Landsberg is Professor of Economics and Director of the Political Economy Program at Lewis and Clark College, Portland, Oregon; and Adjunct Researcher at the Institute for Social Sciences, Gyeongsang National University, South Korea. He writes regularly at Reports from the Economic Front.

Martin Hart-Landsberg is a frequent contributor to Global Research.  Global Research Articles by Martin Hart-Landsberg

Complete History Of U.S. Debt Defaults

Source: Market Oracle

John S. Chamberlain writes: On July 13th, the president of the United States angrily walked out of ongoing negotiations over the raising of the debt ceiling from its legislated maximum of $14.294 trillion dollars. This prompted a new round of speculation over whether the United States might default on its financial obligations. In these circumstances, it is useful to recall the previous instances in which this has occurred and the effects of those defaults. By studying the defaults of the past, we can gain insights into what future defaults might portend.

The Continental-Currency Default

The first default of the United States was on its first issuance of debt: the currency emitted by the Continental Congress of 1775. In June of 1775 the Continental Congress of the United States of America, located in Philadelphia, representing the 13 states of the union, issued bills of credit amounting to 2 million Spanish milled dollars to be paid four years hence in four annual installments.
The next month an additional 1 million was issued. A third issue of 3 million followed. The next year they issued an additional 13 million dollars of notes. These were the first of the "Continental dollars," which were used to fund the war of revolution against Great Britain. The issues continued until an estimated 241 million dollars were outstanding, not including British forgeries.
Congress had no power of taxation, so it made each of the several states responsible for redeeming a proportion of the notes according to population. The administration of these notes was delegated to a "Board of the Treasury" in 1776. To refuse the notes or receive them below par was punishable by having your ears cut off and other horrible penalties.
The notes progressively depreciated as the public began to realize that neither the states nor their Congress had the will or capacity to redeem them. In November of 1779, Congress announced a devaluation of 38.5 to 1 on the Continentals, which amounted to an admission of default. In this year refusal to accept the notes became widespread, and trade was reduced to barter — causing sporadic famines and other privations.
Eventually, Congress agreed to redeem the notes at 1,000 to 1. At a rate of 0.82 troy ounces to the Spanish milled dollar, if we take the current (July 2011) price of silver, $36 to the troy ounce, this first default resulted in a cumulative loss of approximately $7 billion dollars to the American public.
Benjamin Franklin characterized the loss as a tax. Memory of the suffering and economic disruption caused by this "tax" and similar bills of credit issued by the states influenced the contract clause of the Constitution, which was adopted in 1789:
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts.
The Default on Continental Domestic Loans
In addition to its currency issuance, the Continental Congress borrowed money both domestically and abroad. The domestic debt totaled approximately $11 million Spanish dollars. The interest on this debt was paid primarily by money received from France and Holland as part of separate borrowings. When this source of funding dried up, Congress defaulted on its domestic debt, starting on March 1, 1782. Partial satisfaction of these debts was made later by accepting the notes for payments of taxes and other indirect considerations.
In an act of 1790, Congress repudiated these loans entirely, but offered to convert them to new ones with less favorable terms, thereby memorializing the default in the form of a Federal law.
The Greenback Default of 1862
After the Revolutionary War, the Congress of the United States made only limited issuance of debt and currency, leaving the problems of public finance largely to the states and private banks. (These entities defaulted on a regular basis up to the Panic of 1837, in which a crescendo of state defaults led to the invention of the term "repudiation of debts.")
In August of 1861, this balance between local and federal finance switched forever; the Civil War induced Congress to create a new currency, which became known as the "greenback" due to the green color of its ink. The original greenbacks were $60 million in demand notes in denominations of $5, $10, and $20. These were redeemable in specie at any time at a rate of 0.048375 troy ounces of gold per dollar. Less than five months later, in January of 1862, the US Treasury defaulted on these notes by failing to redeem them on demand.
After this failure, the Treasury made subsequent issues of greenbacks as "legal-tender" notes, which were not redeemable on demand, except through foreign exchange, and could not be used to pay customs duties. Depending on the fortunes of war, these notes traded for gold at a discount ranging from 20 percent to 40 percent. By the stratagem of monetizing this currency with bonds and paying only the interest on those bonds in gold acquired through customs fees, Lincoln's party financed the Civil War with no further defaults.
The Liberty Bond Default of 1934
The financing of the United States government stepped up to a whole new level upon its entry into the Great War, now known as World War I. The new enterprises of the government included merchant-fleet maintenance and operation, production of ammunition, feeding and equipping soldiers entirely at its own expense, and many other expensive things it had never done before or done only on a much smaller scale.
To finance these activities, Congress issued a series of debentures known as "Liberty Bonds" starting in 1917. The preliminary series were convertible into issues of later series at progressively more favorable terms until the debt was rolled into the fourth Liberty Bond, dated October 24, 1918, which was a $7 billion dollar, 20-year, 4.25 percent issue, payable in gold at a rate of $20.67 per troy ounce.
By the time Franklin Roosevelt entered office in 1933, the interest payments alone were draining the treasury of gold; and because the treasury had only $4.2 billion in gold it was obvious there would be no way to pay the principal when it became due in 1938, not to mention meet expenses and other debt obligations.
These other debt obligations were substantial. Ever since the 1890s the Treasury had been gold short and had financed this deficit by making new bond issues to attract gold for paying the interest of previous issues. The result was that by 1933 the total debt was $22 billion and the amount of gold needed to pay even the interest on it was soon going to be insufficient.
In this exigency, Roosevelt decided to default on the whole of the domestically held debt by refusing to redeem in gold to Americans and devaluing the dollar by 40 percent against foreign exchange. By taking these steps the Treasury was able to make a partial payment and maintain foreign exchange with the critical trade partners of the United States.
If we price gold at the present-day value of $1,550 per troy ounce, the total loss to investors by the devaluation was approximately $640 billion in 2011 dollars. The overall result of the default was to intensify the depression and trade reductions of the 1930s and to contribute to fomenting World War II.
The Momentary Default of 1979
The Treasury of the United States accidentally defaulted on a small number of bills during the 1979 debt-limit crisis. Due to administrative confusion, $120 million in bills coming due on April 26, May 3, and May 10 were not paid according to the stated terms. The Treasury eventually paid the face value of the bills, but nevertheless a class-action lawsuit, Claire G. Barton v. United States, was filed in the Federal court of the Central District of California over whether the treasury should pay additional interest for the delay.
The government decided to avoid any further publicity by giving the jilted investors what they wanted rather than ride the high horse of sovereign immunity. An economic study of the affair concluded that the net result was a tiny permanent increase in the interest rates of T-bills.
What Will Happen in August of 2011?
Many people are wondering about the possibility of a default by the Treasury on August 3, 2011, when, according to the Treasury's projections, it will no longer be able to meet all expenses without additional borrowing.
In this event, it is unlikely a default will occur. Historically, governments prioritize debt service above all other expenses. If the expansion of funds via debt becomes ipossible, the Treasury will cease paying other expenses first, starting with "nonessential" discretionary expenditures, and then it will move on to mandatory expenditures and entitlements as a last resort.
In extremis, what will happen is that all the losses will be foisted onto the Federal Reserve. The Fed holds something on the order of $1.6 trillion in debt issued by the Treasury of the United States. By having the Federal Reserve purchase blocks of Treasury debt and defaulting on these non-investor-held securities, the United States can postpone a default against real investors essentially forever.
John S. Chamberlain lives in Natick, Massachusetts, and works as a software engineer specializing in earth science and artificial intelligence. He has an A.B. in politics from Princeton University and an M.S. in computer science from Northeastern University. Send him mail. See John S. Chamberlain's article archives

Economist Forecasts 20 Percent Further Drop in Housing Prices

(ABC News Radio/WLS) -- When will we reach bottom in the housing market? With lenders filing foreclosures more slowly and an excess inventory of homes, housing prices could fall another 20 percent next year, says one economist. Gary Shilling, one of the economists who predicted the subprime mortgage crisis, says the "depressing effect" of two to 2.5 million homes in excess inventory will push prices down.

Foreclosure filings, in which lenders take back homes with delinquent mortgage payments, decreased 30 percent in the first half of 2011 compared to the same period last year. Banks seized 421,212 homes in the first six months of the year, down from 529,633 in the first half of last year, foreclosure listing company, RealtyTrac Inc. said Thursday.
In Illinois, the Governor has announced a plan to spend $100 million taxpayer dollars to give further aid to homeowners who are underwater, with money from the federal 'Hardest Hit Fund.'  This program leaves at least one Chicago mortgage profesional asking 'how will they modify a loan of somebody who doesn’t have a job?' and 'what is the state going to do if these people don’t pay their mortgages'?

But questions that began last fall about hastily-signed foreclosure filings, in part, have led to slower approvals. RealtyTrac estimates that 1 million foreclosure-related notices that should have been filed by banks this year will be pushed to next year.

With only 18,000 jobs added in June, the country also has a high unemployment rate at 9.2 percent. Also contributing to a decrease in housing demand is an overleveraged consumer base and home prices that have already seen a double-dip decline, according to the Case-Shiller Index, Shilling said.

"In the past, almost everyone was sure that house prices would never fall, and on a national level, they hadn't since the 1930s," Shilling wrote. "Now everyone knows prices can fall, have collapsed and continue to drop. Who wants to buy an asset that is highly likely to continue dropping in price?"

Shilling said a place to live and a great investment "are no longer contained in the same package," an owner-occupied home. He added the "zeal" to buy the biggest house one can afford is gone and households are seeking smaller abodes.

Steven Leslie, lead analyst with Economist Intelligence Unit's Financial Services Briefing, said he agrees that housing is in a long-term slump.

Leslie said he has "a lot of respect" for Shilling, who is a "big bear on the housing market," but he points out that rent prices have increased. Leslie said rental prices typically have more influence on housing prices than housing inventory.

Copyright 2011 ABC News Radio/WLS Radio

President Obama Threatens to Veto "Cut, Cap and Balance"

The Obama administration says President Obama would veto the so called "cut, cap and balance" amendment supported by House Republican freshmen and members of the Tea Party if it came to him for signature.
The bill includes a constitutional amendment that requires a balanced budget and allows the government to borrow $2.4 trillion more - but only in conjunction with large spending cuts.
The Office of Management and Budget released a statement that the administration "strongly opposes" it, saying, "Neither setting arbitrary spending levels nor amending the Constitution is necessary to restore fiscal responsibility."
The Office of Management and Budget says the bill "would set unrealistic spending caps that could result in significant cuts to education, research and development, and other programs critical to growing our economy and winning the future. It could also lead to severe cuts in Medicare and Social Security, which are growing to accommodate the retirement of the baby boomers, and put at risk the retirement security for tens of millions of Americans."
Rep. Jim Jordan, R-Ohio, is a big sponsor of the bill and noted his party is doing what they promised when they got elected. "[T]his is just kicking the can down the road. And that's -- the American people sent us here to make big tough choices. They didn't send us here to set up a commission, give the president veto power. That's not what they sent us here to do," he said on Fox News Sunday.
"We are headed for a cliff. If we don't fix it, it's -- now, we are in big trouble," Jordan added.
While there is some support in the House, it is not expected to make it through the Senate.
The president is supporting a "big" deal to handle the debt ceiling issue, and what the White House calls a "balanced" approach that includes cuts but also tax increases.
Lawmakers are deadlocked over an agreement on raising the debt ceiling and have held several meetings at the White House within the last week. Obama met with House Speaker Boehner and House Majority Leader Cantor Sunday night. August 2 is the deadline on which the Treasury Department says the U.S. would default on its debt.
The House is expected to vote on the "cut, cap and balance" bill on Tuesday.

Media Report Uncovers Use of Starvation in Petitioner Death Camp

Source: Time Weekly

A recent report by Time Weekly on the torture and death of a former army veteran documents the use of starvation in a county government detention camp

The death of a former army veteran in a petitioner detention camp by a Time Weekly report on July 14 revealed the use of starvation and torture in a detention camp located in Shanxi Province.
The petitioner named Xu Lingjun died on March 18, 2010, after being tortured and starved for nine months in a “legal training camp” for local petitioners run by the Chenggu County government in Shanxi Province.
According to the report, several other petitioners in the camp were also tortured and starved at the detention camp administered by the county government.
The training camp, set up in May 2008, is used as a detention center for petitioners in Chenggu County.
Xu was sent to the institution in June 2009, after he repeatedly sent petitions to the local and central government. Laid off from a factory in 1998, Xu claimed he did not receive benefits that he was guaranteed as a disabled army veteran.
An autopsy carried out by Hanzhong City’s Public Security Bureau found no trace of food residuals in Xu’s stomach apart from two coin-sized ice chips. His body was then sent for cremation by the local government.
After Xu’s death, ten petitioners in the institution suffering from similar conditions were sent to the hospital for medical care.
In China, petitioning is the primary channel for individuals to seek legal redress. In practice, it is often obstructed by local authorities.
To date, the training camp is still in operation, and no criminal investigation has been launched into the case despite the appeals from Xu’s family to the local procuratorate and court.

We're All Greeks Now

Departing for New Hampshire in November 2010, Sen. Judd Gregg, the fiscal conservative President Obama wanted in his Cabinet, blurted an inconvenient truth: "This nation is on a course where if we don't do something about it, get ... fiscal policy (under control), we're Greece."
The remark was regarded as hyperbole. But Gregg had a point. For though Greece, measured by the size of her economy, is only 2 to 3 percent of the EU or the U.S. economy, she is a microcosm of the West.
Consider the demography.
According to the most recent revision of the U.N.'s "World Population Prospects," Greece in 2010 had 11.2 million people. 

More than 24 percent were 60 or above, more than 18 percent 65 or older. Three percent were 80 or above. And, every year, for every nine Greeks who are born, 10 Greeks die.
Greece is slowly passing away.
Fast forward to 2050.
Greece's population will have fallen by 300,000 to 10.8 million. The median age will have risen by eight years to 49.5. Half the population will be 50 or older. More critically, the share of Greece's population 60 or older will be 37.4 percent, with 31.3 percent over 65. One in nine Greeks will be over 80.
If Athens is breaking under the weight of early retirement and pensions for seniors today, her situation will be horrendous by mid-century.
Where, in 2010, there were four Greeks under 60 for every Greek over 60, by 2050, there will only be 1.7 Greeks under 60 for every Greek over 60.
Conclusion: The retirement age must rise, and pension benefits fall, or Greece collapses. 

What of the possibility of a new baby boom? Not likely, given that the fertility rate in Greece has been below replacement levels for three decades and is today only two-thirds of that needed to replace the present population.
Indeed, by 2050, the fertility rate of Greek women will have been below zero population growth for 80 years. One wonders: How can the U.N. estimate that Greece's population will fall only 3 percent by then? Is the U.N. assuming mass immigration from the Muslim world?
But what does Greece have to do with the rest of Europe, or with us? 

Only this. The median age of all of Europe is rising, and the demographic numbers for Greece look positively rosy alongside those of the east, where population declines in the tens of millions are projected for Russia and Ukraine. And outside Iceland and Albania, not one nation of Europe has a fertility rate sufficient to maintain its population. Those that are projected to grow, like Britain, have to be relying on Third World immigrants and their higher birth rate.
But while this may maintain an existing population size, immigrants from the Maghreb, Middle East, Caribbean, Latin America and South Asia, on average, lack the language, technical skills and educational levels of native-born Europeans.
The same is true in the U.S., where peoples of European descent are expected to drop to half the population by 2041. Hispanics will grow from 15 percent to near 30 percent of the U.S. population, and their absolute numbers from 50 million to 135 million by 2050.
Yet, again, Hispanics and children of Hispanic immigrants have not, as of yet, reached close to parity in educational achievement with Americans of East Asian or European ancestry.
People equate today's immigration with the immigration of 1890-1920. But another major difference is this: We erected a Great Society over 50 years that did not exist in 1920.
In Washington in the 1950s, a city of 800,000, half black and half white, food stamps had not been invented. Families fed themselves. Today, in a District of Columbia of 600,000, one in five are on food stamps. Nationally, a program that did not exist in 1964 feeds one in seven Americans, 44 million people, at a cost of $77 billion a year. And that is but a small fraction of our new Great Society.
We are entering a new "age of austerity," said British Prime Minister David Cameron in 2009. 

The halcyon days are over. Government payrolls, as is happening from California to New York to Washington, D.C., will have to be slashed. Pension and health care benefits, not only for seniors, will have to be reduced. Retirement ages will have to be raised. From food stamps to foreign aid, programs are going to be capped and cut. The left believes it can get the money from the wealthy. But the top 1 percent of Americans in income already carry 40 percent of the federal income tax load, while the bottom 50 percent of wage-earners ride free. This, too, will have to end.
We are either going to man up and radically reduce government at all levels in the United States, or the bond markets are going to do it for us, as they are doing it today for Greece, Ireland and Portugal.
We're all Greeks now.

The Natives Are Getting Restless: Chinese Police Station Attacked, 5 Killed

As if a global solvency crisis and a possible rekindling of the only middle-east conflict that matters were not enough, here is China to remind everyone that keeping 1.3 billion people happy is not very easy. According to AP, "Several attackers, a policeman and three others were killed Monday during an attack on a police station in China's far western Xinjiang region, state media reported. It said other police rushed to the scene and shot dead "a number of thugs." One policeman, two hostages and a civilian were also killed, Xinhua said. A woman from the information office of Xinjiang Public Security Department in Urumqi confirmed the attack, but would not give any details. As is common with Chinese officials, she refused to give her name." To be sure the official explanation is one that breaks down the conflict along ethnic lines: the last thing the Chinese need is a spark to realize that the unhappiness they may feel (especially those without access to off balance sheet bank loans to fuel their gambling habits), is all too real.
From AP:

Xinhua did not give a reason for the attack. But Xinjiang has been beset by ethnic conflict and a sometimes-violent separatist movement by Uighurs (pronounced WEE-gurs), a largely Muslim ethnic group that sees Xinjiang as its homeland. Many Uighurs resent the Han Chinese majority as interlopers.

Dilxat Raxit, spokesman for the Germany-based World Uyghur Congress, said several sources inside Xinjiang told him the violence erupted when a large group of Uighurs tried to protest in Hotan on Monday morning. A clash broke out between the demonstrators and police, he said, and police opened fire.

More than 100 Uighurs had gathered to demonstrate against alleged illegal seizures of Uighur-held land and to demand information about relatives who they said had disappeared amid a police crackdown that began after riots in the regional capital of Urumqi in 2009, Dilxat said.

Dilxat said he could not identify his sources or say where they were located in Xinjiang for fear they would face official reprisals.

The region has been especially tense since the deadly 2009 clashes erupted between predominantly Muslim Uighurs and Han Chinese migrants. Uighurs attacked Hans, overturning buses and torching shops in the regional capital of Urumqi in a riot the government says killed 197 people.

Alas, we get the feeling that this incident will be repeated elsewhere in China, this time without the benefit of the WEE-gur scapegoating.