Long time reader TomK asked for my take on this article by Jeffrey Rogers Hummel titled Why Default On US Treasuries Is Likely.I'm going to keep this short, I had planned to take the weekend off from all writing.
Hummel's argument appears to be a combo of ideology that is very reasonably backed up with plenty of numbers. To be clear the argument is compelling.
It is a long post. Earlier in the week I read something similar elsewhere (sorry don't recall where) that explained it very succinctly; when your minimum credit card payment no longer covers the monthly interest you are in big trouble. Hummel's post says this in a more articulate manner by focusing in on government spending as a percentage of GDP and taxation a percentage of GDP and how the numbers, where they appear to be headed based on what we know today, simply cannot work.
Possible (or probable?) outcomes include inflating our way out, "repudiating" the debt (which he feels is more likely) and as an olive branch of sorts he talked about shuttering the medicare program. Obviously all three are unpalatable across many fronts.
I am not the guy to outdebate the author or figure out the solution but I felt there was one glaring omission from the article. Inflating or repudiating has dire consequences for the many countries who hold and continue to buy large amounts of US debt. Quite a few countries own too much to just sell because who would buy? Additionally the extent to which the greenback is the currency used in many transactions globally and the number of countries that peg to the greenback creates an urgency (either now or in the future) to seek out a globally coordinated solution.
That is not to say a globally coordinated solution could be found and successfully implemented but for me to agree with the conclusion drawn in the article I need to see this point addressed even if it is subsequently shot down.
10 comments:
Roger,
the end of the democrocies are heavy words. The US debpt is well below many eourpean contries after the recent intervetions. These interventions have provided the necessary liquidity to come out of the hole. It depents what the fed will do next as to what the enviroment will be like. I remembre in 1981 we 14% interest rate today is below 5 so the long term interest rates are to increase. Property value will stabalize. That is there will be inflation but the value of property will increase less than inflation. Currency and treasury is not the place to be. It was niot clear to me before that the fed providing liquidity would be positive as to spur a bull run on stocks. For those like Ritzholt that never noticed the greenshoots are still holding the bag. I am turning more cautious since some of the bearish services are turning bullish and I still feel that we may have a bit more to go to 1166 on the S&P. We may turn down after because the fed on the second phase has to take that liquidity out and it is a tricky manuvour to do even politically more difficult to achieve. That is the reason that I am not so bullish in 2010.
Best,
Jeff from Milan, Italy
An interesting and timely topic. My personal take has always been that there are 3 possible ways, in some combination, out of the current deficit/spending fiscal crisis: (1) Significantly raise taxes on enough people to actually cover the spending. This means raising taxes, in a significant way, on people who make well below Obama's magical $250K figure. (2) Borrow, meaning that interest rates will be double-digit for a considerable time into the future and taxes will go up sufficiently to cover the interest on the debt. And/or, (3) inflate. Given 20th century history, I predict #3. Any of the 3 possible solutions means a decrease in future Americans' standard of living.
JCarr
If people stop buying treasuries the fed will buy them so there will not be a default.
Limiting entitlements is the preferred solution, but the will try raising taxes instead which will be counter productive as you will simply increase unemployment and shutter small businesses.
We are turning Japanese, but first a bull market IMO.
Austrian school screeds and, frankly, far too many economic arguments generally all have the same feel: They're just so emphatic, so carefully or passionately reasoned from 'self-evident' premises, you feel they must have it right even though hardly any of them agree on anything and virtually all of them have failed as predictors at one point in time or another; i.e., if economics were a science most of its theories would be falsified by now and a Kuhnian revolution would be ongoing (well, who knows, maybe it is in progress, finally).
IAC there are many possibilities but the US and most of the developed world have had debt ratios significantly larger than now without defaulting, even to the point of exceeding GDP -- e.g., during and immediately after World War II -- so we should probably allocate a relatively low probability to that outcome, at least for now. A currency crisis seems rather more likely, probably presaged by a gold bubble, but I wouldn't bet the US dollar will get the worst of it; in a world of fiat currencies it is quite possible everyone will come to believe the US dollar is the worst currency in the world ...except for all the others.
My own guess is that all the pump priming will foster a few more bubbles, likely of progressively diminishing size, before it becomes clear that increasing productivity (that's the missing #4 in JCarr's list above) will not pull us out as it has in the past because, ultimately, what is produced has to be purchased. Since job destruction has assumed secular proportions since the 2000 crash it seems unlikely the national economic mood will become expansive soon; e.g., http://tinyurl.com/lyhw9n
JMO
Thanks for your thoughts Roger. I never gave much thought to the repudiation argument, and the article did not convince me.
Hyper-inflation seems more probable, but only after the government tries to keep debt holders happy with a few rounds of massive tax hikes. And we all know what that will mean in terms of economic grow and jobs.
@RW,
Have you watched Chris Martenson's "Crash Course". If so, any thoughts?
Somewhat rambling thoughts to follow:
I've got a MBA in finance, and have passed CFA Level 1 so I have an "education" so to speak, and I understand conventional finance theory.
What I realized over the past year with the onset of the fall 2008 collapse is that I really didn't understand the nuts and bolts inner workings of both the U.S. and global financial/monetary systems, especially as it relates to debt/credit, the "creation of money", and the implications of a debt-based fractional reserve system.
I'm not sure I do now, except that in the pit of my stomach, I can't help but feel there is something entirely unworkable and untenable about the entire system, and that 10, 20, 30 years from now, we may see something entirely different the the previous 20-30 years.
So what? Well, I guess my main concern is what really is the optimal "store of value" for the savings one acquires as the result of labor.
Is it paper fiat currency? Which history is replete with examples of total failure? Is it government bonds? Is it gold? Which has been money for thousands of years. Is it stocks? Presumably, having a percentage ownership in the productive enterprise of a society should always have value except in some sort of worst-case scenario where all previous legal claims on assets are declared null and void. A sort of entire system reset.
I can't find the exact quote at the moment, but I can't get out of my head Mises' thought that the final stage of a credit-induced crack-up boom is total destruction of the currency.
Just curious to hear your thoughts on these matters.
I think it is very useful to examine future scenarios even if they seem unlikely or unprecedented. I am reading "Reinventing Collapse" which compares to the US and the late USSR on a few different fronts. (note that I don't necessarily agree with all particulars of the author's analysis).
Like RW pointed out any pat theories for what is going to happen in the next couple decades are probably going to be mostly wrong. It is hard to say if default is more likely than mustering the political will to chainsaw slabs of blubber from the federal budget.
This is akin to deciding if a raft is going to tip to the left or right before running a rapid. It is also possible that it could flip over the front, or get spun around and flip over backwards. It is also possible that a heavily laden boat makes it through a class 5 with beer intact even though all on-lookers thought it was done for.
I personally don't think that defaulting will save the dollar or the social programs.
I think that the default issue is a bit farfetched.
Inflating our way out of our poor financial,economic and (dare I say) pathetic political decisions is more apt to be on target.
T
MikeC: Understanding modern money presents some conceptual challenges -- so much of what it is now seems ephemeral, a matter of a book entry or data bytes -- but while I think Chris Martenson's work is genuinely helpful in most respects he has his own slant here, some of which appears apocalyptic or questionable; e.g., the deceptively 'commonsensical' notion that governments can be analyzed as you would a business (which naturally finds government wanting) ignores the rather obvious fact that governments are not businesses any more than business corporations are individual persons and it requires a very specific set of ideological assumptions to argue as if they are.
Still it is difficult to disagree with the notion that our national debt has become excessive: Its not nearly as large as it was in WWII of course but it really is amazing what a few decades of administrations dedicated to taxing less while spending more were able to accomplish; the relatively modest budgetary successes of the Clinton administration hardly made a dent in the mountain of liabilities that confront us now.
How global currency regimes will eventually realign or fall out as a consequence of this past profligacy to say nothing of our current response to it is as much as mystery to me as the next fellow but I do think Roger has the right take on one count: A US dollar collapse is not good for anyone and virtually every government and central banker from here to Timbuktu is going to fight a smash-up. If the system were closed the only alternative to default or hyper-inflation would be growth with the latter seeming less likely than increasing inflation ...if the system is really closed that is.
IAC you might find it useful to contrast Martenson's understanding with that of another amateur, who's last name of Hummel is (coincidentally I'm sure) the same as the author of the article TomK linked. This particular Hummel became so interested in credit and money he immersed himself in the subject and, in the process, developed some very nice learning materials available at http://wfhummel.cnchost.com/
Not being a pro myself I can't vouch for anyone's orthodoxy but I find this Hummel's slant somewhat more balanced and less prone to emphatics than others, if you get my drift.
Hope everyone enjoyed their game (doubtless plural in Roger's case [g])
OT but Matthew's analogy to the nonlinear trajectory of rafts in a rapid and the unexpected survival of the overladen beer boat elicited a recall. Many years ago I rafted the Zambezi working as a swamper and, because most of my experience was on the Colorado river in the Grand Canyon which also has very large rapids, received some good-natured hazing from the boatmen about Zambezi rapids being comparatively bigger.
Truth to tell some were -- we even had to portage a few -- but I wasn't going to let on and so every time one of the boatmen would ask, “how about that one,” I'd say something like, “pretty good but I'd guess the drop at Lava Falls (or the hole at Crystal or the standing wave at Hermit, etc.) might be a tad bigger.”
This kept up until the fifth day when we camped above a rapid called “Ghostrider.” It was a monster, cutting through a sheer, basalt gorge with huge haystack waves at the entrance and standing waves masking big boulders with holes right and left before a right-turning bottom that was barely visible: Not just big hydraulics that you hold on and plow through but technical maneuvering required at entrance, middle and end; in short a huge Class V. When asked, I allowed that this rapid might be a bit bigger than Lava Falls but I'd know for sure once we got through.
We ran successfully next morning although my boat got jammed into a corner pocket against the cliff face at the end that we were lucky to get out of.
Afterward one of the boatmen who had been on the first Zambezi exploratory told me how the rapid got its name. Exploratory crews from Sobek are among the most experienced white water specialists in the business but when they scouted that (currently) unnamed rapid no one wanted to be the first to try it so they sent an empty boat down as a trial: The boat made it perfectly upright the whole way as if an invisible master boatman was at the oars; I was told that most of the boats that followed could have used an assist from that ghost.
Okay, enough lollygagging for now.
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