Government Spending

The Final Bubble: U.S. Government Debt

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Prominent economic I-told-you-so-er Peter Schiff makes the succinct case in the Wall Street Journal for why tripling down on massive U.S. government debt produces long-term risks that are inconceivable for most mainstream politicians, economists, and commentators:

[T]he nations funding the majority of America's public debt—most notably the Chinese, Japanese and the Saudis—need to be prepared to sacrifice. They have to fund America's annual trillion-dollar deficits for the foreseeable future. These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand.

These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people. When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher) and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

But just because the game has lasted thus far does not mean that they will continue playing it indefinitely. […]

If any other country were to face these conditions, unpalatable measures such as severe government austerity or currency devaluation would be the only options.

Link via Instapundit.

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  1. I wouldn’t invest with Schiff

    From the link:

    I have talked with many who claim they have invested with Schiff and are down anywhere from 40% to 70% in 2008. There are many other such claims on the internet. They are entirely believable for the simple reason Schiff’s investment thesis was flat out wrong.

  2. Small chunk of land, check

    Tall fences, check

    Cache of firearms, next on the list

  3. SIV,

    The fact that I wouldnt invest with Schiff doesnt make him wrong about this or a bunch of other stuff.

    Just makes him wrong about investments.

  4. Paulson (the other one) was more right than Schiff, he just keeps his mouth shut and rolls around in his pile of money.

  5. that’s why it’s called the “almighty dollar.”

  6. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

    This argument reminds me of the “battered spouse” scenario. He promises to be behave, and not beat her anymore. She comes home. She always comes home.
    Until she doesn’t.

  7. Are there any counrties that aren’t fucked? Just cusrious, cause I’m thinking about getting a one-way passport pretty soon…

  8. The US will either repudiate the vast majority of this debt through moderate inflation, or the market will repudiate it for them via a currency devaluation. Either way, it’s far from the disaster that is portrayed in the article. In fact, the “crash” of either debt or currency is the only trigger that will yield a rebalancing of our economy towards production, and away from deficit financing. It has to happen, and won’t kill a single person. Except maybe some suicide prone hedge fund managers.

  9. That’s curious, rather…

  10. robc,

    The Mish link I gave just shows he wasn’t as prescient as he is given credit for. I would’ve predicted a US housing and equity collapse if they let me on CNBC too:)

  11. SIV,

    The difference between you, me, Schiff and Paulson is that Paulson figured out how to invest in housing collapsing.

    It doesnt make Schiff (or you and me) wrong. My investments lost 30-40% last year too. Doesnt mean I was wrong.

  12. ” In fact, the “crash” of either debt or currency is the only trigger that will yield a rebalancing of our economy towards production, and away from deficit financing.”

    It’ll be hard to rebalance toward prodcution when over half the population will be on welfare – they have no incentive to produce anything.

    –Other than producing new notions of additional goods and services that they’re “entitled” to at someone eles’s expense.

  13. This is exactly why the long term arguments for deflation are untenable. Short term, different story. Buy long TIPS, Taktix – there is an auction of 20 year TIPS at 1pm today – call your broker.

  14. Excuse me while I take out my hip flask.

  15. domo,
    Exactly how much inflation would we need to make the debt manageable? For that matter, what percentage of the US GDP does the national debt currently equal?

  16. economist,

    2007 estimate was 60.8% of GDP. That was better than Canado, 62.3% but worse than the Netherlands, 57.3%.

    Source: CIA world factbook

  17. If INflation is a monetary phenomenon, then DEflation must be, as well. The money supply is not exactly contracting. We have been seeing price shocks based on demand destruction, with some currency exchange effects thrown in.

    This is what I have been thinking, recently. And intentionally inflating the currrency is not likely to stabilize much of anything.

  18. Most of the real national debt doesn’t even show on the government’s books.

    That would be the unfunded liabiltiy for social security and medicare.

  19. New Zealand at 22.9%, for those looking for a western democracy with low debt. Also, Australia, 15.4%.

  20. Jeebus H on a cracker, when our best-case scenario is inflation/currency devaluation, we are well and truly fucked.

  21. This deficit spending is okay, because a Democratic president and Congress are incurring it. I’m only telling you this because I remember how all the libertarians shilled for the Bush administration. Yeah, I’m that good.

  22. Gilbert Martin,

    Most of the real national debt doesn’t even show on the government’s books.

    Anyone know if the GAAP versions are still being produced?

  23. Thanks, robc.

  24. I hate you free-market fundamentalists. AAAAAAAAAAAARRRGGGGGGGGHHHH!

  25. Doesn’t anyone miss me?

  26. economist, I imagine the actual scenario will involve some combination of currency depreciation and inflation. given that, the answer is some combination of those two variables. I think the current level is something around 65% of GDP – not including debt held by the SS “trust fund” etc. To determine the level of inflation/depreciation, you would have to assume some sort of “manageable” debt/gdp ratio where you think the US would again become a good credit. Then you would have to look at the maturity schedule of debt and impose some sort of future inflation curve on it. add to that some future path of the dollar. Tell me those three variables, and the answer is trivial – notwithstanding that it’s impossible.

    My personal wild-ass-guess is 4-5% inflation over 10-15 years (starting in 2-3 years), and a 20-30% devaluation in the dollar.

  27. I was in cash and US bonds:^)
    Bubbles make me risk averse as I am wont to procrastinate on shifting a position.

    What I found interesting about John Paulson’s success is that he would have been too early if not for the fortuitous delay in securing permission and capital for his play. Timing is everything and it is largely luck in the timing.

  28. P Brooks,

    “If INflation is a monetary phenomenon, then DEflation must be, as well. The money supply is not exactly contracting.”

    Well, it is actually. Money is credit, and credit is money. The velocity of money is falling like a rock and people are sitting on cash. the expansion of the Fed’s balance sheet is truely astounding – but that doesn’t mean it wouldn’t be 4 times as large to match the combined effects of reduced lending and credit tightening. Short term real government rates are still over 3.5%!

    “Most of the real national debt doesn’t even show on the government’s books.”

    The stated reason for this is that the liabilities can be changed by law – which eventually it will have to be. You’re right that treating it like it doesn’t exist is total BS.

  29. SIV,

    Paulson was too early anyway, his anti-housing funds struggled for a while until housing finally tanked. I guess he would have been way too early otherwise.

    That is the problem with going negative. To steal a line from someone – the market can stay irrational longer than you can stay solvent.

  30. Gee, what’s happening here? Almost all the comments are better than the article itself! Who says there’s no such thing as a free lunch!

  31. This is exactly why the long term arguments for deflation are untenable.

    Cue Keynes “In the long term we’re all dead”

    domo,

    Deflation can run for a while.It has before.

  32. I heard a new acronym today that I think will apply nicely to these situations: BOHICA

    Bend Over Here It Comes Again.

  33. The stated reason for this is that the liabilities can be changed by law – which eventually it will have to be. You’re right that treating it like it doesn’t exist is total BS.

    Is this the time to point out again that keeping your corporate books like the fed keeps theirs is an invitation to receiving free housing from the fed for a looong time?

  34. T,

    Most corporations arent in charge of setting the rules.

  35. “Anyone know if the GAAP versions are still being produced?”

    I beleive the Social Security and Medicare Trust fund (an oxymoron if there ever was one) trustees produce annual reports with estimates of the unfunded balances.

    And the Treasury department produces an accrual accounting basis set of government financials.

  36. And the Treasury department produces an accrual accounting basis set of government financials.

    This is what I was referring to. They were created for a while, then they got canceled for a decade or so, then they started up again. Hadnt heard anything about them, so wasnt sure if they were still being produced.

  37. This deficit spending is okay, because a Democratic president and Congress are incurring it. I’m only telling you this because I remember how all the libertarians shilled for the Bush administration. Yeah, I’m that good.

    Please stop spoofing commenters. It devalues the conversation, confuses people unnecessarily, and forces us to spend more time on technical fixes and less time on journalism. Seriously, just knock it off.

  38. Cache of firearms, next on the list

    Better hurry. You’ll miss the firearms bubble, the only economic stimulus that Obama’s actually been able to do so far, and the only type he’s apparantly quite ready to regulate away.

    I don’t know the HTML code for an audio slow echo series of “nothing to fear…nothing to fear..”, which is too bad as this would be the perfect place for it.

    Oh, and ammo, or reloading. One or two firearms are more than sufficient, but suck if you run out of ammo.

  39. 2009 will see 10%+ unemployment and inflation.

  40. SIV,

    It can. I think it won’t. but that’s my opinion. Interesting that today this artical comes out. At this very moment, my bloomberg screen tells me that long dated TIPS have richened 2% into the auction this afternoon, while long bonds have cheapened by as much. This tells me that Bernanke is not being taken seriously in his pledge to buy long term debt to keep yields low – and that his long stated plan to conduct monetary policy in a deflationary environment is probably not credible.

    My view is that this will lead further asset price collapse, and massive short term deflation. This will result in a huge retirement (lack of it) problem for people in their 50’s, but long term, is probably ok for the country. Sure we’ll have to pay more for our chinese toys, but we’ll save, economize, and return to a more balanced economic model. Not because Obama says so, but because the markets will insist upon it.

  41. That’s a whole pillar of joe’s debate strategery, Matt. Make up assertions that he doesn’t agree with and attribute them to other people.

  42. 2007 estimate was 60.8% of GDP.

    I’ll bet that went up last year, and will probably skyrocket this year.

  43. “The stated reason for this is that the liabilities can be changed by law – which eventually it will have to be. You’re right that treating it like it doesn’t exist is total BS.”

    Changed by law = means testing = ripping off millions of people who paid payroll taxes into the system for decades who will get a big goose egg in return.

  44. Hey Matt Welch,

    Why you are here, I was about to excoriate you for never publishing my iraq war/GDP figures, but when I went to find the original thread, my search turned up your post from Dec 23 when you did so. So thanks. Sorry my rss feed seems to have ignored it, and I was subsequently unable to participate in the discussion – but you are a man of your word, even if you seem to have difficulty using excel 😉

  45. domoarigato,

    Your advice to go long TIPS is ok advice, but it worries me that its the same government that gets to define the CPI inflation term in the yield formula. If a significant amount of debt was in the form of TIPS, would it not become irresitable to play with that inflation figure to save the gov interest expense?

  46. Should have typed “While you are here” See, I’ll never get that reason job if I can’t convince the editors that I can write decent english…

    Gil, you are correct that that means testing is one way to accomplish it. I don’t think it’s the only way, and I hope not the way we choose. That said, it’s barely better than welfare as it is.

  47. even if you seem to have difficulty using excel

    “Difficulty” doesn’t begin to capture the totality of it. Imagine you were, I dunno, addicted to heroin, but unable to operate a syringe or even a hookah. It’s very frustrating.

  48. Wow that Mish article SIV posted was really telling.

    Thing is, I’m not a stock investor.

    I think I still agree with Schiff that it is very likely that the US will end up in a hyper-inflation scenario at some point. Unfortuanately for his investors, but perhaps fortunately for us, it hasn’t happened yet.

    I hope that it’s still possible that we can avoid such a scenario. But with all the defecit spending and monetary base expansion that’s apparently going on, we may be stalling the inevitable and making the future collapse worse.

  49. Most corporations arent in charge of setting the rules.

    Not directly, anyway. See the other thread about Google’s lobbying.

  50. scott clark,

    Our buddies at the BLS take a lot of crap. Fortuneatly, there is also the PCE and GDP deflator stats. Any meaningful wholesale manipulation would require a pretty immense conspiracy theory argument. I see it as a pretty unlikely scenario. Also, TIPS are a tiny percentage of gov’t debt. Get yours in 52 minutes!

  51. @Matt Welch: fix your damn forum, as I’ve suggested numerous times. There are technological ways to deal with trolls. I have implemented them for my own forums with great success. It ain’t rocket science.

  52. “Gil, you are correct that that means testing is one way to accomplish it. I don’t think it’s the only way, and I hope not the way we choose. That said, it’s barely better than welfare as it is.”

    It is my opinion that means testing is what is eventually going to be implemented. It is consistent with the stick it to the “rich” mentality increasing numbers of people are signing on to as a rationalization for their desire to sponge off of others.

  53. @Matt Welch: fix your damn forum, as I’ve suggested numerous times. There are technological ways to deal with trolls. I have implemented them for my own forums with great success. It ain’t rocket science.

    We are in the process of doing so. However, that doesn’t mean I can’t browbeat people out of resentment!

  54. squarooticus,

    As I have suggested numerous times, there are technological ways to deal with trolls that dont rely on reason doing anything. Its good to see they are working on something, but until then, use INCIF.

  55. Unfortunately, INCIF doesnt help with people spoofing joe, but I dont see the silly lefiti wars.

  56. …it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

    Shorter ?: the US is too big to fail.

  57. USA! USA! We’re # 1! W00t!

  58. I would think H&R should be a model of self organizing efficiency. Let the non-trolls apply social pressure – don’t coerce the douchebags!

  59. domo is right, the spoofing of Lefiti seems to have been largely successful in shutting him up.

  60. not to mention being more entertaining than his actual posts. Low bar though that may be.

  61. You can’t apply social pressure to an anonymous commenter.

  62. Let’s see… there are, give or take, twenty different free WiFi hubs around here, including Arby’s (nothing like a nice Jamocha shake to keep yer trollin’ powers up); with a little judicious “hittin’ ‘n runnin’ it will probably take months for them to block me. And that just adds to the fun.

    And, if I can slip a few “straight” personae onto some of those hubs, they probably won’t want to block the whole thing.

  63. Registration is an option, but given the “stick it to the man” attitude of Reason folk, that may not be applicable.

  64. “You can’t apply social pressure to an anonymous commenter.”

    Why not? I presume they read the thread as well as post to it. Ignoring seems to produce the good result, whereas flipping your shit, the opposite…

  65. I, for one appreciate the efforts of our trolls on this website, as a whole they provide some value (at great effort on their part) while require zero of my time to ignore as applicable. This efficiency gives me more time to focus on important things; like explaining monetary policy to partially formed Austrian economist wannabe’s.

  66. When currencies fail, it happens suddenly.
    It’s not just our enormous debt that is a sword dangling above our heads. 47 nations met in Beijing in October and they want to escape the web of our economic plunges. They have pledged reform. This means scrapping the dollar as the world reserve currency and replacing it with a basket of currencies. The dollar is also being unpegged from crude oil sales.
    Either of these developments send our economy into chaos, which is why we invaded Iraq 6 months after Saddam began accepting currencies other than the dollar and why we wanted to invade Iran.

    When the dollar crashes and is no longer accepted for crude, we will have to take oil by force, in the interest of national security. We will then forget the Middle East and take it from the more conveniently located Venezuela. Russia and China will sacrifice this pawn in exchange for the Ukraine and Taiwan.

  67. 2009 will see 10%+ unemployment and inflation.

    Warren,

    10%+ unemployment is certainly quite possible. Inflation much less so. In theory the fed can run their presses 24/7 and force 10’s of trillions cash into the economy. In practice it’s a wee bit more complicated.

  68. Can we mark Ra as a conspiracy theorist? And an economic idiot?

  69. Ra, your thesis is interesting and reads like a tom clancy novel. Some pieces I like: when currencies fail, they fail suddenly. true, but I’d ask: what happens when they all fail at the same time?

    Some bits I’m less enthusiastic about: Scapping the dollar and pegging to the euro/accepting euros for crude will somehow cause a rift in the financial universe. hmmm. Why?

    As far as the rest of the narrative – bravo, good story.

  70. Fresno Bob, Helicopter Ben doesn’t think so. Actually, I agree, it’s not and never will be like Zimbabwe. I do think we will see some monetization of the deficit. The mechanism for this will the purchasing and maturing of US government debt over time – financed at 0%. tax rebates funded in this manner are as good as printing cash and handing it out. Might be called for, frankly.

  71. Re: fixing the posting, just get the little karma points click things. That way it’s the commenters policing themselves.

  72. Christ, browbeating? Promising a good browbeating to H&R posters is like opening a satchel full of bondage gear in front of of a crowd of “bottoms.”

    As for the economy, I’m pretty sure it’s going to suck hard for quite some time.

  73. > “In theory the fed can run their presses 24/7 and force 10’s of trillions cash into the economy. In practice it’s a wee bit more complicated.”

    If you print a sheet of 32 $100 bills every second, it would take 10 years of continuous printing to print 1 trillion dollars.
    Our debt is not being covered by dollars. It is no longer even covered by Treasury bonds. Our debt is just pixels launched into the system. At least Zimbabwe prints out their shame.

  74. “Our debt is not being covered by dollars. It is no longer even covered by Treasury bonds. Our debt is just pixels launched into the system.”

    I’ve said as much myself. This is a feature, not a bug. The same electrons can be “inconvenienced in reverse,” as it were. Which is why this is better than distributing actual paper, and infinitely less likely to result in the same situation.

  75. > “what happens when they all fail at the same time?”

    It’s all relative, isn’t it but no one else has our enormous unpayable debt. There’s no way out, with our large trade deficit.
    Although everyone may be suffering, no one else has to worry about being removed as the world’s reserve currency, so no one else is as volatile as us. They have all been forced to live somewhat within their means, whereas we have abused our credit position to create a monster.

    > “Some bits I’m less enthusiastic about: Scapping the dollar and pegging to the euro/accepting euros for crude will somehow cause a rift in the financial universe. hmmm. Why?”

    We are like a girl who has Daddy’s credit card, while we are the world’s reserve currency. Change that and it’s all over. Same thing with crude. If it’s not traded in dollars, how are we going to pay for it? In addition to our domestic needs, we’ve got troops in 130 countries who are guzzling the stuff.

  76. Ra,

    “It’s all relative, isn’t it but no one else has our enormous unpayable debt. There’s no way out, with our large trade deficit.”

    Our deficit as a % of GDP is hardly enormous, unpayable, or even unusual.

    “We are like a girl who has Daddy’s credit card, while we are the world’s reserve currency. Change that and it’s all over. Same thing with crude. If it’s not traded in dollars, how are we going to pay for it?”

    Oh Noes, our dollarz are no good! right now, oil is quoted in dollars. Changing that to euros or yen isn’t going to change the economic value of the dollar or of oil any more than switching from pounds to kilos changed how many meals you get from a given pot roast. Oil producing countries accept a wide variety of currencies, the makeup of their foreign reserves mirrors the amount of oil the various countries have purchased from them. If they refuse to take dollars, they won’t be able to sell their oil to us, since that’s what we got. You still are left with the fundemental argument of why should our currency depreciate faster than the euro/pound etc.

  77. The fundemental anchor behind our currencies value is the economic production power of our nation. Currently, we produce little, and outsource a lot – because relative purchasing power makes this a lead pipe cinch decision. A big depreciation (combined with the American workers unparalleled productivity) can and will change this equation as it become profitable to produce things here and send them abroad. Thereby reducing our deficit.

  78. I would think H&R should be a model of self organizing efficiency.

    The owner of a site banning people from that site also falls under the rubric of self-organizing, you know.

    When the dollar crashes and is no longer accepted for crude, we will have to take oil by force, in the interest of national security.

    Or, we could just buy euros and use them to buy crude. Sure, the crude will be more expensive after the dollar crashes, and we will be taking on some exchange rate risk, but I think its a little silly to say that the only way we can oil priced in euros is to invade.

  79. “@Matt Welch: fix your damn forum, as I’ve suggested numerous times. There are technological ways to deal with trolls. I have implemented them for my own forums with great success. It ain’t rocket science.”

    NOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO! Now I can’t troll anymore. Remember, Matt, if you f*&^ with bull you will get the horns! AAAAARRRRRRRGGGGHHHHHHHHH!

  80. “domo is right, the spoofing of Lefiti seems to have been largely successful in shutting him up.”
    I like to think there’s a little Lefiti in all of us. Like the foreskin or the gallbladder.

  81. Matt Welch,
    Can we still use sock puppets?

  82. Do you have a little Lefiti in you? Would you like some, you market fundementalist shitheads?

  83. funny, economist – whose sock puppet are you?

  84. “domo is right, the spoofing of Lefiti seems to have been largely successful in shutting him up.”

    Yeah, I’ll take some credit, too…

  85. I am no one’s sock puppet. However, Mr. Hat is my sock puppet and has a mind of his own.

  86. even if you seem to have difficulty using excel

    “Difficulty” doesn’t begin to capture the totality of it. Imagine you were, I dunno, addicted to heroin, but unable to operate a syringe or even a hookah. It’s very frustrating.

    Don’t worry about it. Excel is a tool for middle-managers to help themselves feel smart and savvy.

    Don’t even get me started on pivot tables.

  87. Paul,

    Not in finance. There its a tool banker use to look busy while they are hoping the axe will fall on the three guys next to them.

  88. The fundemental anchor behind our currencies value is the economic production power of our nation. Currently, we produce little, …

    Nonsense. We’ve got a successful monopoly on producing little pieces of paper with pictures of dead American presidents on them. What else would we ever need produce?

  89. You can deal with trolls by publishing a hash of the poster’s IP address next to their name.

    For example:

    joe (9jl3g4j093) | January 26, 2009, 10:00pm | #

    After a few posts from regular users, people will recognize the correct IP hash (and recognize the different IP hash of a troll).

    People don’t need to sign up for anything, they can still remain anonymous, and it will solve the troll problem.

    You could even make the hash a little nicer by putting it on a list of something else, for example turn the hash into the name of a fruit or vegetable, or animal or insect, or city, or any list of thousands of items so collision is unlikely. Example:

    joe (Honey Bee) | January 26, 2009, 10:00pm | #

  90. “My personal wild-ass-guess is 4-5% inflation over 10-15 years (starting in 2-3 years), and a 20-30% devaluation in the dollar.”

    The way things are going maybe 35-10%. Anything can happen though.

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