Unlimited Debt: When the glass overflows, we all get wet
By Tony Allison, July 20, 2009
“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time.” John Maynard Keynes “The Great Slump of 1930” published December, 1930
The world today seems to be spinning faster on its axis than ever as humanity scrambles to stay afloat in a world drowning in debt. It all seemed like such a good idea back in the day, as the credit-based US economy seemed to create prosperity out of thin air for decades. The economic alchemists explained that the more we consume, the more the economy will prosper. And because of easy and abundant credit, we didn’t have to pay until later!
Unfortunately, later has arrived. Growth built on the sandy foundation of debt-based consumption (instead of saving and investment) was fun while it lasted. But now the economic party glass has been filled to overflowing with debt, and we are all getting wet. The great global debt party must now be wound down and cleaned up, but no one seems willing to face the inevitable hangover. The US has more than doubled its debt burden, relative to GDP, since the 1980’s and the consequences are beginning to crash the party.
Source: Casey Research, The Casey Report, July 2009
“To maintain export competitiveness, many global currencies, including the Chinese Renminbi, were pegged to the dollar at an artificially low rate. This helped create the US trade deficit driven by excess US demand for imports based on an overvalued dollar. Foreign central bankers invested the dollars received from exports in US debt to minimize the appreciation of their domestic currency that would make their exports less competitive. The recycled dollars flowed back to the US to finance the spending on imports, helping keep US interest rates low, which facilitated more borrowing to finance further consumption and imports.”“Recent global prosperity was founded on a series of elegant Ponzi schemes.” Satyajit Das, “Ponzi Prosperity” PrudentBear.com
Central banks to the rescue?
The world’s central banks, being highly political organizations, don’t want the debt party to end. Ending the party, by allowing the global economy to de-leverage and restructure in a more free-market and sustainable manner, would likely cause a great deal of economic pain and political “instability”. The inevitable cleansing process is too unpredictable and the banking elites might not enjoy the new economic or political equilibrium.
Thus the debt extravaganza continues, this time at warp speed, as the US and other major nations incur unimaginable levels of new debt (on top of servicing old debt) in a desperate attempt to help the world “regain its footing”, or more bluntly, get the prosperity party back in gear, Keynesian-style.
Pedal to the metal
Of course debt has been quite useful in helping foster growth and building economies around the world. But too much of a good thing can be lethal. Debt leverage in excessive amounts is inherently unstable and leaves little room for error. It’s much like driving a sports car faster and faster on a twisting mountain road. It’s exhilarating until a minor driving error sends the car flying off the road. With less speed (or leverage), the mistake could have been easily corrected without serious damage.
As of now all we’ve done is change drivers. We’re still driving way too fast on a dangerous road. The only difference is now the driver works for the government! Debt-fueled private consumption has been replaced by debt-fueled government spending. If we don’t de-leverage our economy soon, the odds increase that our government driver will send us flying off the next hairpin curve into a full blown currency crisis.
Without mixing more metaphors, it is clear that the US, as well as many other nations, are willing to debase their currencies seemingly without limit rather than go through the very painful (but necessary) process of de-leveraging and restructuring their economies. This is likely to just prolong the crisis.
Japanese stimulus not successful
As the debt piles up with much more to come, the results have been less than stellar so far. Credit conditions have not eased enough. Money is not flowing into the real economy. Stimulus spending thus far has been mostly transfer payments and totally ineffective at boosting the economy. Even real infrastructure spending may not necessarily kick-start sustainable growth. The Japanese government has spent trillions re-building its infrastructure and it has yet to boost Japan out of its lost two decades.
“Japan’s rural areas have been paved over and filled in with roads, dams and other big infrastructure projects, the legacy of trillions of dollars spent to lift the economy from a severe downturn caused by the bursting of a real estate bubble in the late 1980s. During those nearly two decades, Japan accumulated the largest public debt in the developed world — totaling 180 percent of its $5.5 trillion economy — while failing to generate a convincing recovery.” The New York Times, February 5, 2009
Sources: Hayman Capital/John Mauldin
Funding Crisis on the horizon
The US is clearly not the only country that is projected to issue massive amounts of new sovereign debt in 2009. But as shown by the chart, it has by far the lion’s share, $3.02 trillion (56%). The projected amounts needed globally this year are staggering; $5.36 trillion dollars, or roughly 9% of global GDP.
John Mauldin discussed the immensity of the situation recently in an excellent article entitled “Buddy, can you spare $5 Trillion?”
“I’ve been writing for months that I don’t think the US can find $2 trillion dollars this year and then come back to the well for another $1.5 trillion next year without serious disruption in the markets. Where do you find that much money when all the rest of the world also wants to borrow massive amounts?”
“The graph shows the US will need to issue $3 trillion in debt. I thought it was only 1.85. But the number has grown to almost $2 trillion (as I wrote it would). Then you need to add in off-budget items like TARP, state and municipal debt, and so on. Pretty soon it adds up to another trillion.”
Mauldin stressed that this estimate is for government financing only. It does not count the needs of corporations, individuals or commercial mortgages. His conclusion is there simply isn’t enough capital around, under current conditions, to fill the global funding needs in 2009 as well as the ensuing years. Perhaps we will see higher interest rates to attract more capital, but that would be damaging to a US economy already struggling with 10% unemployment, likely to go higher later this year. Perhaps the US will ramp up its quantitative easing and just print the money we need. That would lead to its own set of issues as foreign holders of US debt (i.e., China) would see the value of their holdings severely debased, and could start dumping Treasuries out of desperation.
The tangible asset hedge
For those of us who believe that a dollar crisis is inevitable at some point, it makes common sense to diversify one’s assets into areas that will hedge against dollar-denominated paper assets. That is why I believe that tangible assets and well-run commodity-based international companies will provide at least some protection from the deluge of debt heading our way.
Some have predicted a sudden, globally-coordinated currency devaluation to help inflate away these mountains of debt and boost the US economy before the 2010 elections. I believe if that were to happen, the price of gold would likely vault much higher overnight. There is no way to reliably forecast the timing or eventuality of this event, but I feel it’s another prudent reason to diversify a percentage of one’s assets into gold or gold equities.
No free lunch
Unlimited debt is a hard concept to visualize (but $5,000,000,000,000 in one year is getting there). Unfortunately, unlimited debt is likely to lead to unlimited consequences. The old saying from the 1930’s, “there ain’t no such thing as free lunch” is finally coming to the fore. The Ponzi economy has run its course, and in one way or another the lunch bill must now be paid.
“When something cannot go on forever, it will stop.” – Economist Herb Stein (1916-1999)
Today’s Markets
U.S. stocks rose, sending the Standard & Poor’s 500 Index to its highest level since November, as a gauge of economic indicators topped projections and speculation grew that CIT Group will avoid bankruptcy. Caterpillar and Alcoa rallied strongly as the Conference Board’s gauge of the economic outlook increased for a third straight month. CIT Group jumped 79 percent as a person briefed on the board’s deliberations said the lender has reached a financing agreement with bondholders.
The S&P 500 added 1.1 percent to 951.13 at 4:05 p.m. in New York, above its best close since Nov. 5. The Dow Jones Industrial Average rallied 104.21 points, or 1.2 percent, to 8,848.15, erasing its loss for the year and closing at a six-month high. The Nasdaq also added 1.2 percent to close at 1909.29.
On the Comex, August gold gained $11.30, or 1.2%, to close at $948.80 an ounce, the highest settlement price since June 11. In other metals Monday, July copper ended at $2.46, the highest level for a front-month contract since mid October. The more active September contract gained 4.6 cents, or 1.9%, to $2.469 a pound.
Oil futures finished slightly higher on Monday, as dollar weakness and rising global equity markets buoyed sentiment among energy traders. Still, oil prices ended well below their intraday highs and analysts warned that the fundamentals of the oil market remain weak. Light sweet crude for August delivery rose 42 cents to $63.98 a barrel on the New York Mercantile Exchange. The contract will expire on Tuesday.
Wishing you a good evening,
Tony Allison
© 2009 Tony Allsion
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