the eminent US govt. bankruptsy

[stone]

Medium Tex:

A balance sheet recession accompanied by consumers deleveraging would be like feeding corn to a pig who has an intestinal parasite.  No matter how much he eats he can't seem to gain any weight.  
In our system, the intestinal parasite is our too big to fail financial institutions.

And the more we feed in through deficit spending the bigger and more voracious that parasite gets.

[BearBones]

One side-effect of this screwed-up monetary system we're in is that it tends to push down interest rates for extended periods of time. So even though the federal government has created trillions in new debt, the percentage of the budget devoted to debt service is lower today than it was a few years ago.

If interest payments amount to, say, a trillion dollars a year and spending becomes inflationary at, say a 1.5 trillion-per-year level, then the federal government only has 500 billion dollars worth of room before any additional fabricated dollars push up inflation. In all likelihood, the government will just spend it anyway, leading to some moderate inflation (probably >3%, < 6%). But you're right that the longer this goes on, the more of a problem debt service becomes, even at very low interest rates. I don't think anyone knows how this will turn out, except for maybe Japan. They've been about 10 years ahead of the curve.

Very helpful, even if the pig analogy is getting strained...

As I see it, at least 2 things could become inflationary: 1 When and if the pigs get nourished and start putting on fat again, or 2. if there are more and more pigs to be fed around the world, and if the supply of corn becomes limited (particularly due to resource scarcity). So then the Fed raises interest rates, right? But then the debt/gdp really skyrockets. Does anyone think that we can have a health economy with debt/gdp approaching or exceeding 1, as it has done in Greece, et.al.?

[Pointedstick]

Very helpful, even if the pig analogy is getting strained...

As I see it, at least 2 things could become inflationary: 1 When and if the pigs get nourished and start putting on fat again, or 2. if there are more and more pigs to be fed around the world, and if the supply of corn becomes limited (particularly due to resource scarcity). So then the Fed raises interest rates, right? But then the debt/gdp really skyrockets. Does anyone think that we can have a health economy with debt/gdp approaching or exceeding 1, as it has done in Greece, et.al.?

To add on another layer of complexity, the federal government doesn't feed the economy like a farmer feeds a pig; instead it spends money on certain industries and avoids others. The equivalent would be a farmer injecting nutrients directly into the part of the pig he wants to be bigger (ewww). Our federal farmer has for years been injecting corn into our pig's mouth and teeth (defense contractors and military spending) and leaky parasite-filled gut (financial sector). He has neglected the legs (transportation infrastructure) and muscular system (manufacturing).

For example, if the federal government bought all the hard drives in the world one year, that would put enormous inflationary pressure on the electronics industry as they all scrambled for a slice of the federal payola. We've seen wage and price inflation originating in the defense sector as a result of the huge cash infusion (example), while the transportation and manufacturing sectors have withered, and all the money added to the financial sector has basically been set on fire. If the federal farmer started feeding the pig normally, the money would be able to circulate through the economy normally rather than being directly added to certain direct industries. This would probably entail some kind of per-capita direct spending, like what Alaska does, maybe like the FairTax's prebate or stone's citizen's dividend.

In the end, the supply constraint is the quantity of real resources in the economy. If the government wants to buy more of something than exists, adding more zeroes to the seller's bank account isn't going to produce more products, at least not quickly or without substantial inflation. But as long as there are goods and services produced in excess of what the government and people purchase, things work pretty well.

This is why Greece is so screwed; their economy basically doesn't exist. The biggest sectors are tourism, FIRE, and government welfare; few productive industries, many cyclical and unstable industries, and extremely high government spending. Thankfully, the American economy is still incredibly productive, which limits the damage that the government can do to it.

[BearBones]

Good info, pointedstick. But whether or not the money infused is being used wisely for whole economy or unwisely for some of its parts, I am still concerned about what happens if the coincident debt continues to grow faster than gdp. At some point, we are faced with 2 choices (as we are currently): either austerity (which could damage the economy) or increased spending and decreased taxation (which does not guarantee that the economy will respond quickly or robustly enough, and which guarantees further growth of debt). In either scenario, the result could very easily be exponential growth of debt/gdp, right? Don't most economists believe that some debt/gdp is dangerous? At some point, can't this monopoly game collapse, even if being played by a formerly great nation with reserve currency status?

[Pointedstick]

In general, if the excess money created grows faster than GDP then it's up to people to hoard it or spend it in ways that don't enter the transactional economy if they want to contain inflation.

If the government prints a quadrillion dollars and then sets it on fire, that doesn't create inflation, does it? Similarly, if the government prints money and gives it to entities that don't spend it (banks, people who want to hold government bonds), or spend it right back to the government (student loan payees), or spend it at firms that themselves will hoard it (private debt payees paying back their banks), then the money doesn't wind up chasing the same quantity of goods, and thus doesn't become inflationary. In other words, where the newly created money actually goes matters more than how much of it is created.

Most economists believe that a high debt to GDP ratio is dangerous, but most of them miss the reasons why. It's a real danger for a country that services a debt denominated in a currency it can't control (like Greece) for obvious reasons, but countries like the USA or Japan have an easier time because servicing the debt entails simply creating more money to pay the debtholders. This can continue indefinitely so long as the additional created money does not wind up raising inflation. I believe Japan's debt to GDP ratio is more than 200% right now and it doesn't seem to have brought on hyperinflation or total productive collapse. Japan is having problems, true, but those problems are rooted in an aging and declining population more than the structure of their monetary system or the actions of the people pulling its levers.

The monopoly game collapses only when the underlying economy and society becomes so sick that papering it over with money creation stops fooling people. We're talking industrial collapse, the loss of a war, a massive shift toward consumption and away from production, or something like that.

I'm not going to argue that a damaged or corrupt monetary system can't hasten those conditions in the real world where it's controlled by politicians who have no idea how it works or even what they're doing.

[BearBones]

I believe Japan's debt to GDP ratio is more than 200% right now and it doesn't seem to have brought on hyperinflation or total productive collapse. Japan is having problems, true, but those problems are rooted in an aging and declining population more than the structure of their monetary system or the actions of the people pulling its levers.

The monopoly game collapses only when the underlying economy and society becomes so sick that papering it over with money creation stops fooling people. We're talking industrial collapse, the loss of a war, a massive shift toward consumption and away from production, or something like that.

I'm not going to argue that a damaged or corrupt monetary system can't hasten those conditions in the real world where it's controlled by politicians who have no idea how it works or even what they're doing.

Interesting. Thanks. You and others have mentioned Japan as an example in which inflation has not been an issue despite mounting debt. What do you and others think will ultimately happen to Japan (and, no, this is not a rhetorical question)?

[stone]

I believe Japan's debt to GDP ratio is more than 200% right now and it doesn't seem to have brought on hyperinflation or total productive collapse. Japan is having problems, true, but those problems are rooted in an aging and declining population more than the structure of their monetary system or the actions of the people pulling its levers.

The monopoly game collapses only when the underlying economy and society becomes so sick that papering it over with money creation stops fooling people. We're talking industrial collapse, the loss of a war, a massive shift toward consumption and away from production, or something like that.

I'm not going to argue that a damaged or corrupt monetary system can't hasten those conditions in the real world where it's controlled by politicians who have no idea how it works or even what they're doing.

Interesting. Thanks. You and others have mentioned Japan as an example in which inflation has not been an issue despite mounting debt. What do you and others think will ultimately happen to Japan (and, no, this is not a rhetorical question)?

I get the impression that Japanese government debt effects Japan no more than it effects the rest of the world. It is a bit like CO2 emmisions in that regard. The huge amounts of Japanese government debt were instrumental for the bubble leading up to 2008:

http://en.wikipedia.org/wiki/Carry_(investment)

By early year 2007, it was estimated that some US$1 trillion may have been staked on the yen carry trade.[5] Since the mid-90's, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies.[6] These activities include subprime lending in the USA, and funding of emerging markets, especially BRIC countries and resource rich countries. The trade largely collapsed in 2008 particularly in regard to the yen.

Basically for the global economy, the acumulated government debts create a vast ocean of "hot money" lurking and ready to blow bubbles, create commodity price spikes, crashes etc. To my mind it is a bit like letting pools of gasoline build up on the streets. The more there is, the worse the danger of a huge financial fire storm.

[Gumby]

Does anyone think that we can have a health economy with debt/gdp approaching or exceeding 1, as it has done in Greece, et.al.?

The Debt/GDP ratio is somewhat meaningless, in the sense that there is no magic threshold number where a nation becomes insolvent.

Robert J. Shiller explains...

Debt and Delusion
by Robert J. Shiller

Economists like to talk about thresholds that, if crossed, spell trouble. Usually there is an element of truth in what they say. But the public often overreacts to such talk.

Consider, for example, the debt-to-GDP ratio, much in the news nowadays in Europe and the United States. It is sometimes said, almost in the same breath, that Greece’s debt equals 153% of its annual GDP, and that Greece is insolvent. Couple these statements with recent television footage of Greeks rioting in the street. Now, what does that look like?

Here in the US, it might seem like an image of our future, as public debt comes perilously close to 100% of annual GDP and continues to rise. But maybe this image is just a bit too vivid in our imaginations. Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

That would clearly be nonsense. After all, debt (which is measured in currency units) and GDP (which is measured in currency units per unit of time) yields a ratio in units of pure time. There is nothing special about using a year as that unit. A year is the time that it takes for the earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.

We should remember this from high school science: always pay attention to units of measurement. Get the units wrong and you are totally befuddled.

If economists did not habitually annualize quarterly GDP data and multiply quarterly GDP by four, Greece’s debt-to-GDP ratio would be four times higher than it is now. And if they habitually decadalized GDP, multiplying the quarterly GDP numbers by 40 instead of four, Greece’s debt burden would be 15%. From the standpoint of Greece’s ability to pay, such units would be more relevant, since it doesn’t have to pay off its debts fully in one year (unless the crisis makes it impossible to refinance current debt).
Source: Robert J. Shiller: Debt and Delusion

[BearBones]

Does anyone think that we can have a health economy with debt/gdp approaching or exceeding 1, as it has done in Greece, et.al.?

The debt/GDP ratio is somewhat meaningless. There is no magic threshold number where a nation becomes insolvent.

Got it. So I should say, does anyone think that the probability of a poor outcome becomes much higher if the debt/gdp ratio continues on the current trajectory much further?

[Gumby]

Does anyone think that we can have a health economy with debt/gdp approaching or exceeding 1, as it has done in Greece, et.al.?

The debt/GDP ratio is somewhat meaningless. There is no magic threshold number where a nation becomes insolvent.

Got it. So I should say, does anyone think that the probability of a poor outcome becomes much higher if the debt/gdp ratio continues on the current trajectory much further?

Yes. It's certainly possible for any nation to spend too much money (and thus cause inflation). However, I think one really needs to consider the amount of private credit in existence in order to see the full picture when it comes to "too much money" in the private sector.

Nevertheless, there is an interesting paradoxical issue with having too much debt... Hyman Minsky is famous for his "instability hypothesis". Even though the size of the debt is not a "problem" for a sovereign fiat nation whose debts are denominated in its own currency, the very existence of massive amounts of safe debt can theoretically cause fragility in the markets. (That theory appears to have been proven correct during the period leading up to the 2008 financial crisis.)

L. Randall Wray (an MMTer economist) explains in this short video...

http://youtu.be/gRE-IDYfi8Y

In other words, perhaps our nation won't become insolvent or experience high inflation .. but if Minsky was right, we will likely see more and more periods of fragility in the markets as time goes on. That appears to be the biggest risk in the United States. Even more of a reason to hold the Permanent Portfolio.