Gyroscopic Investing

http://phys.org/news/2012-09-economic-freedom-18th.html

The US had plummeted to 18th place in economic freedom. This from the article:

"The report indicates that the U.S. is on the wrong track," Gwartney said. "Freer economies grow more rapidly and achieve higher income levels. Now, for more than a decade, the United States has been expanding the size of government, increasing both debt and regulation, and using subsidies, grants, tax breaks and mandates to centrally plan large sectors of the economy. A system of crony capitalism has emerged. The declining economic freedom rating of the United States provides confirmation of this trend."

The cornerstones of economic freedom are personal choice, voluntary exchange, freedom to compete, and security of private property..."

What a shame. I wonder if this has something to do with the increasing polarization of the electorate and politicians? It's seemed to me that for the last decade at least, each political party has spent the time attacking the other side's incursions on freedom while ignoring their own party's contribution, then being terrified by those very same things as soon as their party is in power. As a result, both sides get to successfully diminish freedom in their own preferred ways.

Sort of on topic re. our "mess".

This is a non-partisan video produced by an accountant, Hal Mason, retired after 27 years with IBM.
He looks at the budget, its revenues and expenses, and very simply illustrates the problem.
Amazingly, we get all the media talking heads blathering and shouting for hours and never get clarity.
This guy does it in a couple minutes.

http://www.youtube-nocookie.com/embed/EW5IdwltaAc?rel=0

Mountaineer wrote: Sort of on topic re. our "mess".

This is a non-partisan video produced by an accountant, Hal Mason, retired after 27 years with IBM.
He looks at the budget, its revenues and expenses, and very simply illustrates the problem.
Amazingly, we get all the media talking heads blathering and shouting for hours and never get clarity.
This guy does it in a couple minutes.

http://www.youtube-nocookie.com/embed/EW5IdwltaAc?rel=0

A bit too much doom and gloom, don't you think?  Saying our debt is 32 times Greece's is not really a fair comparison.  Debt might soon be over 100% of GDP... who cares, to be honest?  It's certainly not a relevant figure.  100% of GDP does not mean that debt is not serviceable.

His prescription is massive entitlement cuts and tax increases... I'm pretty sure that would do us a lot more harm than good.  Yet another accountant intent on balancing the budget, when to be honest, a country that can print the world's reserve currency would be far wiser to run a deficit if only to encourage growth in GDP.

Storm wrote:   100% of GDP does not mean that debt is not serviceable.

Thanks to the folks here I understand why you say that, but:

A. is there really no upper limit to levels of debt that are servicable for the US?

B. Is it really a good idea to keep adding large amounts to the debt e.g. if Obama adds as much during the next 4 years as he did during the last 4 years.  There must be downsides.

It all depends on where the money goes and what inflation is at. If conditions are deflationary (e.g. delevereging, housing crash), then expanding the money supply will produce only very mild inflation. And if much of that newly-created money winds up sitting idle on bank balance sheets, un-spent and un-loaned, then it doesn't really enter circulation and so it can't have an inflationary effect.

The "upper limit" is really determined not by some kind of hard-and-fast ratio, but by the productive capacity of the economy, the monetary conditions, and the degree to which the newly-created money actually enters circulation. It's not as simple as as just saying that more printing = more problems.

Benko wrote:A. is there really no upper limit to levels of debt that are servicable for the US?

From a technical standpoint, there is no upper limit when debt-based money is created to buy future debt. The government could create $10 quadrillion in debt over the next 20 years and if nobody wanted to buy government debt, the Primary Dealers would just funnel those newly created reserves back into Treasuries all the while. However, modern monetary realists point out that in a hyperinflation scenario the Primary Dealers would likely renege on their contractual agreement to funnel their excess reserves into Treasuries. So, yes, in certain scenarios the Primary Dealers could choose to stop doing their job. But there's no technical/mathematical limit that prevents future Treasuries from being purchased down the road.

Benko wrote:B. Is it really a good idea to keep adding large amounts to the debt e.g. if Obama adds as much during the next 4 years as he did during the last 4 years.  There must be downsides.

It all depends on what private credit is doing. You can't just look at the National Debt in isolation. For instance, if there's very little private credit being issued, then you need more debt-based money from the government to keep liquidity in the economy. Keep in mind that in a debt-based monetary system, such as ours, ALL money (except coins) comes from either public debt or private credit.

Of course there are downsides to having too much risk-free Treasuries issued into the private sector — it tends to cause increasing frequency of fragility in the markets as people take greater risks with private credit (a la 2008).

See: YouTube: Crash Course on Hyman Minsky

One other thing about the debt to GDP ratio that should tell you anyone making this comparison is just doing it for dramatic effect:

Imagine Joe Homeowner has a $200,000 mortgage and a $50,000 annual income.  Would you say his debt to GDP ratio is 400%?  How can he possibly not go bankrupt if his debt to GDP ratio is over 100%?

And, keep in mind, this is a normal working homeowner, who can't print money like the government can.  The only way Joe Homeowner will ever go bankrupt is if he stops paying his mortgage payments.

The only way the US will ever go broke is if they intentionally stopped making debt payments, even though they have a bottomless stack of blank checks that they can write for any amount, they would have to intentionally just stop paying.  Huge difference.

Storm wrote: The only way the US will ever go broke is if they intentionally stopped making debt payments, even though they have a bottomless stack of blank checks that they can write for any amount, they would have to intentionally just stop paying.  Huge difference.

I think the "Cry Uncle!" point will come when the interest on all prexisting issued debt compounds at a rate faster than the inflation equation.

I'm new enough at all this to not be sure of what that means in real world practical terms, but this could easily be used (not saying that most of you believe this) to say that Thatcher's comment:

The problem with socialism is that you run out of other people's money

doesn't apply to the US and we can spend all we like.  Which would certainly make all the democrats and some large fraction of the republicans very happy.

The real problem with Socialism is that it leads to centralized oppression and enforced uniformity. Paying for it is a secondary concern if you're a country that controls your own currency. If, however, you do not control your own currency (e.g. most of the EU) then Thatcher is absolutely right.

Benko wrote: A. is there really no upper limit to levels of debt that are servicable for the US?

There is, but the trick is that it's highly dependent on the rate of interest.  The danger for us is that interest rates can change and debt service that was once manageable suddenly becomes horrifying.

When you have an enormous debt and inflation is relatively tame (such as today), you can just punish savers with 0% interest rates and keep debt service reasonable.  This allows many to whistle past the graveyard on the debt issue.

But if inflation picks up, interest rates need to rise or inflation will quickly get out of control.  And holding interest rates at zero through high inflation would eviscerate savings and ravage the economy.  With short-term interest rates even at 5%, our interest costs become frightening.

Benko wrote:B. Is it really a good idea to keep adding large amounts to the debt e.g. if Obama adds as much during the next 4 years as he did during the last 4 years.  There must be downsides.

The trouble is that the downsides don't necessarily manifest right away.  That's the way of things with debt.

Imagine that I have an adjustable-rate mortgage with near-0% interest.  I can build up an enormous level of debt.  Millions, even.  It just doesn't matter because interest payments are so miniscule.  But when interest rates rise, that debt service burden suddenly becomes enormous.

Thousands and thousands of households fell into this trap.  Since we are constantly rolling over our national debt, we face similar risks.  It's simply not safe to build up such a staggering level of debt and pin all of our national hopes on the assumptions that a) interest rates will always be zero and b) inflation will never rise.

Now of course we all know that nations have the special ability to discharge debt via inflation.  But this certainly doesn't provide us with unlimited latitude and consequence-free debt.  Higher interest rates will prevent this trick from working as well as you might think.  Bondholders don't stand idly by to be robbed by high inflation.  And if interest rates are suppressed in order to circumvent the bond market, there's great risk of a currency crisis.

Lone Wolf wrote:

Benko wrote: A. is there really no upper limit to levels of debt that are servicable for the US?

There is, but the trick is that it's highly dependent on the rate of interest.  The danger for us is that interest rates can change and debt service that was once manageable suddenly becomes horrifying.

Horrifying in the sense that we'd just issue more and more and more and more debt to pay the interest? But, technically that's not a "limit" to servicing the debt. So long as the Primary Dealers maintain their contractual obligation, and the Fed helps them with liquidity, the debt can always be "serviced" in a fiat debt-based monetary system. I'm not suggesting that it's good to service that much debt, but the mechanisms are already in place to service an infinite level of debt in the same way that a pinball machine never runs out of pinballs. Though, Primary Dealers might opt-out of that contractual agreement is if hyperinflation were to ensue.

Even if the debt were a burden like the US were a currency user, not an issuer, it's only a burden to the degree our GDP can't service it.  Thing is, any inflation actually increases GDP, thereby decreasing our debt-to-GDP ratio.

Further, if we're supplying other countries with our currency & bonds for them to either save with or use to help control their currency, then this probably skews the math even more, as there will be a constant sucking sound from overseas for our dollars and debt.

Sometimes I wonder if we should have a debt/GDP calculation that includes the GDP of all the countries that make vast use of the US dollar either as a currency or a peg.  Obviously this wouldn't tell the whole story, but it would be interesting to look at.

Is there a difference between the following two scenarios:

1.  Inflation of 2% and short term interest rates of 1%.  This equates to a real interest rate of -1%.

2.  Inflation of 10% and short term interest rates of 9%.  This equates to a real interest rate of -1%.

Isn't the outstanding debt still eroding at 1% a year, even though the gov't is paying more in interest?  So the higher interest payments are simply covering the increased erosion from inflation.  It may appear that the debt is increasing but the purchasing power of the debt is actually eroding at the same rate in both scenarios.

To me the real problem will arise when real interest rates increase on the national debt...although this can act as a type of stimulus spending.  Maybe high real rates during the 80's and 90's are somewhat responsible for the economic boom...

Gosso,

I think it's the other way around.  Economic boom made it so the government could hold rates above inflation and still have people chasing yields in riskier pots.  Of course, though, it's probably chicken egg, as the stock and bond markets are constantly looking at each other to price themselves.

moda0306 wrote: Gosso,

I think it's the other way around.  Economic boom made it so the government could hold rates above inflation and still have people chasing yields in riskier pots.  Of course, though, it's probably chicken egg, as the stock and bond markets are constantly looking at each other to price themselves.

You could be right.  The fall of oil prices and the baby-boomers entering their prime spending years could have played a bigger role.  Plus many other "stuff"...a perfect storm, perhaps.