Tag Archive for: deflation

Towards A Nationalist Economic Policy

Suggesting that managed inflation and currency devaluation are pathways to greater national prosperity is bound to invite howls of derision. But critics may be ignoring factors, which, if acknowledged, might point towards consensus. At the least, it might provoke a more useful discussion.

With that in mind, here are four economic realities in America today:

1 – Despite that the word “fiat” is often used as a term of derision, all currencies are fiat unless backed by redeemable commodities. China is stockpiling gold amidst rumors they may try to tie the Renminbi to gold. Good luck with that.

2 – Throughout history, nations with the ability to sustain capital formation through financial innovation are the ones that succeeded. Prudently managed fractional reserve lending, a financial innovation, enables far more liquidity in the economy.

3 – The biggest engine of liquidity is not printing currency – there’s only about five trillion in actual printed US dollars extant in the world – it is debt formation, backed by collateral, that finances massive projects and asset acquisitions.

4 – American has been on a borrowing binge since the 1980s and total market debt – consumer, commercial and government – now stands at nearly 3.5 times GDP. This level of debt is unsustainable.

On this final axiom there should be agreement. As for the others, concerned observers might agree to disagree. Suffice to say that the economic disruption, and unintended consequences, that would accompany transition to a commodity backed currency would dwarf what we may expect in most other scenarios for the American dollar. So how do Americans unwind nearly $80 trillion in hard debt?

If one accepts the premise that this debt is unsustainable, and that further debt accumulation is no longer possible, than broadly speaking, to facilitate the inevitable rebalancing there are only two possible outcomes – inflation or deflation. The problem with deflation is there is no model of deflation that doesn’t include a complete collapse of liquidity and a near cessation of economic activity. A deflationary collapse would not simply wipe out a few big banks. It would wipe out all banking, big and small, multinational and local, because the value of the collateral that backed all their loans, no matter how healthy their reserve ratios had previously been, would have collapsed.

There is a model of inflation, however, that permits America to continue to prosper economically. It is vital to make the distinction between inflation caused by wages increasing faster than asset values vs inflation caused by asset values increasing faster than wages. Understanding this distinction, and recognizing what is at state in the choice between them, cuts to the heart of what constitutes nationalist economic policy vs globalist economic policy.

Globalist Economic Policy

For at least the last 20 years, American wages have not kept pace with inflation. Examining the core elements of this inflation offers clues to why most Americans are worse off economically than they were 20-30 years ago. And the primary driver of inflation outpacing wage growth is the financialization of the American economy. This is the reliance on creating overvalued assets (asset bubbles) to serve as expanded collateral to enable increased consumer borrowing.

Allowing consumers more capacity to borrow took momentary pressure off of consumers to earn higher wages. This served the interests of multinational corporations and international banks whose profits were optimized when they exported jobs and imported workers. By importing cheap products from overseas and stimulating borrowing on inflated home equity values, for a time, most Americans weren’t suffering the consequences of an economy running on debt instead of productivity.

It’s worth considering all the ways that financial inflation was imposed on ordinary Americans, forcing them into debt. Already reeling from the globalist tactic of exporting jobs out of their country, and importing workers (and welfare recipients) into their country, Americans also had to contend with higher prices for everything that couldn’t be imported – which are those items that use up most disposable consumer income – rent or mortgages, and utility bills. Why?

The answer to this exposes the other primary strategy of globalism, synergistic with the tactic of exporting jobs and importing low wage workers, which is climate change mitigation in all of its almost endless permutations. In the name of protecting the planet, artificial scarcity has been imposed on Americans from coast to coast, and in those regions where state and local governments are overran the most with globalists, that scarcity is most acute.

In the name of fighting climate change, globalists – oops, environmentalists – challenge the ability of entrepreneurs to do anything. To the extent new housing developments are permitted, after years, not months, and millions, not thousands, in fees, they must be confined within the boundaries of existing cities.

It is impossible to overstate how misanthropic this policy is in terms of its effect on ordinary Americans. At the same time as millions of immigrants, legal and illegal, continue to pour into the country, draconian environmental laws are cramming all new housing within the footprints of existing cities. Tranquil neighborhoods are being demolished to make room for millions of newcomers. People are being literally piled on top of each other. But the investor class sees their real estate portfolios soar. Collateral grows, enabling more borrowing, enabling more spending.

Renewable energy, also mandated by law in the interests of supposedly cooling the planet which is supposedly warming catastrophically, also creates artificial scarcity. The cost of renewable energy far exceeds that of conventional energy, which itself costs far more than it should because of permitting delays, lawsuits, and excessive regulations.

Renewable energy requires costly upgrades to the power grid. It requires storage assets to make up for the daily intermittent nature of wind and solar power. The lifecycle costs to manufacture, operate, decommission, and periodically replace wind and solar power arrays are grossly underestimated, especially when considering how these systems have to be oversized to account for seasonal fluctuations in renewable energy output. Power management systems at the grid level and within the home, extending to every “wired” appliance, also add stupendous costs. But public utilities earn far higher revenues when they deploy renewables, which, since their profit percentages are regulated, is the only way they can increase their profits. And everyone up and down the supply chain, from green entrepreneurs to high tech companies, exploit mandated market opportunities that would not otherwise exist.

Climate change panic has turned our schoolchildren into manipulated puppets and morphed a generation of environmentalists from sincere activism to militant hysteria. These minions support every piece of legislation and every lawsuit, despite the impact: higher prices for everything, artificial scarcity, and inflated collateral to keep the borrowing party going. Other significant sources of inflation, college tuition and health care in particular, have other primary causes – in particular, unionization and the inefficiencies and higher costs that come with unionization – but the pretext for demanding higher wages and benefits in the first place, or even the drive to unionize itself, stem from the reality of unaffordable homes and unaffordable energy.

Nationalist Economic Policy

It is important to emphasize that nationalist economic policy is not “conservative,” nor is it Republican. The only reason nationalists, or conservatives, for that matter, vote for Republicans is because Republicans are not Democrats. While far too many Republican politicians are still just members of the establishment uniparty, at least they haven’t had their vanguard completely taken over by international socialists and climate change zealots. But to suggest that a nationalist economic policy is further evidence of yet another betrayal of alleged Republican, “fiscal conservative” principles is to miss the point entirely.

A nationalist economic policy should have one goal: unwind American debt in a manner that will avoid a deflationary collapse while at the same time shifting the weight of ongoing inflation from financial asset inflation to wage inflation. To do this, both of the key premises of globalism have to be broken. Immigration must be limited to reduced quantities of highly skilled immigrants, and climate change alarmist legislation must be replaced with practical policies designed to promote private sector development of cheap and clean fossil fuel throughout the United States and around the world.

Reducing the supply of labor via more restrictive immigration policies will cause wages to inflate. Increasing the supply of housing and energy by reforming absurdly restrictive environmentalist laws will cause prices for these commodities to level off or at least not rise as quickly as wages. And this might be enough to slowly allow the real value of debt in the economy to erode via inflation. But why stop there?

Fiat currencies maintain their value based on the underlying economic strength of the nations that issue them. The US Dollar is the reserve and transaction currency of the world because no other large national economy has anywhere near America’s industrial diversity, demographic vitality, wealth of natural resources, top universities, broad and deep leadership in high technology, political stability, and military strength. What if devaluing the dollar would actually increase America’s underlying economic strength, and what if the only way to devalue the dollar were to continue to engage in federal deficit spending, and incrementally lower the federal reserve lending rate?

Cue the howls.

About a year ago, it was leaked to the press that President Trump was asking his economic advisers “what’s better, a strong dollar or a weak dollar?” Literally everyone, from the entire media establishment to every anti-Trump pundit, took this opportunity to ridicule Trump, as if he should have already known the answer to this question. But there is huge disagreement among experts on this question, and Trump, as usual, was displaying common sense by asking to hear both sides of the issue.

Trump’s gut instincts appear to favor devaluing the dollar. A devalued dollar means it costs relatively more to import raw materials than to extract them domestically (note to environmentalists – it’s also less hypocritical). It also means it costs relatively more to import manufactured goods than to manufacture them domestically. This not only creates jobs, it further bids up the cost of wages. These policies will also help mitigate potential negative impacts on Americans of yet another rising mega-trend, automation.

Everything Trump’s doing, restricting immigration, developing oil and gas wells and pipelines, trying to repatriate money, and negotiating better trade deals, is designed to shift the model of inflation that we’re dealing with from a bad inflation model to a good inflation model.

As for deficit spending, it’s very principled to talk about deficit spending as if it’s an evil, and it’s certainly something that’s created a problem, but at least in the short run, it is not possible to eliminate deficit spending. If wages are increasing faster than the cost-of-living, than spending on entitlements including Social Security can be indexed to stay at or below the rate of inflation, slowly reducing its share of the federal budget. Immigration reform can reduce that burden on federal and state/local budgets. Maybe military spending can settle in at somewhat a somewhat lower percentage of GDP than it did during the last cold war. We can certainly use federal money more efficiently, and probably save a few hundred billion there. But precipitously eliminating the federal budget deficit is impossible, and continuing deficit spending might actually help devalue the dollar, stimulate “good” inflation, and diminish the real value of government and consumer debt.

International Globalism vs. Nationalist Globalization

Ultimately the choice of economic policies for the U.S. comes down to only one; inflation where wages grow at a faster rate than assets appreciate. The reverse of that is the financialized economy we’ve lived with, which has enriched the globalist political donor class but impoverished everyone else in America. The catastrophic third option is deflation, which carries a high risk of cascading implosions of collateral, putting the economy into a depression era tailspin.

There is no policy without risk and without downside. Inflation, for example, will victimize holders of fixed income investments no matter what. It might as well be wage inflation rather than asset inflation, particularly since asset inflation can lead to property tax increases that are particularly harmful to people on fixed incomes. And it’s a bit disingenuous for budget hawks to attack economic solutions involving inflation, when these are typically the same folks who want to throw America’s seniors onto 401K plans. Such a strategy would imply a supreme confidence in every American individual’s ability to manage their own personal retirement portfolios, including, presumably, inflation hedged investments.

Americans, along with citizens in every nation, have a choice. They can become commodities in a global marketplace, where the assets they’ve earned and accomplishments they’ve logged have no meaning and no merit. Or they can assert their sovereignty, preserving their culture, their wealth, their independence, and the privileges they’ve earned as citizens. They can compete with other nations, they can coexist with other nations, they can cooperate with other nations, but they can survive with their identity and traditions intact.

In America’s case, the challenge is particularly complex, because of America’s leadership role in the world. The American military doesn’t have to engage in nation building. It can be more judicial in deciding when to engage in police actions. But no matter how much those activities are attenuated, America’s military still has to pursue international terror networks, wherever they are, and America’s military still has to deter Chinese expansionism. Like it or not, America is in an undeclared cold war with China, and has been for decades. This is a war that can only be kept cold through deterrence, and deterrence, while fabulously expensive, is cheaper than a hot, horrific war.

Globalization, to clarify, is not the same thing as globalism. Technological advances make globalization inevitable. Intercontinental travel is now available and affordable for literally billions of people. The internet has made mass communication available from anyone, anywhere on Earth, to anyone, anywhere else on earth. Electronic transfers of funds occur instantaneously from anywhere to anywhere. Trade between nations has never been easier. And multinational corporations and banks have lost their national identities and operate as global entities.

Globalism, by contrast, is an ideology. In the crudest, most accurate terms possible, globalism can be described as the naive belief that turning global governance over to an unelected cadre of corporate and financial elites is the best possible future for humanity. But it’s not, because globalists want to cram humans into congested cities like cattle, erasing cultural and national identities and traditions. They want to ration availability of energy, water, land and raw materials, justifying it in the name of saving the planet. And they’re willing to relentlessly demonize, marginalize, ostracize and silence anyone who questions their agenda, stigmatizing them as racists and climate “deniers.”

Perhaps some globalists are truly naive, while others are cold and cynical. If so, naive globalists apparently think that rampant population growth among the impoverished nations constitutes less of a burden on the planet and its peoples than empowering these nations with cheap fossil fuel which would induce them to voluntarily check their population growth. And perhaps cynical globalists simply don’t care. They just want the power that globalism offers them, and if renewable energy fails to deliver a sustainable civilization and chaos ensues, so what? The great cull would be a violent but very effective shortcut for the elites to establish their breakaway civilization, their privileged Elysium.

The reality of accumulating debt and persistent federal spending deficits will eventually push Americans to a crossroads. Most everyone agrees about that. Hyping the tropes that keep donor dollars flowing into libertarian think tanks is not the same as offering constructive alternatives. Those critics who wish to offer up a solution more realistic that what is proposed herein are emphatically invited to do so.

This article originally appeared on the website American Greatness.

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Inflation vs Deflation – Only One Choice

Critics of government deficit spending correctly point out that perpetual debt accumulation is not sustainable. They’re right. But before they criticize an economic policy that aims to use inflation to whittle away the real value – and hence the actual burden – of accumulated debt, they’d be wise to consider the alternatives. Because there aren’t any.

Deficit spending has been touted as a potential driver of inflation, because only with devalued (inflated) currency can Americans hope to erode the real value of mounting levels of government debt. Continuing to print U.S. dollars, it is claimed, can only lead to too many dollars in the system, and hence a devalued dollar. We should be so lucky.

When American households join the Federal Government in spending more than they make, the only way to keep this up is to lower interest rates and increase the value of the underlying collateral. This second factor, the value of collateral, is particularly important for the American consumer, who has relied on home equity appreciation to enable ongoing borrowing which in-turn enabled ongoing spending beyond their means. The so-called financialization of the American economy over the past few decades has been specifically aimed at increasing the value of assets in order to stimulate more borrowing and spending.

The deflationary risk caused by debt accumulation becomes most acute if and when this asset-price bubble bursts. When the market value of the collateral suddenly becomes worth less than the amount of the loans outstanding, banks cannot extend new credit to the private sector, even at very low rates of interest.

Another way to put this is as follows: Liquidity is a function of two factors, money supply and collateral. But the impact of available collateral is far more critical to maintaining liquidity than the money supply. According to the most recent data from the U.S. Federal Reserve, in the first quarter of 2019 the total U.S. wealth, all sectors, totaled $98.3 trillion. What happens to the value of that collateral if banks cannot extend new credit? How is a deflationary spiral avoided when no new borrowing is possible, causing a collapse of demand to purchase assets, causing a compounding drop in the market value of those assets?

This is the cascading collapse of liquidity that was narrowly avoided in 2009. But with total market debt in the U.S. still hovering at approximately 343 percent of GDP, or not quite $80 trillion, it remains a threat to the American economy. Raising interest rates at this time risks the catastrophic possibility of a deflationary collapse, because if interest rates rise, borrowing and spending slow down, asset values drop because of reduced demand, and one after another, bank balance sheets show loan balances that exceed collateral value. Yet this is the alternative that deficit hawks apparently prefer to managed inflation. It is neither a more virtuous solution, nor is it necessary, nor would it work.

Even if raising interest rates does not trigger an economic calamity, it would merely continue the relentless transfer of wealth in America from the middle class to the investor class – Americans would not have borrowed so much if the economy had not become financialized, making everything cost far more. Inflation transfers wealth back from the investor class to the middle class, by eroding the value of their debt. Those responsible Americans who didn’t succumb to the debt temptation should think twice before rejecting the inflation choice. It won’t matter if your bank savings are intact when the banks fail.

How Can Inflation Be Managed to Benefit Ordinary Americans?

If one is willing to assume that inflation is a better pathway out of excessive debt than deflation, the prevailing challenge becomes how to ensure this inflation will benefit ordinary Americans. Since the 1970s, wage inflation has not kept pace with asset inflation. The challenge is to flip that ratio, so that asset inflation (and debt devaluation) does not keep pace with wage inflation.

If this can be accomplished, the cost of living for ordinary Americans will actually go down, even in an inflationary environment. Their wages will be increasing faster than the consumer price index, and the real value of their debt and interest payments will be declining. How can this be done?

As noted in a previous article, two key policy shifts are necessary to ensure wage inflation outpaces asset inflation and the CPI. First, get immigration under control so there is a sellers market for labor instead of a buyers market for labor. Second, relax the extreme environmental laws that prevent Americans from developing their own natural resources and upgrading their infrastructure. Relaxing these ridiculously excessive, punitive, misanthropic, misused and extreme environmental regulations will also dramatically lower the price of new homes.

Not only does increasing mining and drilling operations within the United States create more jobs, but it is a necessary step to take as domestic inflation equates to currency devaluation. By devaluing the dollar through inflation fueled by deficit spending and low interest rates, in-country development of natural resources becomes cheaper than importing them.

Managed Inflation is the Only Alternative

Critics of deficit spending act as if there is a choice to be made, that somehow the circumstances and givens that confront America’s policymakers are not unyielding, that somehow by harping on the virtue of living within our means, they can bend reality. But they can’t. The harsh reality is this: America’s federal government is locked into a pattern of deficit spending that cannot be stopped in the near future. America’s accumulated debt will either be smoothly resolved via managed inflation, or resolved catastrophically via unmanageable deflation that will cause an economic meltdown.

Moreover, federal deficit spending needs to increase. Now. Because putting aside the fantasies of all who would wish this weren’t so (libertarians, socialists, and nationalists all have such wishful thinkers well represented within their ranks), America is in a battle for global supremacy with the Chinese, who must be contained by the United States waging an expensive cold war that will last for decades. One does not have to be a “neocon shill” to recognize this sad fact. One only has to study history, and then observe the actions of the Chinese regime.

None of this macroeconomic reality is meant to absolve the American consumers who decided to sink into debt up to their eyeballs. It doesn’t excuse the students who chose to pay obscene amounts for college tuition, using borrowed money, nor does it excuse the loan sharks who extended them that credit, or the criminals who turned higher education into a money making scam. It is not meant to ignore the costly, useless “solutions” demanded and received by poverty pimps and identity fascists. It doesn’t let off the hook all those environmentalist fanatics and their opportunistic “green” crony capitalist puppeteers who tied our economy up in knots, nor does it forgive the public sector unions who made government services unaffordable and inefficient.

It just is what it is. Where do we go from here?

There is no palatable alternative. If America’s policymakers return to the feckless cowardice of the Obama years, appeasement will again define federal policy. Appeasement of the Chinese by neglecting our military readiness and a firm commitment to containment. Appeasement of the deficit hawks by raising interest rates, as if somehow without inflation we’re still going to whittle away $80 trillion in government and household debt. Appeasement that will turn the fate of the world over President Xi, and turn America into a debtors prison.

The United States needs to spend more on its military, it needs to spend more on its infrastructure, even if that means increasing the federal deficit. The United States then needs to restrict immigration and roll back extreme environmental regulations in order to ensure that wages inflate faster than the consumer price index. This managed inflation will not only whittle away the real value of American debt, but it will serve as a tool to reduce the real value of non-military, non-infrastructure related entitlement spending.

This article originally appeared on the website American Greatness.

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National Debt and Rates of Return

Over the past few weeks it has been clear that another exploration of deflationary risk is in order. Having already published Inflation vs. Deflation (3-15-10) and Avoiding Global Deflation (7-18-10), as well as The China Bubble (6-8-10) there seemed no point in compiling additional alarming, but anecdotal information. Nothing has changed. Debt is too high almost everywhere, certainly in the U.S. and the Eurozone, and even if Chinese debt ratios appear low, the information available could be misleading because China’s banking system is opaque, and much of their collateral may be grossly overvalued.

Because for the past thirty years the global economy has relied on rising debt to fuel rapid economic growth, as debt levels become unsustainable, economic growth slows. When that occurs, asset values drop, meaning that outstanding loans are no longer backed by sufficient collateral. Even in a mildly deflationary environment – which for now, thankfully, is all we are dealing with – real rates of return on large investment funds cannot realistically be projected at levels that cause total interest payments to consume an inordinate percentage of GDP. The more debt exists as a percentage of GDP, the more a burden interest payments become, and the more imperative it becomes to keep interest rates low to maintain solvency – whether that is solvency of government, business, or household entities.

As an aside, when considering levels of debt, what level is deemed sustainable will affect the ability of nations to issue currency without triggering currency devaluation – and paradoxically, the more weakened other currencies are relative to each other, the more difficult it becomes for any nation to resort to currency devaluation to whittle away the real value of their debt on global markets. In short, the accumulation of unsustainable debt both mandates and impels low rates of investment returns.

In this post I’ve attempted to compile information on total national debt in comparison to annual gross domestic product (GDP), and then attempted to correlate this ratio to national assets (based on 10x GDP) to calculate the amount of national credit available based on a borrowing ceiling of 50% of assets. I also attempted to determine total interest payments as a percent of GDP based on various rates. Finding good information is difficult, the topic is vast, and many assumptions are inevitable in the course of producing useful generalizations, but here goes:

This post presents four tables designed, hopefully, to convey information useful to evaluate the strength of currencies and the sustainability of total national debt; they evaluate the Eurozone along with the other six largest nations, the US, China, Japan, Brazil, Russia, and India, who collectively represent about 70% of the estimated global GDP. The first table estimates government debt as a percent of GDP. The second table, just for the U.S., displays reported total debt (government, commercial, consumer) as a % of GDP for the years 1890 through 2010. The third table estimates total debt as a percent of GDP, and then calculates available credit based on a collateral value of 10x GDP, with a borrowing limit of 50% of collateral value. The fourth table estimates total interest payments as a percent of GDP based on interest rates of 2%, 4%, and 8%.

These tables are compiled with data from a multitude of sources; CIA, GPO, UN, World Bank, IMF, US Census Bureau, and much more. Of extraordinary value in these compilations is Wikipedia, where tables referencing multiple authoritative sources can be found listing GDP, Population, and other basic data. The debt of nations can be split into three very distinct areas: government – local, state, and federal – businesses, and consumers. These national debts, along with the GDP of nations, are denominated in trillions. The GDP of all nations combined, for example, is valued at around 58 trillion in 2010 U.S. dollars.

All of these reported debts represent claims by creditors for things that have already happened; were already built or consumed. These various debts don’t include any unfunded future liabilities, there are no future services that can be withheld in order to reduce these debts. These total debt balances are for money that is already spent, home mortgages, commercial mortgages, corporate and financial debt, and the debt of governments. In researching information on the internet, while GDP estimates are readily available, and the federal government debt of nations is reasonably available, the rest of the data is fairly elusive.

In the above table, government debt is compared between the seven largest economic entities, including the Eurozone as one entity. The information on debt comes from the 2009 CIA table Gov’t Debt as a % of GDP. The GDP and population figures, including those compiled for the 16 member nations of the Eurozone, come from compilations on Wikipedia; List of Countries by GDP, and List of Countries by Population, which in-turn sources its data from the CIA, the IMF, and the World Bank.

This table, which doesn’t include state and local government debt, shows the U.S. with a reported government debt equivalent to 54% of GDP, which is better than the Eurozone, with a debt/GDP ratio of 79%. In reality the government debt as a percent of GDP when you compare the U.S. and the Eurozone are probably about the same. Among the major nations, India (57%) and Brazil (60%) also have high levels of government debt, and Japan has a staggering 193% debt/GDP ratio. Only Russia (8%) and China (17%) have apparently avoided crushing levels of government debt.

Government debt, however, is only one leg of the stool; the other legs are commercial debt and household debt. In the next table data is presented for the U.S., looking not just at government debt, but all debt. The data for this second table is gathered from three sources, which all corroborate an astonishing statistic – that the total debt in the U.S. is currently higher than it was during the great depression in the 1930s. Currently the reported total debt / GDP ratio in the United States is 370% and rising. At the height of the great depression, total debt / GDP was barely 300%.

Instead of presenting this data graphically – three corroborating versions of which can be seen in the reports from MarketOracle, Morgan Stanley (ala Paul Kedrosky), and Daily Markets – the above table breaks the last 120 years of American history into four 30 year financial eras. In all four 30 year periods, the total U.S. debt fluctuated between 140% and 160% of GDP. Two of the 30 year periods, the those beginning in 1890 and 1950, respectively, saw debt as a percent of GDP display very little variation. For example, between 1890 and 1920 the maximum debt/GDP ratio was 165%, and the minimum debt/GDP ratio was 125%. For the period beginning in 1950 the variation was even more unremarkable, with the 1950 beginning level of 140% comprising the lowest ratio, and the 1980 ending level of 160% comprising the highest ratio. This parallel between the two relatively stable periods makes any parallel one may infer between the two relatively unstable periods quite ominous. Because the 300% debt/GDP extreme achieved in 1930 took 20 years and a grueling economic depression to unwind. As of 2010, America’s total debt is around 370% of GDP and rising.

The next table, below, attempts to determine what resources the United States and other nations may have available to maintain their debt load or even increase it. In order to come up with some comparisons, two major assumptions are made – that national assets are equivalent to ten times GDP, and that total debt is equivalent to triple the reported government debt (with the exception of the U.S., where there is a more accurate estimate of $51 trillion in total debt). As can be seen, based on these assumptions, the debt/asset ratios for these nations (col. 3, below) display predictable parallels to the debt/GDP ratios, except in the case of the U.S.

Parallels break down, however, with the next step, which determines how much additional credit these nations can muster (col. 4, below). For the purposes of comparison, available credit is calculated by assuming a nation’s collective borrowing remains viable up to an amount equivalent to 50% of their collective assets. As can be seen, the absolute value of each nation’s GDP has a decisive effect on the calculation, since countries with much larger GDPs such as the U.S. have as much remaining borrowing capacity – 19.8 trillion – as the much smaller Chinese economy – 22.4 trillion – despite the fact that China has a debt/equity ratio of 5% vs. America’s 36%.

There are a lot of caveats to any sort of compilation of national borrowing capacity. Altering the assumptions yield vast repercussions. What if the debt held by households and businesses don’t mirror the levels of government debt? What if some nations have asset bubbles that are significantly more over-valued than the assets in other nations? But it’s important not to let these concerns completely overshadow the point, which is that global debt as a percentage of global GDP and global assets is getting dangerously elevated. This is obviously the case in the U.S., Japan, and the Eurozone, but what about China? Because China has a nearly impenetrable banking system, getting aggregated information is impossible, but the Chinese probably have significant debt that is not observable, and they may have asset bubbles – which collateralize their debt – that are about to pop.  Consider these quotes from the article “China’s record debt has economists worried,” published last November by Bill Powell in CNN Money:

“The U.S. fueled its housing and consumption bubbles by providing easy credit. China seems headed in the same direction, although the victims would be different this time. In the first nine months of the year, Beijing has shoveled $1.27 trillion in new loans into the economy, up 136% from the same period last year. That money has gone to three main areas: infrastructure, manufacturing, and real estate. According to a recent analysis by Monaco-based hedge fund Pivot Capital Management, China’s total lending reached 140% of GDP at midyear. That kind of lending makes China an ‘outlier’ compared with other BRIC (Brazil, Russia, India, and China) countries — and is already well beyond the levels that ‘have led to sharp and brief credit crises in the past,’ the Pivot Capital report contends. Moreover, an increasing number of Chinese loans are being funneled into projects unlikely to generate an attractive economic return. From 2000 to 2008 it took just $1.50 in new credit to generate $1 of GDP growth. Now that ratio is 7 to 1. (In the U.S., just before the financial crisis hit, the ratio was only 4 to 1.)”

For more on China, consider the report “China’s rising bank debt could leave nation exposed” published earlier this month by Ambrose Evans-Pritchard in The Telegraph:

“Chinese banks are expanding their balance sheets rapidly through higher leverage – a policy that relies entirely on the continuance of torrid growth. Concerns are mounting about the opaque operations of China’s banks. The regulator ordered them to carry out a stress test this month based on a 60% fall in property prices.”

Before moving on, it’s important to connect the vulnerability of national economies who have relied on excessive debt to deflationary pressures. The U.S. housing market, for example, has now collateralized the accumulation of debt by U.S. households that easily exceeds $10 trillion. What happens when these homes are all suddenly worth 50% as much? This same scenario may also occur with the commercial real estate market in the U.S., putting another nearly $5 trillion in debt at risk. Government debt, while not explicitly collateralized to hard assets, is none-the-less backed by the vitality of the economy of the nation. Business debt is collateralized by the assets of the business, which lose their value in a downturn. The point is this: If the value of the collective assets in the U.S. go from 10x GDP to 5x GDP, i.e., if they lose $70 trillion in value, there is no fiscal or monetary policy imaginable that could prevent a collapse of liquidity and a deflationary spiral.

The next table examines the sustainability of debt levels in the major nations by estimating debt service as a percent of GDP based on various interest rates. While these debt levels are speculative in the case of nations other than the United States, because they are based on a total debt estimate of 3x government debt, in the case of the United States all of the variables are fairly well documented. As can be seen, debt service at an interest rate of 2% consumes 7.2% of U.S. output, at rate of 4% consumes 14.4% of U.S. output, and at a rate of 8% consumes 28.8% of U.S. total output.

What this all means is hard to distill, but salient points abound. Debt payments necessarily are paid from an active producer to a passive consumer. Incentives to produce are dashed in a debt-rich economy. Existing debt and current deficits are only part of the picture – cash-flows are also being decimated now by payments for future liabilities. While pay-as-you go plans such as Social Security are unfairly identified as a source of massive unfunded liability (ref. Funding Social Security), the Wall Street pension plans are in dire straits because they been projecting investment returns that are elevated because they depended on accumulating debt. Here the relationship between national debt and rates of return is a painfully relevant indicator of impending deflation – we have reached the point there is too much debt out there to pay high rates of interest without going bankrupt, and consequently our retirement pension funds will require far greater infusions of cash from the workers, further lowering productivity.

Turning to salient questions, why would economists deny an economic cycle is in recession, if growth is only through growing assets atop a speculative bubble? Didn’t any experts think total national debt mattered? Why for that matter, isn’t information readily available on aggregate debt by nation and currency zone? Is consumer debt or commercial debt that hard to estimate? Can no informed assumptions be made? Are discussions of aggregate debt still irrelevant? If not, where are the figures?

The GDP numbers used here, along with the debt numbers in all sectors for the USA, come from what appear to be reliable and redundant sources. Therefore the estimate that just a 3% real rate of return on total debt in the USA will require interest payments of 10.8% of GDP is well founded. Of equal importance is the impact the reduction to a 3% earnings projection has on the long-term balances for investment funds that are obligated to disburse defined benefit obligations to current and future retirees. If return projections are lowered to 3%, they will necessarily require gigantic leaps in their annual collections in order to fulfill these future promises.

National debt of all kinds, government, business, household, is facilitated by low interest rates. Once these low rates induce a sufficient percentage of national assets to be encumbered, either contractually or intrinsically as part of the economic ecosystem that determines and defends the vitality of a nation’s currency, it becomes crucial to maintain low rates to avoid bankruptcies. In the early stages, and then with increasing desperation, as these low borrowing rates stimulate economic growth catalyzed by excessive speculation, assets acquire value that would not accrue in an environment of sustainable, higher rates of interest. These overvalued assets are the collateral, they secure additional borrowing, they are engines of liquidity. The higher debt levels get, the more new debt it takes to generate the same unit of economic growth. Eventually buying must slow down, and asset values come down to earth, which means loans are secured by property that is worth less than the loan. When this becomes pandemic, you have a deflationary decline.

National debt and rates of return is an endlessly compounding topic that defies concise explanation, hence a conclusion to this post that may as well be throwaway haiku. One final aside: Related to passive investor claims on ongoing productivity, which in the U.S. at 3% interest is 10.8% of all output, is the demographic reality that defines nations as much as their levels of debt. Japan, the Eurozone, and China all confront rapidly aging populations, although the Chinese are a generation behind Europe and Japan. The U.S. has a perfectly even age continuum, with about 20 million people in each five year age group through about age 60. Brazil still has a pyramidal age structure, although the slope has steepened in the last 10-20 years. In general, the 30% of global output not summarized here are emerging nations, with young populations and relatively low levels of debt. Will they be the locomotives that pull the developed world out of their debt funk, by playing an integral part in a new wave of sustainable growth? Or will the canny and heedless West simply mortgage the emerging world like it mortgaged itself, making them just another bubble? Or are we advancing so fast, our efflorescence of technology and freedom so rapid, that real economic growth will erase our debt?

Debt elimination without a deflationary crash requires GDP growth while simultaneously reducing debt. But without bubbles the world would no longer dream, or reap the lasting benefits from the valid advances every bubble leaves behind. In the future, what’s wrong with a space tourism bubble, where we vacation at a constellation of resorts orbiting in the vicinity of L5? Or a geriatric bubble, with products such as exoskeletons that would enable safe downhill skiing at age 110? Or highly advanced virtual reality devices, bubble enclosures in reality, where young and old enter cyberspace and become indistinguishable? Aren’t bubbles innovative engines? But debt is debt, and walls are walls, and interest rises, and interest falls.

The Razor’s Edge – Inflation vs. Deflation

Deficit spending has been touted as a potential driver of inflation, because only with devalued (inflated) currency can we hope to erode the real value of our mounting levels of government debt. Continuing to print U.S. dollars, it is claimed, can only lead to too many dollars in the system, and hence a devalued dollar. We should be so lucky.

A few years ago, in Sept. 2007, in a post entitled “Inflation vs. Deflation,” I cited a recent (at the time) quote from Paul Kasriel, an economist with The Northern Trust Co. in Chicago. He explained the danger of deflation quite well, describing what happened in Japan:

“Japan experienced a deflation in recent years because the bursting of its asset-price bubble in the early 1990s created huge losses in its banking system. The Japanese banks had financed the asset-price bubble. When it burst, the debtors could not keep current on their loans to the banks and therefore were forced to turn back the collateral to the banks. The market value of the collateral, of course, was less than the amount of the loans outstanding, thereby inflicting huge losses of capital to the Japanese banks. With the decline in bank capital, the Japanese banks could not extend new credit to the private sector even though the Bank of Japan was offering credit to the banks at very low nominal rates of interest.”

Another way to put this is as follows: Liquidity is a function of two factors, money supply and collateral. But the impact of available collateral is far more critical to maintaining liquidity than the money supply. Let’s suppose the entire privately held asset base of the United States is 25 times GDP – it’s probably worth much more than that, but let’s use these multiples – this suggests that the total private collateral in the U.S. is worth nearly 400 trillion dollars. On the other hand, let’s suppose the combined deficit spending – otherwise known as “stimulus” spending – in the U.S. is 10 trillion dollars per year – it’s much less than that, at least so far. Yet this 10 trillion dollars, in terms of liquidity, is a mere trickle compared to the value of the collateral, which is the basis of credit lending. What happens if entire sectors, such as the housing sector, decline in value by 50% or more? What if the entire asset base of the U.S. declined by 50%? Can a ten trillion dollar annual trickle of newly minted dollars make up for a decline in the borrowing base (the asset base) of 200 trillion dollars? No chance. This is what happened in Japan in the 1990s, this is what happened in the United States in the 1930s, and this is the specter we face today. Deflation is the devastating scenario that every fiscal and monetary policymaker in the United States is doing everything they can to avert. Inflation would be a cake-walk by comparison.

To further understand why deflation looms as a greater threat to the U.S. economy than inflation, consider what additional bubbles still remain in the U.S. economy. Two huge sectors come immediately to mind – the municipal bond market, and the commercial real estate market. Municipal bonds are at risk of default because public entities, nearly everywhere in United States, are on the verge of bankruptcy. The reason they teeter on the edge of bankruptcy is because these public entities have negotiated pension and compensation plans for public sector workers that are far more generous than anything available to ordinary workers or professionals in the private sector, and these inordinately expensive personnel costs have now far outstripped the willingness or the capacity of taxpayers to pay through even higher taxes. Barring dramatic and immediate reforms – lowering compensation and benefits in order to eliminate these deficits – municipal entities in much of the United States are on a collision course with bankruptcy. If they default on their bond payments, the value of municipal bonds will collapse. Meanwhile, investment has been pouring into bonds as the returns on equities have corrected. The bond market in general, and the municipal bond market in particular, is a massive asset bubble that is on the verge of bursting.

The commercial real estate market is in similar danger. Currently landlords are enduring high vacancies but are, in general, refraining from releasing space at lower rates. They know that if they lower leasing rates for their space, this will cause the value of their commercial property to be reassessed, reducing the amount of collateral their property will support. This reduction, in turn, will trigger calls for principal reduction payments by banks who service the mortgages on these properties, since lowered property values can put property owners into default on their loan covenants. A similar situation already exists with residential properties, except in this case instead of tolerating vacancies to keep rates high, banks are holding foreclosed properties to avoid flooding the market which would cause the price of residential real estate to drop even further. It is difficult to overstate the threat of deflationary impacts if any these precarious situations snowball, once a breach occurs.

Another potential bubble of staggering magnitude is the public employee pension funds. It is ironic, that public sector unions, who pretty much control the messaging in elections (which they buy, using taxpayer’s money), in our public schools, and through their supporters in the media, have taught the gullible among us to loath capitalism, resent private wealth, and vilify Wall Street, yet their public employee pension funds are now engaging in perhaps the most irresponsible example of casino capitalism yet. Rather than support reducing the bloated pension benefits they are currently obligated to fund, and rather than accept a conservative real rate of return on their investment portfolio of 3.0% per year, the public employee pension funds are engaging in investment activity that is riskier than ever in a desperate attempt to reflate their asset base. Read this from Pension Pulse’s Leo Kolivakis, written on March 9th, 2010, in a post entitled “Public Pension Funds Doubling Up to Catch Up“:

“Private pensions are in no mood to crank up the risk, but public pension funds are back to business as usual, and even looking to leverage up to obtain their magic 8%. Many public plans are still sticking to the motto that more private market assets will lead them out of their troubles. They’re in for a nasty surprise. Last January, I wrote that the alternatives nightmare continues, and I don’t see it getting much better. In fact, as mighty endowment funds like the Harvard Management Company look to unload real estate and other private equity holdings, private markets will likely suffer a long drought, especially since public markets are not going to deliver anything close to what they delivered in the last 30 years. So what are public pension funds doing? Cranking up the risk, investing in failed banks, leveraging up, shoving more money in private equity and hedge funds, whatever it takes to achieve that insane 8% average annual return they’re all still fixated on.”

Bonds, real estate, and pension funds, ultimately, are all collateral – the primary engine of liquidity. Over the long-term, the only way to stabilize the value of collateral is to establish a sustainable positive cash flow. When the financial history of early 21st century America is written, it is interesting to wonder how historians will characterize the behavior of public sector unions, who were indifferent to deficits, who were incestuous with Wall Street, who rode the waves of unsustainable debt and deficit-fueled phony booms to guarantee their members would enjoy magnificent benefits calibrated on bubble values, but contracted to endure even after the bubbles burst. Will the refusal of all-powerful public sector unions to embrace fiscal reform be seen by future historians as contributing to the collapse of the bond markets, the pension funds – and under the burden of new taxes instead of reform, property values, as the nation’s collateral imploded? At the least, it is fair to say that what today’s leadership of public sector unions decide – whether they embrace concessions for the sake of the nation, or not – is one of the biggest opportunities remaining to avert further financial calamities.