One thing is clear:
A huge mountain of interlocking, interconnected debt is a house of cards, and a monetary or financial system based upon such a thing is prone to collapse by default-cascade: one weak link in the chain breaks down the entire system.
But the next collapse of the debt-pyramid is a long-term trend that may be a long way — and a whole host of bailouts — away yet. A related but different problem is that of government spending. Here’s American government debt-to-GDP since the end of WW2:
After reducing the national debt to below 40% in the 70s and 80s America’s credit binges since that era have quickly piled on and on to the point that without a major war like World War 2, the national debt is above 100% of GDP, and therefore in a similar region to that period.
Simply, America’s government must find a way not only of balancing the budget, but of producing enough revenue to pay down the debt. This has inspired the current crop of Republican nominees to produce a slew of deficit-reduction plans, including Herman Cain’s hole-ridden 9-9-9 plan which shifts a significant burden of taxation from the wealthy and onto the middle classes. Worse still, taxes on spending hurt the economy by discouraging spending. Want to expand your business with the purchase of new capital goods? 9% tax. Want to increase revenues through advertising? 9% tax. Want to spend your earnings on goods? 9% tax. That’s a hardly a policy that will encourage economic activity in an economy that is (for better or worse) led by consumption.
Whichever way the tax burden falls, the sad reality is that any plan that focuses on taxing-more-than-disbursing is just sucking productive capital out of the economy, constraining growth. The other “remedy” inflating the currency (to inflate away the debt), punishes savers, whose investment is necessary for productive growth.
Dean Baker shows a historical case of such an event. Argentina, crippled by its peg to the dollar, defaulted on its debt since 2001:
All the crushing weight of taking productive capital out of the economy crushed growth. Then Argentina defaulted on its debts, and rebounded, astonishingly. Of course, most of blogosphere is looking at Greece in this debate. I am not, because I recognise the Argentinosaurus in the room: America’s foreign-held debt load (payment for all those Nixonian free lunches) is undermining the dollar’s status as global reserve currency, a pattern of development that will ultimately force exporters — on whom America relies — out of exporting to America for worthless sacks of paper and digital. International trade has always been on a quid pro quo basis — and since 1971 that has worked fine for America — dollars have been a necessary prerequisite to acquire oil, other commodities and supplies and pay dollar-denominated debts.
So I think the time has come to explicitly advocate a radical solution to save the dollar — but just as importantly to save the middle classes, and productive capital from the punitive taxation (and welfare cuts) required by austerity.
America needs to balance its budget by gradually (and with negotiation) defaulting on its debts. The first prong of this is totally defaulting on the debt held by the Federal Reserve — this is simply just a circuitous way of cycling money from government to a private agency and back again to the government, while the private agency (the Fed) pays member banks 6% annual no-risk dividends. The second prong is to begin negotiations with international creditors to revalue American debt proportionate to what America can afford to pay in the long run.
Far from infuriating creditors, I think that the evidence shows that this move would benefit everyone. A strong American economy is important to Eurasian producers and exporters. An American-economy dragged down by debt-forced-austerity means a smaller market to sell to, and to gain investment from. The only significant counter-demand for such an arrangement might be a balanced-budget amendment, so that America could no longer borrow more than it can raise in revenues.
Of course, there are other avenues to explore: slashing military spending (and giving the money back to the taxpayer, or to the jobless, or to infrastructure programs) is one such avenue: as I have explained at length before, American military spending is subsidising a flat-market, and making non-American goods artificially competitive in America.
But the real issue today is that liberals mostly want to talk about higher taxes, and conservatives mostly want to talk about austerity. They’re missing the Argentinosaurus in the room: the transfer of wealth from the American public — and the productive American economy — to foreign (and domestic) creditors, and the downward pressure that this is exerting on American output.
Debts — even AAA-rates debt (or AAAAAAAAA as an Oracle once put it) — all carry risk: the risk that the debtor is getting into too much debt and won’t be able to pay back his obligations in a timely or honest fashion. Creditors are making a mistake to be ending money to a fiscal nightmare whose only economic refuge is money printing.
So will America continue to tread the bone-ridden road of austerity, high taxation and crushing economic contraction, leading to excessive money-printing, and ending in the death of the dollar and an inflationary firestorm? Or will it choose the sustainable route of negotiated default, low taxes, a return to productive, organic growth, and the opportunity to decrease reliance on foreign energy and goods?
What’s that sound? No, not the crashing Argentinosaurus.
azizonomics 
“America needs to balance its budget by gradually (and with negotiation) defaulting on its debts.”
What? It isn’t the debt that’s breaking the budget- borrowing is cheap. It’s the government spending. You want a radical solution? Go after the entitlement and military spending, come up with a tax system where everyone has some skin in the game and the actual taxes paid are closer to the marginal rates.
Your “radical solution” is called austerity. While I agree with cutting military spending and reforming entitlements, borrowing is cheap because interest rates are artificially low because treasuries are in a stupendous bubble.
What I am calling for is calling time on the bubble in a controlled way before it bursts in a more dangerous way. Most of the “demand” for treasuries is totally artificial. The artificial demand comes from creditor/producer nations particularly China and Arabia with massive trade surpluses being cajoled into treasuries, from quantitative easing and from the illusion that treasuries are a safe haven (this is pure delusion — we have negative real rates, period). When the artificial demand is ended (by — for example — China dumping huge quantities on the open market at all-time-high prices) rolling the debt will become impossible (look at Italy) and we will be left with two choices: print money, or default.
Now we don’t know when the artificial demand will be curbed, but if the recession and negative real rates continue, the day will come soon enough. When it does, I’m pretty sure the powers-that-be will choose the former — with the help of Paul Krugman who will still be obliviously shouting “demand shock” and stating the monetary base could be expanded another 300% without significant (>5%) inflation.
Now — while there are lots of other eventualities (none I can think of are particularly good for America) — the emergence of that kind of febrile atmosphere is the perfect ground for a hyperinflationary storm — all that’s needed is an energy/goods/components supply shock — and printing shitloads of money to monetise debt is the perfect trigger to push OPEC and the United States of Eurasia (Iran, Russia, China, Pakistan) into a full-blooded attempt to throttle the dollar (the Eurasians want their turn at reserve currency status) by curtailing exports (especially energy) to America.
Although Argentina is Argentina and not the U.S. or Europe, I found these articles interesting: http://www.silverbearcafe.com/private/10.08/tshtf1.html
In other news: Inflation in the UK at 5.2%! http://www.dailymail.co.uk/news/article-2050388/Fuel-price-rise-energy-cost-increase-send-inflation-rate-5-2.html
So the solution is just default, with no changes in the state finances/entitlements/etc.? Why would the Eurasian states support this – I mean, US has no trouble consuming their products right now, and will have no problem consuming them after a default, after which the debt will begin to pile up again in short order. Default worked for Argentina and can work for Greece because they’re small economies that were/are choked by their debts and lacked financing. US currently does not experience any lack of financing, so if it can grow to finance its debts, it could just as well do it right now.
The problem can’t be solved without reforming the international monetary system. Globalization would not have ripped apart the middle class if a gold standard was in place. Keynes’ Bancor http://en.wikipedia.org/wiki/Bancor is (to me) nothing more than a gold standard – however put into a framework where it cannot be manipulated by individual states. China knows this probably, and that’s why they’re supporting it (or something like this). They know that US can’t ever compete with them again (and pay their debts at the current value of the dollar) absent this. Their push for this is probably because they want to conserve their current $ reserves (avoid a haircut), while also allowing for a gradual recovery of the international economic imbalances (because they’re confident they now have a sufficient technological base that they can grow by themselves without extracting jobs/manufacturing from the West at an accelerated pace).
Why is such a supranational mechanism similar to a gold standard required? Because, as I’ve argued in another comment, globalization does not work as it currently stands. Ambrose Evans-Pritchard attributed this to “rigged” currencies. But as I’ve argued in the same comment, there is no such notion as a rigged currency absent a gold-standard-bancor-style way for the imbalances in international trade to be corrected.
Andrei, I agree with your post. Globalisation will not work if:
1. Exchange rates are supported (Manipulated by Government)
2. Free Labour movement is restricted (Visas)
3. Tax Treaties are not uniform
A lot of the Economists of the 19th and 20th Century, wrote their theory without regard to ancient, neolithic or Aboriginal hunter gatherer (Island Theory) economics, because they though that God created Adam and Eve.
As a result the fundamental fact that there is “No free lunch” when it comes to the economy. You either wake early, hunt, gather, make tools, provide servides such as sexual favours, or you starve, shiver, or sleep in the open.
If the Socialist, Keynesian methods run their course, an economy will deteriorate and become uncompetive, through higher costs of production, due to inactivity of labour, and flight of capital.
Because we don’t have a “One World Government” with free trade, labour, capital, currency; national economies will stagnate and their citizens will suffer.
This is why Wars are waged. It is kill or be killed in the end. If China offers her young single men a house, car and an American mail order Bride, and they are unemployed and starving, don’t count out a millitary expansion. A % of 1.3 Billion people must have read Mein Kempf, and will try to upstage Hitler.
I think America will somehow start a proxy war triggering a Sino-American war (or namely WW3, or WW2.5) before its military might lags behind China. With MAD preventing the widespread use of nuclear weapons, America still has military power enough to beat up the rest of the world within a glance.
I don’t know about that. With regards to standard wars, you can’t conquer anyone with 12 aircraft carriers and “smart” weapons. This didn’t work before and will never work in the future. This is not to say they might not try (if some mad puppet ever gets to be in charge).
Absolutely Andrei. Look at Iraq and Afghanistan. Without unleashing nukes, America would be truly humbled if it tried to invade further into Eurasia. So American faces the same problem as Rome — not enough men, not enough willpower, and not enough money to run a transcontinental empire.
Has any Economist calculated the 6% Dividend payment and the effects on the USA economy? If it is a Super profit, then in effect it has been slowly bleeding the USA.
I know in the past the USA had interest rates exceeding 6%, but why doesn’t it adjust down to reflect the low interest environment?
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I disagree with the idea of simply defaulting and moving on. This is just another means of kicking the can. When a people don’t feel the real pain of default, then they will continue to elect politicians in endless cycles of debt/default.
Obviously, a nation without debt can grow. That’s a no brainer. But that is basically stealing. It’s immoral, and it just ends up re-occurring over and over.
Pay back your debt! If you cannot raise revenue enough to pay debt, then pawn your possessions. Force Greece to pawn the Acropolis, then save up to buy it back. This is the only way to teach a people that debt is truly something to pay attention to.
What works on the individual level works on the macro-economic level. Its a fallacy to think they are different.
This is an interesting point.
I agree that the only way to learn is through pain.
At the same time, it goes both ways: if creditors hadn’t stumped up the money, the government debt boom could never have happened. Creditors need to take some pain too, to establish to them that if they invest their money in funding government largesse they can lose, big time. This is the most frustrating thing about the Eurozone: creditors are being shielded from responsibility. This will just mean there will be more irresponsible creditors.
Also, getting to the point of default is a pretty painful process. Greece has taken a lot of pain already. Default, and let it be over. It will take a generation or two for those lessons to be unlearned. Let them stop suffering.
There is also an intergenerational issue: why should I — as a 24 year old kid — suffer for the generations of my parents and grandparents? They borrowed the money, they took the benefit, and my generation are left jobless and destitute picking up the pieces of a burst credit bubble.
I also hate the fact I am governed by laws (and have to repay debts) I never agreed to. Hopefully one day I am allowed to secede and become a sovereign nation of one. The only hope of that happening in my lifetime is through seasteading.
Well, Europe is fucked. A moderate estimate suggests it will take $100 trillion to bail out the whole stinking edifice. That’s more than global GDP. These debts are not only punitive to the young, they are economically destructive.
When Europe goes down it will take the entire global debt pyramid down with it by default cascade. The entire international financial system is fucked. Everything will be defaulted on, and soon, maybe even in the next year or at worst ten years.
The only way out is to forcibly shrink the debt, and most of these remedies are politically impossible, because creditors (e.g. China) won’t take haircuts. But that is like King Canuut. Without organic growth, without creative destruction, without innovation, all the problems will just get worse. And finally it will collapse uncontrollably.
I don’t have to get into seasteading to get my wish of debt erasure.
Surely there must be some middle way between total uncontrolled collapse and an improbable voluntary global reset. And my guess is that TPTB will choose some way. That’s why I appreciate people like James G. Rickards who understand that the status quo is untenable and at least try to come up with solutions. We’d better have a clue and an opinion about what they’ll get us into.
Now regarding growth, I’ve become accustomed some years ago with John N. Gray’s ideas about a stationary state economy. Of course, it’s only about how you measure growth (it’s not like we’ll keep doing the same things over and over again); it’s likely the kind of exponential growth he have been blessed with so far can’t go on for long. Then I recently stumbled upon Chris Martenson’s “Crash Course” who similarly suggested that the economic model of the last century was not a designed system but the actual effect of cheap and abundant energy.
Most people in this forum can throw out a few solutions. My favourite is applying a global haircut (say, 50%) on all debt to forcibly shrink the global debt-to-GDP ratio without triggering a default cascade, and without shafting anyone in particular, and with much less inflationary risk than printing funny money. The problem? It’s politically untenable — creditors want their pound of flesh, and they will see the global financial system collapse before they ever agree to haircuts.
There are other things we can do — I favour significant alternative energy stimulus spending (so long as it goes on technology and jobs and not largesse like Solyndra) to cut oil dependency and raise demand. I favour cutting back empire, and spending it on infrastructure and tax cuts. I favour letting failing businesses fail to open new segments of the market to new businesses, and restoring creative destruction. If America and Europe had leaders who could do some of these things, we would have a better chance of avoiding global financial collapse. But there is very little leadership, or bravery on these issues. Leaders have followed stability, cronyism and creditors over creative destruction and capitalism, and that has meant there has been no liquidation, and debt has continued to rise.
As for John Gray, well, this is really a different topic. The reason I am talking about growth is because of the debt — growth is supposed to be a panacea. If you have a zero-debt economy, you can have a healthy zero-growth economy. With compound interest, if you have no growth you have an economic disaster.
PS: To be thorough “cheap and abundant energy” -> “cheap and abundant energy and resources” (The image of that copper nugget the size of a cow – the likes of which could be found in the USA circa 100 yrs. ago – keeps coming back in my mind; now they mine for 0.2% grade ores).
Well, yes but those are just “good principles”. The problem is that we need a framework (monetary especially and a new paradigm in economics more generally). From what I read, our current monetary arrangements are only suited for exponential growth. You can watch Chris Martenson’s “Crash Course” and see if you agree with him.
The thought that this whole global mess will simply end up in a debt jubilee breaks my heart. We are *so close* to showing the layman that fiat money, the banking cartel and socialism are the cause of so much grief. If we don’t learn our lesson then it is absolutely inevitable that we will be in the same situation again.
Articles like this: http://www.oftwominds.com/blognov11/Zeus-unleashing-future1-11-11.html (`Unleashing the Future: Advancing Prosperity Through Debt Forgiveness (Part 1)`)
…are becoming more common place. This is the ultimate can kicking, only it is possible to kick the can 100 years down the line. We are on the verge of a real revolution, I truly hope we don’t just end up with mass debt forgiveness and a simple restart of a slightly-tweaked system.
While I doubt any one particular representation of history will win an absolute victory, the rise of Ron Paul does suggest that the central banking credit bubble model is losing credibility. However, whatever happens at this juncture in history, I am absolutely certain this will happen again in the future. The idea that we can “show the layman” the truth about XY and Z and prevent future debt bubbles is akin to Fukuyama saying that 1991 was “the end of history”.
In some ways, though, I do fear the end of this system — not because I am in favour of credit-based money (I’m not) — but because its collapse will probably result in war.
For that reason, I would happily take a global debt reset, and a slightly-tweaked fiat system over an all-out intellectual victory, but that doesn’t seem to be a real choice, because as many articles advocating debt jubilees are produced, creditors will not hear it for a second, and will happily drive the world to a new global war before they accept default.
Of course, whatever kind of money is to be used, the best antidote to debt is a system where creditors know that if they lend to the wrong people they will lose their money. The threat of a default that is not bailed-out makes lenders much more cautious. That prevents debt bubbles from forming. The gold standard largely prevents this, but so do debt jubilees.
It’s not that I wasn’t impressed but I’m at the stage where I think that those guys are so cut off from reality that engaging in an argument with them seems futile (of course, that’s exactly what they think of “the others”).
I hope you’re right about Malthus – but it’s Martenson’s person that gives me pause and makes me think he’s onto something. He’s not the kind of depressed person saying we’re all going to hell – quite the contrary: he’s very sure of his facts and is quite a positive person and he certainly always seems open to whatever argument might challenge his beliefs. And he doesn’t think we’re going to hell, at least if we pay attention to what we do (like you recommended he installed solar panels on his roof for example).
PS: Actually, I’ll usually only comment on your blog – or any other blog for that matter – when I think I have something that might challenge the author’s views (however minor my arguments may be). Otherwise, comments like “I agree” will do well to forge human relationships but are quite useless from an epistemological point of view (and most of the time I only have spare time for knowledge :P).
As I’ve mentioned before I appreciate you challenging me. Mostly because I need this kind of discussion to really refine my views. Also, it generates long threads, which makes this website seem more popular than it really is.
As for our friends Krugman et al being cut off from reality… Well, to some degree. They kind of inhabit their own meta-universe, and they do tend to ignore contradictory and challenging evidence (instead of engaging it, like I believe we should try to). But it’s not their support we have to fight for. It’s the public consciousness. Liberty has to win the argument on television, on the radio, on the internet. They will say “sounder money prevents us from expanding the money supply when we need to and inflating our way to prosperity”. This idea offers something for nothing — that money printing at next to no cost can provide prosperity. It’s very seductive, and we have to smash it.
One more thing: I remember this idea from Taleb’s “Black Swan” – he was saying that a paranoid person bent on improving the security of passenger airplanes (as in being able to withstand terrorist attacks) might have prevented 9/11 but would have been fired in disgrace for being a lunatic. So perhaps Malthus has been wrong for so long just because of all the Malthusians out there.
And a correction (in my prev. comment): “I’ve become accustomed” -> “I’ve become acquainted”
The only way that the Malthusians will be proven correct is if societies fail to adopt an adequate strategy for infrastructure, energy, etc. Similarly, the only way Michael Scheuer could have been correct is if the DOD failed to adopt an adequate strategy, which is exactly what they did.
The difference is that there is much more breathing room with the Malthusian concerns. There is no aeroplane that will strike us tomorrow. Countering terrorism is much harder than countering shortages, because it is quite multi-dimensional. With Malthusian concerns we know what we have to focus on: producing enough food, water, space and energy. These are concerns for the long run, and are largely addressed by the market. With terrorists, they could strike anywhere and at any time, and the market does nothing to prevent them.
My comment was more philosophical in nature just like Taleb’s. I just wanted to say that we should perhaps thank Malthus’ “lunatic” disciples from keeping us away from our extinction.
Also, I hope you are correct about the breathing room but… my instincts tell me we don’t have that much breathing room; humans are volatile animals and who knows what can happen when the fragile framework in which will all live in is shaken by just one bit. I certainly do agree with Martenson that the next 20 years will be unlike anything we’ve experienced during the last century. Whether the transition will be painless and lead to more prosperity – well, this is only up to us. We simply can’t continue using up our resources like before (it’s not just oil but even the most basic chemical elements) and ideas like mining the asteroids while interesting are not doable (in terms of EROEI) in the short time frame we’re confronted with (that’s just my humble opinion).
Yeah, as I’ve said before I appreciate Malthusianism because it makes us engage with the question of resources. I am probably very harsh and unfair about it, because it is an important dialogue (even if most of the Malthusians concerns have turned out again and again to be wrong).
I think the key is that we can’t keep using resources without putting something real in place to make sure it all keeps flowing.
“Good luck trying to introduce a new monetary framework to the political and academic worlds without a huge purifying market crash to fully discredit monetarism and Keynesianism.”
You may be correct, but consider that there are plenty of well trained economists waiting on the sidelines – economists that do not agree with Keynes, or that do not agree with today’s interpretation of his ideas, or economists of the Austrian-flavor. Guys like Krugman & Roubini are just the clowns that are now in the limelight and embarrass themselves over and over again without any shame. I just read a recent Krugman article and I’m appalled at the sleight of hands he uses at each crucial point in his arguments.
Krugman is a gifted polemicist, a competent mathematician, but an utterly biased, hateful and shrill historian and analyst.
“Krugman is a gifted polemicist, a competent mathematician”
You’re probably right, but I tend to evaluate a person on the whole. Reminds me of how journalism is taught over here: they try to make talented writers instead of making people that have things of substance to say (things that are not either fluff, truisms and unintentional sophisms). If you look at Taleb’s interviews you’ll see that he stutters (in English) and always takes time to collect his thoughts (even though he knows >5 languages or something) – but he can be incredibly eloquent if he takes the time to collect his thoughts in writing. I’d say Taleb is the epitome of the type that has a deep understanding of things (that’s why he will probably never qualify as a gifted orator or prolific writer) – at the opposite end of the spectrum we have gifted orators that are shallow in thinking and understanding and will only present prepackaged theories superimposed on the current events (hence those sleight of hands). Just so you know – I’m not Taleb’s lap dog or something – I certainly don’t see truth in everything that comes out of his mouth – but I have a tremendous admiration for his philosophical understanding of the world (I myself came up with many of his aphorisms on my own – so he didn’t convert me, but instead I found a like-minded person).
As someone who has actually debated Taleb, I will say his weaknesses are sometimes he will heavily over-generalise, sometimes he will use ad hominem attacks (in violation of his own aphorism: “You don’t know you have won an argument ’til they attack your character”), and sometimes he can be overbearing.
On the other hand, he is supremely imaginative, and extremely well read (this knowledge of history and philosophy and philology, theology, psychology, etc, can be quite scary), and very reflexive in debates.
My great weakness is that I am not immediate enough to debate or dialogue so well face to face. I have taken to this medium because I can think out and nuance my arguments and beliefs better with composed writing.
“he will heavily over-generalise”
Yes, noticed that too.
“You don’t know you have won an argument ’til they attack your character”
About this, I don’t think it’s that condemnable – not if you do it post debate/debates. I mean, once you’ve exhausted all of your arguments in a debate with a person, and tried to apply the “principle of charity” and self-doubt, and still you feel that person is unable to answer the crucial points in your arguments and instead he keeps on repeating the same things like a broken record and/or throwing hollow responses at you – then you can safely categorize that person as an idiot (at least with regards to a specific area of knowledge) and move on so as to preserve your mental energy for more useful things (doesn’t mean you necessarily have to call them like that in public – though I wouldn’t see this as verboten). If that person is potentially dangerous due to the power it can wield, recoursing to such brutal and unorthodox means might even be morally required.
“sometimes he can be overbearing”
Yes, having less of an ego might have prevented that.
Sorry for messing your thread but it seems that if I click on reply in the notification email, then the comment will not be properly positioned in the thread.
“You don’t know you have won an argument ’til they attack your character”
To further clarify: Taleb would not be contradicting himself if he throws insults following the process I described above, but his opponents throwing insults at him without going through that process.
I personally go out of my way not to use ad hominems. I think this website is a fairly comprehensive catalogue of my debating style, and I think I have used an ad hominem once, and I was particularly upset that day as a member of my family had been involved in an accident!
Perhaps when I am much older and a distinguished guy like Taleb I will feel I have earned the right to use them. Right now, I don’t deserve to.
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