Random Thoughts on the "Debt Mess"

 

To give perspective and to preserve some measure of sanity, as seen from these Excited
and Disunited States, I am writing a short note of reference to myself (and perhaps to a
few others) at the beginning of this New Year of2013. With due deference to modesty, I
should precede this note with the usual portent E. & O. E. (errors and omissions
excepted). Instead why not simply profess that ifI am telling a lie it is because I believe
that I am telling the truth. For the sake of brevity, the references made are so clearly
recognizable that I shall not belabour their well known origins.
Where to begin? Why not with some relevant and obvious truisms that I think
bear on or perhaps even defme the topic at hand, to wit: "1. The road of hell is
paved with good intentions. 2. Example is the school of mankind, and they will
learn at no other. 3. History is indeed little more than the register ofthe crimes,
follies and misfortunes of mankind". These will nicely serve to frame my
thoughts. Well maybe along with one other; the professions of some 18 tho
Century "wise" men that democracy as then seen was bound to fail because men
(and their political representatives) will eventually discover that they can vote
themselves all sorts of goodies which in the end their State cannot possibly pay
for, thereby causing this "new" idealistic experiment of democracy to end in
complete disaster.

How Europe, the United States, and Japan constituting roughly 2/3 of the world annual
"GDP", have managed to get themselves into this fix is a long and a somewhat different
story in each case, but in the main it was all pretty much based on stupidity, reasonably
good intentions and not on some evil design. But the resulting terrible debt burden,
common to them all, debts that extend so widely and are so widely interconnected, is a
great ugly tar ball, and like a loose cannon it just crashes about and touches and smears
everything it reaches; seemingly it touches and sticks to just about everything. Without
getting the fiscal deficits under control (meaning at the very least that the annual fiscal
deficits must grow very much less quickly than their respective economies) then, as added
to their already existing national debts, a sort of impossible debt death spiral is inevitably
reached from which no return is possible. At that point mathematics and the basic
understandings of macro economics simply do not operate, and a sort of economic black
hole is reached. This stuff is not abstract, or academic, or irrelevant. If that is in doubt,
then just go and visit the tragedy presently unfolding in Greece.
The first (impossible?) question in which we are now engaged seems to be whether a
democracy based on the universal franchise is even capable of coming to terms with their
collective and accumulated "sinful" debt, and to resolve to repay a good part of it in a
meaningful manner. Perhaps in afterthought that should have been the real concern of
those 18 th Century writers, because the very question that they then raised has, courtesy
of our intrepid Central Bankers, so far been answered in the negative, at least until now.
Which spawns and begs the second question, given a fair will and utter determination, is
it even possible to resolve this debt crisis in a meaningful way? I mean by that, not

sneakily or willfully to inflate our way out of the debt, or default on it (essentially the
same thing), but on growing our economy and repaying some meaningful and substantial
amount of the debt over a reasonable period of time without in the process also destroying
the free enterprise and private capital market economic system, the goose that lays our
golden eggs. And also doing so without destroying the lives of untold millions of
perfectly innocent people. In other words, to maintain, more or less, THE PRESENT
WELFARE STATE WHICH IS DEEPLY IMBEDDED, INHERENT AND
PERMANENT IN OUR MODERN NATIONAL EXISTENCE and simultaneously to
deal with the debt mess! That is our burning question and that is (perhaps) also our
impossible dilemma.
Think on this for a moment; very conservatively right now, the US has slightly above
100% national debt to GNP ratio. Continue on at the current rate of $1OOBmonthly
federal deficits (some $1.2 Trillion/year) times 4 years (duration of new Administration)
and we will at best arrive at some $23 Trillion of federal debt in 2016. At current rates of
growth of 2% or slightly less, we would be in a $17 Trillion national economy.
Something doesn't add up here, and we are sliding backwards in the critical debt to GDP
ratio. Bear in mind also that the best research now suggests that any ratio of debt to GDP
over say 90% brings very serious troubles in its wake.
I think for the US, it is late but still possible to begin to reverse the deficit/debt crisis by
taking the "right" measures as follows: an acceptance and the application of something
like the Simpson-Bowles recommendations, a national sales or VAT tax, means testing
entitlement programs and somehow curbing them (but I don't know how), against all
odds making practical sense and application of the regrettable "Obama" health care law,
the imposition of slightly higher taxes for mostly everyone, ABSOLUTEL Y NO NEW
WELFARE PROGRAMS, no more costly and unnecessary foreign wars, and the
achievement of at least a neutral annual balance of payments position (ie., no trade
deficit) through the pursuit of national energy independence, (which is the only practical
vehicle available to solve that issue). IF WE ALSO MODESTLY GROW OUR
ECONOMY AT THE SAME TIME, then over a period of say 10 years the mess can (in
theory) be cleaned up and we will finally return to the status quo ante before 9/11.
However my imagination fails me in thinking that the same cautious optimism can be
held for Japan, Spain, Italy, and hate to think it also France. Obviously forget Greece,
Portugal and probably Ireland but their weight is light in this momentous mess. If France
and their banks goes, and there is very real present concern about that happening, there
goes the EU (for Germany simply is not big enough to sustain that loss), and that will
obviously have huge spillover effects.
Up to now have I said anything that has not been written, studied and debated by very
well qualified people? I think most regrettably the answer is no! I wish it were otherwise.
For example Rogoff and Reinhart in their seminal work "This Time is Different" and
some subsequent very important follow up papers by them, would if asked surely say that
I have merely taken a short penetrating glance at the obvious, and not nearly as well as

many others would and have done, and of course they would be right.
That said, I might point out this is the first time we are now dealing not just with
sovereign states, but with sovereign national welfare states, and I think that is a very
different animal than heretofore written about in terms of huge debt crisis's. Moreover
we are also dealing with their setting amidst globalization and competing with national
states that are, up to now, clearly not welfare states, and therefore burdened with much
lower cost and debt structures in their economies, and that too is very much a first. These
two facts make the present situation immensely more difficult to resolve than the many
prior crisis's so ably described by the aforementioned scholars. I will hazard a further
observation that our situation is infinitely more serious and precarious than the Great
Depression, because, unlike our situation, it occurred in the absence of a huge
(unmanageable?) debt crisis.
Moreover, it is most unhelpful that this business is set in the background of undeniable
climate change, the economic effects of which are simply incalculable, and which very
probably will eventually render all other issues irrelevant; as a sidebar it makes this note
absurd to boot; but I'll plod on just a tad more anyway, undeterred by the insight of
Keynes that in the end we are all dead, and thus all issues are resolved.
Question one: OK supposing we bridge our national differences and reach a broad
meaningful consensus (good luck on that) to apply the prescriptions above (which are
widely accepted by most economists) what if the EU does goes down? Can our notional
10 year "recovery" program sustain such a shock? I have no idea, and I think that the
answer here is unknowable. The EU structure is impossible ab initio simply because you
cannot indefinitely have a common currency operating happily within a large internal
customs union of very differing economies and with very different efficiencies. Initially
the inevitable happened, the less efficient economies borrowed great gobs of capital at
much lower rates of interest than they ever could before (and from which they did not
generate a positive income stream), and at the same time they also ran into serious
balance of payment problems (trade deficits), without the means of devaluing their own
national currencies (heretofore their mitigating mechanism) to deal with the resulting fall
out consequences of even more debt. All that in turn soon enough morphed into
unsustainable sovereign national debt problems for the sinners. Can all these "sovereign"
nations finally succeed (in time) in changing the EU into a new unified and sustainable
political structure and also credibly deal with their individual and collective debts? If they
don't, I think most, if not all, go down. There is the nub of the problem. In a very real
sense it is now as much a political as an economic problem it would seem. Put the two
together and you have a REAL PROBLEM! It is worth remembering incidentally that
most of the world trade is presently facilitated by the major European banks stuffed to the
gills with "bad" local government paper or IOU's.
Question two: What's to be done concerning our adventurous central bankers, and what
they have done so far in accommodating the national governments involved by buying
their essentially worthless paper? Their swollen balance sheets are as unprecedented as

they are impressive in scope (and rapidly growing); can the central bankers figure out a

way to shrink them without also collapsing the whole economic system? Hyper inflation
may well be on the horizon, or maybe it will all result first in deflation and then in hyper
inflation as suggested by some. But clearly, as we go forward on the same path the whole
thing eventually becomes unbelievable, and therefore something has to be done sooner
rather than later. Unfortunately it is not at all clear how it is to be done. It would be most
helpful if Messrs Draghi, Bernanke, King and Carney etc etc would answer that one. No
on second thought they had better not try to do that, it just might do more harm than
good! The problem is that too many knowledgeable people don't think these gentlemen
can do it, including Trichet for example. Sidebar, don't even ask what the commercial
banks (especially in the EU) can do with all this worthless paper that supposedly keeps
their balance sheets solvent! Sovereign bonds, a major part of their capital, that can never
be repaid; maybe just rolling them over for the next century or so will do the trick??? For
the central banks is there also some sort of separate "bang point" of market refusal similar
to the RogofflReinhart bang point described in their works with regard to sovereign states
and their sovereign bonds? Maybe it is the same thing in the end.
Finally speaking of central banks, one might ask what about all those massive stockpiles
of gold they hoard in order to back (well sort of, why else hoard it) their respective fiat
currencies? To whom does all this gold really belong in those inaccessible central bank
vaults? Apparently most of the bars and coins are there, but have they already been sold,
swapped, lent, hypothecated, pledged or whatever to eastern central and other banks, but
still resting in the same old places? Thankfully (I think) central banks are notoriously
opaque on this subject. Sprott Resources for one have tried to match the amount of gold
purchases by oriental central and commercial banks with the annual world production of
gold. China is the largest producer in the world but they keep their domestic production at
home. Now the rest of the annual world production simply does not match the amount of
gold sales to the eastern banks, so the question arises where did all that excess gold come
from? A probable conclusion is that western central banks directly or indirectly were the
source. Just maybe there is little gold left belonging to whom we think it ought to belong,
"backing" our various fiat currencies. If so, does that really pose a serious issue of
confidence? Well, go ask your local plumber for example, and then go figure!
Question three: I can't help wondering about all the unregulated, mostly unrecorded,
interconnected and unfathomable financial papers present in the world financial markets.
We are told that there are somewhere north of $600 Trillion of unregistered credit default
swabs (enforceable insurance promises?) out there. That's ten times the combined annual
world gross product (CAWGP). If they are enforceable and go bad in an interconnected
chain reaction we all go down, and if they are not enforceable in an interconnected chain
reaction then we also go down. Best not to say anymore about that subject! !!
In closing, and in trying to get my arms around all the foregoing stuff, I tried to do my
insignificant little part and voted for Mitt in November. Why? Well for one thing he
would have repealed Obama care which will make an abominable mess out of the present

pretty bad medical insurance mess, and we would have saved a great deal of money that
we haven't got. Secondly, I believe he fully understands the basic laws of macro
economics and has the instinctive smarts to have made a non ideological national
consensus "deal" to put the nation on a sustainable economic path and dealing with the
debt in a demonstrably believable manner. He is a pragmatist not overburdened with
principles or absolutist positions and has shown "flexibility" to make political deals or
policy changes. Thirdly, he would have allowed the Keystone pipeline as a strategic move
to get most of that resource locked up from foreign competitors, and because he
understood not only the need of Gulf refineries to get the heavy crude (they will get it
elsewhere if need be), but also because national energy independence will cure (and more
rather than less) our balance of payments (trade deficits) situation. And what bears
repeating is that you simply cannot deleverage simultaneously both the public and private
sectors, which we badly need to do, absent a national trade surplus. Just one of those
inescapable identity equations that can't be ignored. Finally, he would (as openly
declared) somehow have "fired" Bemanke and start to get the Fed (central bank) back on
a sustainable path and certainly away from this money printing madness that they are
currently bent on continuing indefinitely. Here hats off to Fisher and Laker of the Fed.
The very notion that the main responsibility of a central bank is both to check inflation
AND to secure full employment is inherently contradictory, and the legislation should be
changed back, because a commendable mandate of full employment is best solved by the
general economy, hopefully helped or encouraged by the legislature, and sound money
can best be secured by the Fed.

To pick up a bit more on the Fed, their fairly modest regulatory powers (which Greenspan
failed to employ and that likely would have avoided the 2008 crash, perhaps in a reverend
bow to his inspirational mentor Ayn Rand) should be further strengthened (in addition to
Dodd-Frank) by a regulatory reintroduction of the basic concepts of the Glass-Steagall
commercial banking provisions. That should be further fortified by a requirement and
absolutely pitiless enforcement that henceforth all officers and directors, in the first
instance, shall be held personally accountable in full measure in case of failure of any of
the great commercial and merchant banks. As the French would say, their personal total
ruination might serve as an example "pour encourager les autres".
I have not even touched on the debt positions of many of the states and municipalities, let
alone the huge and ever growing "holes" in both the public and private pension funds.
The latter due primarily to the lack of heretofore reasonable investment yields, which in
turn is caused by the inevitable misallocation of capital caused by the long term zero
interest policies of the Fed. This brought about by the very understandable fear by both
the Fed and the politicians, that if (or rather when) long term interest rates do rise the
existing debt cannot even be serviced. Hopeless; crazy, and totally crazy; I have run out
of printable words!

Well, I have surely said more than enough, and probably have hanged myself in the
process; but in writing this I am more than ever persuaded that I am fully justified in
citing the warnings set forth in the quotations that I began this note with.