When Math meets Dogma
"The Church at the time of Galileo kept much more closely to reason than did Galileo himself, and she took into consideration the ethical and social consequences of Galileo's teaching too. Her verdict against Galileo was rational and just, and the revision of this verdict can be justified only on the grounds of what is politically opportune."
- Cardinal Ratzinger (now Pope Benedict XVI), February 1990
You would think in today's world that people would accept that simple math isn't something you debate. You would think that people would accept that 2 + 2 = 4 and then move on.
But that's not how the world works. Galileo failed when he tried to argue physics with theologians. The problem today isn't physics - it is simple addition - and the theologians of today are political.
"How many fingers am I holding up, Winston?"The iron-clad law of economics is supply and demand. It doesn't matter what other factors are involved and what your political agenda might be, if supply exceeds demand (or visa versa) then things get out of balanced and prices collapse (or skyrocket) until supply and demand come back into balance.
"And if the party says that it is not four but five -- then how many?"
- George Orwell, 1984
This is the framework of how things behave on this planet and it cannot be changed by any political decree. This law has the same moral and political properties as the law of gravity.
It's not a matter of right and wrong. It is simply the way the world works.
Another way that the world works is that people have an uncanny ability to avoid seeing the obvious for extended periods of time if it conflicts with their preconceptions. Governments, and the people who run them, know this to be true and use it against us.
The obvious in this case is government spending.
“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”
- Ernest Hemingway, “Notes on the Next War: A Serious Topical Letter” , 1935
All sorts of justifications have been made for the massive federal deficit spending. People with a superficial understanding of Keynesian economics think that all deficit spending in a depression is good.
These people ignore a) Keynes advocated targeted countercyclical deficit spending designed to increase demand, not just any deficit spending, b) Keynes' theories were proven inadequate by the stagflation of the 1970's, and c) deficit spending is what got us into this mess. Is it logical to think that more of the same can be expected to get us out of it?
On the other end of the curve are the opportunists, who look at federal deficit spending as an opportunity to make a profit. These people ignore the damage done to the economy and currency by runaway deficits far outweighs any potential profits.
These discussions ignoring the glaring truth of what we are facing - the sheer size of the deficit spending precludes it from working.
We are failing to see the forest through the trees.
If this was a horror movie we would be guilty of worrying about a relationship problem instead of focusing on the axe murderer in the next room. If this was a car crash we would be guilty of worrying about our auto insurance rather than focusing on surviving the crash.
The country was more than 200 years old before America's public debt hit $1 Trillion. It hit $6 Trillion in early 2002, and then $10 Trillion in 2008.
By the end of this year it will climb over $13 Trillion. The CBO estimates nearly $10 Trillion in new debt by 2019. In economics this trend is considered "parabolic", and all things that go parabolic are unsustainable.
It begs the question - where will the money come from?
Sometimes people ask that question, which is a very good question, but stop there.
An even better question to ask is - is there enough money?
The IMF, which has repeatedly underestimated the economic crisis, has produced some numbers which are scary in and of themselves.
Fortunately, Carmen M. Reinhart and Kenneth S. Rogoff have studied dozens of historical examples since 1800 and tried to answer that question by basing it what that history teaches us.
If you are like me, $33 Trillion are so far above my ability to imagine that they may as well be using another language. That's why it is important to put things into perspective by comparing this number to other asset classes.
If you understand the significance of these numbers you have arrived at the "Oh, shit" moment. The amount of money required to bail the world out of the current economic crisis, if this crisis plays out at a historical average, is nearly equal to all the private wealth currently in the world.
To repeat the obvious, this doesn't add up. What about the capital needed to fund the businesses of the world? What about the capital needed for private consumption?
Britain is trying to bail out their economy. The Euro nations are bailing out their economies. So is China and Japan. There isn't enough capital in the world for all these bailouts.
Kyle Bass from the US fund Hayman Advisors said the markets were choking on debt.The numbers simply don't add up. Everyone can't do this at the same time. Two plus two are not going to equal five now matter how hard you try to make it happen.
"There isn't enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there," he said. "If the US loses control of long rates, they will not be able to arrest asset price declines. If they print too much money, they will debase the dollar and cause stagflation.
"The bottom line is that there is no global 'get out of jail free' card for anyone", he said.
To argue otherwise is to tilt at windmills.
There is no "what if". The odds of all this deficit spending getting financed at an affordable rate is zero. It's simply not going to happen. You can close your eyes and cross your fingers. You can pray to your gods. You can chant "I believe" all you want, but at the end of the day the laws of supply and demand will win as surely as Galileo's physics.
Once you wrap your mind around this horrible fact, you realize that we are in for a world of hurt.
There are only three possible outcomes: 1) interest rates skyrocket to crushing levels, or 2) the central banks print money on a massive scale, or 3) some combination of the first two choices.
How exactly this crisis plays out is open to debate, but we are starting to see the opening innings.
Government securities declined even as today’s auction of a record-tying $35 billion in five-year notes drew the most demand in three months from a group of investors that includes foreign central banks.Demand for treasuries was huge today, yet the price of treasuries fell anyway. This pushed the yield curve on treasuries to a new record.
What does that mean? Several things.
Despite massive foreign central bank buying, it still couldn't absorb the even more enormous supply of new debt being issued by the treasury. The law of supply and demand remains.
People holding a 10-year treasury note have lost 10.4% of their value since the beginning of this year. Holders of a 30-year note have lost 27.5% of their value.
“There remains the lurking concern that foreign demand is focusing on the short end, leaving the back end of the curve vulnerable,” Alan Ruskin, a global strategist at RBS Securities Inc. in Greenwich, Connecticut, wrote in a note today.In other words, our foreign creditors are only buying short-term treasury debt and leaving the long-term treasury debt to the whims of the market. That's why the Federal Reserve has been forced to purchase $130.5 Billion in treasury debt so far this year, about one out of every six dollars of new debt issued.
Why would foreigners not want our long-term debt? Because they don't believe that we will pay it back in dollars of equal value.
Suspicions that Washington is trying to engineer a stealth default by letting the dollar slide could cause patience to snap, even if Asian exporters would themselves suffer if they harmed their chief market.Even more concerning, the government isn't even half-way through the new debt issues of fiscal year 2009. The longer this goes on the more saturated the credit market of the world will get with dollar-based debt.
Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget. Taxes will get raised beyond what they were in the Clinton years.Higher interest rates, particularly on the long-end of the curve, will push up mortgage rates. If the Fed is forced to raise interest rates, that will effect the short end of the curve. Rising interest rates on a nation with little savings and high debt levels is deadly.
Watch the bond market. Rates should be going down, not up. The bond market is telling us the deficit simply can't be financed down the road.
Higher interest rates aren't the only danger of these massive deficits. The dollar index has fallen 11% since early March when the Federal Reserve announced that it would be monetizing treasury debt.
The last fallacy being pushed that supports the "deficits are good" crowd is that we are suffering from deflation, and deficits are the way to combat it. With deflation we don't need to worry about a falling dollar or rising interest rates.
But the truth is that the deflation scare is already over.
With the S&P up 23% from March 2009 lows, gold up 23% from October 2008 lows, and oil up 42% from December 2008 lows, we bid farewell to the “deflation” that barely was. We’d make the farewell fond but it wasn’t around long enough for us to get intimate.In fact economists around the world are calling for higher inflation as a way of getting out from under our debt burden. Can the Fed actually do that? Fed Chief Ben Bernanke certainly thinks so.
The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning...For those of you who don't understand what Bernanke just said above, he essentially means that the Fed can create such an unlimited supply of dollars that will devalue every other dollar in existence to the point that deflation will never be a problem. It'll make every owner of dollars poorer, but it will stop deflation.
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.