The government doesn’t create new goods by credit-financed spending. Debt financing allows the government to considerably increase its grip over scarce resources, resources that would otherwise be available for alternative investment projects. FULL ARTICLE by Thorsten Polleit
Source link: http://archive.mises.org/11951/beware-of-government-bonds/
Beware of Government Bonds
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as always Thorsten Polleit brings us deep financial analysis. I believe this is the next bubble.
If the pragmatic choice is between citizens buying savings bonds and the Chinese buying Treasury paper, would it not be better for the US in the long run if the financing came from savings bonds?
Yes, the most attractive, even more than Debt Financing, is what we in North America euphemistically refer to as “Quantitative EASING”.
It really means Money-Printing or Legal-Counterfeiting by our Central Banks.
What is this Quantitative Easing?
It’s as though we are “easing” our way out of bed, out of a bad situation, out of the room, out of a dilemma or some unpleasantness, out of a bad disease, with some magic potion, with some sublime medicine.
In fact it doesn’t really sound that bad. And Central Bankers of today (not of yore) will tell you it really is good and tasty for you, take it, you’ll see! It’s better than gumdrops!
Theoretically, it is temporary, and whatever ‘assets’ the Central Bank buys with its newly-counterfeited money are supposed to, later, be sold back to the private sector, in return for the original counterfeited money that was used to buy those ‘assets’.
Of course, it’s sheer lunacy, the last gasp of a sick, dying, BMS (Broken Money System).
By the way, the BLOG LINK from the original article is FAULTY, likely preventing some people from linking to this BLOG.
While I agree with much of this article’s content I have to wonder if the Government’s incentive to inflate can be as strong as is suggested. The inflation benefit accruing to the debt issuer increases with the term of the debt outstanding, and this benefit is effectively realized only when the inflation is manufactured over a time frame less than the average bond term. The deficit growth is currently being managed by creating new (and recycling old) debt in short-term securities. This trend will continue so long as the demand for low risk bills and notes stays high in an uncertain investment environment.
For example, here is the structure for the federal debt (in millions of dollars) as of January 31, 2010:
Marketable: Amount Average Interest Rates
Treasury Bills 1,683,757 0.2%
Treasury Notes 4,227,723 2.9%
Treasury Bonds 727,749 6.3%
Tips 564,070 2.0%
Total Marketable 7,203,299
Nonmarketable 556,191 3.7%
Total Federal Debt (Publically Held) 7,759,490
The remaining $4.5 trillion in federal debt is classified as “intragovernmental” debt, the bulk of which is allocated to various public (SSA) and federal trust and disability funds.
Given that the mean turnover time for the publically held debt is less than five years (and falling) it is becoming less likely that the government can “inflate-away” its obligations. Nearly continuous refinancing thus allows the borrower to insist upon rates that keep up with programmed inflation.
While I have no data on the term structure of the intragovernmental debt, my guess would be that it has a longer average term than the publically held debt. Since the non-SSA debt is just under half of this $4.5 trillion total, any inflation program would, for this portion, constitute a case of government reneging on itself.
If the government sold bonds to haul Antarctic icebergs to the Sahara and make it bloom,then I would be all for it. To sell bonds to buy votes and then print money to cover the bad debt is down right treasonous. If the Founding Fathers sat in Washington for a day, before noon, Old Ben Franklin and Thomas Jefferson would be shooting. They would clear the Temple like Jesus did, not forbearing false weights and measures which are an abomination to God.
Del Lindley, I think your points are valid and pertinent.
What this article is saying to me, however, in addition to what you have already responded to and alluded to, is that we are JUST at the START of impending inflation — it has only been incipient (in relative terms) until now IMO.
So while what you say is true today, it might not remain so indefinitely.
And the authorities have indeed been actually trying to sell longer-termed bonds as well.
To date, The FED (Ben Bernanke) has made purchases of Treasury Bonds (from Tim Geithner) with the money it (The FED) got from its own money-printing exercises, via the aforementioned euphemistically (and mystically) labeled Quantitative Easing.
The FED is the market-maker at the margin in cases where it intervenes as well.
How long can The FED continue to suppress market rates at the long end (or shorter end) via such Bond activity?
For a long time, for sure.
But forever? No.
Think about how artificial this is — The FED is actually PRINTING MONEY to use that money to keep the Price of Money (interest rates) DOWN. Is that stupid and hopeless? If I was a banana-producer, would I create more bananas (money) and use them by intervening in the market to buy bananas (credit/bonds) in the market? I don’t think so. I would just be flooding the market with more bananas, countering what it was that I was actually trying to do. But this is exactly what The FED is doing. It is competing in the market for money, by printing more of it, to buy bonds, to keep the price of those bonds artificially high — thus keeping the prevailing interest rates low. Does that make any sense to you? This is a pipedream that will end in an American Tragedy (much worse than anything Theodore Dreiser had in mind).
This is all an exercise in Entropic Absurdity — any physics major can tell you that. You cannot endlessly extract more energy from a system than it is naturally producing and/or that is being introduced into it from an external source. Our external source is an internal source — that is, us and the central banks that operate our Money Systems. The FED believes that it can Time-Shift the extraction of Energy from the Future into the Present with its schemes. But all it can do is Deplete the Future of this money (energy).
Inevitably, at some point, the pain from debasing the American dollar (and there will be pain) will overcome the reluctance to stop Quantitative Easing.
At some point, the dam will break and overseas investors will demand higher interest rates as compensation for their loss in purchasing power.
No one will forever knowingly accept an interest rate of return below the rate of devaluation of their principal, that is, below the rate of debasement of the American dollar.
The FED sees its job as keeping employment as high as it can, subject to a grudging responsibility to maintain the worth of the American currency.
It sees Quantitative Easing as a tool to promote employment and economic activity, and will not give up that tool unless it is forced to do so.
It is not really a question of “when to remove the stimulus” because the Stimulus in the system will never really be removed, regardless of the party line you and I are fed.
It is more a question of when to STOP THE ADDITIONAS of such ‘stimulus’ (even though IMO all such ‘stimulus’ at this point is really un-stimulating and even de-stimulating to our Economy).
But what about the whole concept and theory that underlies The FED’s practices?
Is it not time to question the morality and constitutionality of what The FED does?
Ask yourself why it is that the Financial Sector in American makes 40% of all the profits of profit-making enterprises in the country?
Ask yourself whether it is not immoral for the Financial Sector, which, after all, exists simply to FACILITATE the workings of the rest of the Economy, TO TAKE SUCH A HUGE BITE OF THE NATION’S WEALTH FOR ITSELF?
It is simply not moral, of course.
Nor is this state of affairs good for America, although some politicians in the past felt it worthy enough to defend on the grounds of the income this sector “earned for America” (that’s a laugh today of course, given how much this sector has “cost America”). Such politicians may have had their reelection campaign contributions bolstered by Big Finance. Or maybe they genuinely believed that this sector was Helping America. Well I hope they take of their rose-colored spectacles soon because we don’t have all that much time.
In fact, this sector has been, and continues to be, grievously harmful.
The Financial Sector is meant, within a properly-functioning Economy, to simply act as an intermediary.
In the simplest terms, it is merely meant to bring the funds of those who save to those who need to borrow.
It is not meant to find ways to arbitrage the very real weaknesses of Our Broken Money System for its own benefit. It is not meant to steal Money that does not belong to it.
That it does this, and can do so legally, just shows HOW BROKEN the Money System really is.
Paul Volcker is on the right track when he promotes his vision of Structural Change due to System Weaknesses —— please see “OBAMA ADVISER WARNS OF CRISIS” at
http://www.theglobeandmail.com/report-on-business/obama-adviser-warns-of-crisis/article1489051/
So what kind of a system do we have that it should need “FIXING”?
Ask yourself why what cost a nickel to buy in 1913 in American should today cost you 1 dollar?
Does that make sense? Some will say that this is normal, and that The FED and other Central Banks must slowly debase their currencies to ‘lubricate’ the Economy. To me this is balderdash. That is just a phony rationalization. It is a form of Keynesian Mental Illness.
Think of how much more productive we are today; think of our technological advances; and think of our relative standard of living.
Why should a pound of butter that cost something like 20 cents in 1913 cost something like 400 cents today, depending on where you buy it?
http://www.thetrumpet.com/index.php?q=3037.1530.0.0
We have only 2% of the population working on the farms today as compared to more than half the population back then, just because we are so much more efficient and specialized at what we do.
Does this not indicate something that is grievously wrong at the core of our system (along with what is indicated by the inordinate, almost-monopolistic, profits made by the Financial Sector)?
It sure does to me.
And this goes to the heart of what the article, BEWARE OF GOVERNMENT BONDS, that we are both responding to, is getting at.
Namely, the Money System allows for this kind of behavior to continue, nay, even encourages such behavior, most lamentably, by its Broken Nature.
Who deserves the benefit of improvements in productivity and technological advances? Surely the people who create and implement these improvements?
How many of such improvements and efficiencies have been created by the people who run our Broken Money System? Have they really created so many, that they should ‘harvest’ 40% of the profits of America?!
IMHO (In My Humble Opinion) I would submit not.
In my opinion our Broken Money System allows for creation of ‘Phony Money’ by our various Central Banks, which then introduce such monies into the Financial Sector via their favored intermediaries.
Those favored institutions, including their own individual sponsoring governments, and the Fractional Reserve Banking System, get the benefits of these monies that are created from the printing press (or in Ben Bernanke’s words from its “electronic equivalent”).
Do the hardworking and productivity-raising American citizens get those benefits?
No. Therein resides THE American Tragedy.
How can we countenance such continuing Theft?
We should not and cannot if we want a viable Future.
Even the financial people involved in this, must understand this Truth.
NO, this should not and will not stand IMO.
There are too many good people like Dr. Ron Paul and like Dr. Paul Volcker who have taken a strong stand against such a Broken Money System.
Indeed, one pound of butter that cost 20 cents in 1913 (when The Federal Reserve — the Central Bank — of the United States was established) today SHOULD COST 2 cents if the benefits of progress had accrued to the rightful owners of that progress — it should not cost 200 times as much. That America has become so much more productive in the interim simply MAKES CRYSTAL CLEAR HOW MUCH The FED has debased your money in the interim.
We need (along with Paul Volcker) to remedy the situation. We need structural change. For it is not enough for Regulations and ‘Regulators’ to restore soundness to the Broken Money System.
The System itself must be healed and fixed, so that future ‘patches’ and such other flimsy ‘remedies’ as The FED and The Treasury are today applying are never needed again.
Because if we don’t fix what IS BROKEN in The SYSTEM, the next session in the Emergency Ward may not even be ‘fixable’ by these flimsy Financial First Aid patch-techniques and by legislation and by Stimulus Bills and TARPS and by the refinancings, and the increased taxing of The People, and by The FED’s Quantitative ‘Easing’.
It is very difficult for ‘regulators’ to keep the Broken Money System on a straight road just like it is difficult to keep a car with a broken steering wheel on the road.
The car MUST be fixed so that it can drive itself. So that when a perturbation in the system does arise, it does not automatically send that car careening off our Financial Road.
The federal government has increased the debt by more than 9% annually since 1970. If investors need income, it is safer to hold a diversified portfolio of corporate bonds than to lend money to the US government. When the US is forced to default on its bonds they will not be wiped out.
A great article–very simple and logical.
The logical conclusion to this manipulation of money is of course government default. However, it is not clear to me how long it can take (1, 2, 10 years?) before it causes the kind of problems where people will take enough notice to do something about it. The Austrians say it will lead to inflation; however, many others make the convincing point that it can lead to deflation, as has happened in the real estate market.
The essential question is unanswered. What does the average person do to protect him/herself?
Del Lindley,
Good post. My question is whether intragovernmental debt matters at all — I don’t think it does.
External debt is only 50 – 55% of GDP, so we’ve got a while to go until its no longer servicable.
http://www.treasurydirect.gov/NP/NPGateway
Kaushik, you are right as far as Housing goes.
But ask yourself if this ‘deflation’ for Housing Prices did not come about AFTER those prices had been DRIVEN to inordinately expensive heights first by the actions of The FED?
Even now, there are many knowledgeable observers who expect Price Deflation to continue in the Housing Sector for a bit longer, if only because those prices are still too high on a fundamental valuation basis in many individual markets in America.
Nick Bradley, I would second your approval of Del Lindley’s post, but I would also counter your post by saying that Federal Government Borrowing measured against GDP or GNP is only one measure.
It may actually work in Japan better than in America.
Japan’s federal government debt I believe is approaching 200% of that country’s GNP.
But that (on its own) does not mean that Japan is worse off than America.
IMO in other words, this is not a hard and fast rule.
We have to look at societal debt as well.
(There is the whole other issue of whether what Japan did in incurring all that government debt was wise — I happen to think it was very damaging, but that is another post.)
In Japan, the people have huge savings, more than enough to offset the stupidly-incurred debt of their government. In other words, the potential lender knows that The People of Japan can ‘backstop’ their own government’s debt.
In America, that is not true.
If people won’t incur additional debt in America on their own, and if the government and its Treasury (and its central bank, The Fed) are convinced that they must incur that additional debt on The People’s behalf instead, just to keep the lights on, or in Keynesian terms, “keep the Aggregate Demand at a suitably high level”, what makes you think that this is not dangerous (even given the ‘low level’ of government debt as measured as a proportion of GNP)?
I am not so sanguine.
When a country’s people stop additional new, incremental spending, and start saving those funds instead, we have IMO reached a watershed, a Continental Divide.
There is no going back to rosier times, because the government cannot hope to fill that gap.
If lenders realize, as the original article suggests, that the U.S. taxpayers are in a poorer position to ‘make good’ new borrowing, or even refinance old borrowing, they will start to become more wary of loaning money to America. These lenders are not stupid — if they see that property tax receipts are down because of empty and unsold or foreclosed-upon homes and because of falling property values, and that unemployment is up (and thus payroll tax proceeds are falling), and that this continues for a long time, where instead will the potential lenders put their money? Why take the risk (especially if there is little compensation for taking on the higher risk in America via higher rates) of lending to America?
As the article points out, prevailing interest rates will rise eventually, whether The FED is using newly counterfeited money from their modern invention, the printing press (or its electronic equivalent, the computer screen), to keep interest rates artificially low by, at the margin, being the buyer of last resort for new Tim Geithner-printed Treasury Bonds, or whether the rating agencies change America’s current rating for risk of default or not.
It is not just the GNP that is the issue — but even there we have a potential problem. Even if the debt does not go up in absolute terms — which we know it will, because Obama’s team has said that there will be Trillion Dollar Deficits going forward for several years — the GNP could concurrently fall. When a Severe Recession or depression sets in, we could have more quarters where the output of (annual) GNP actually FALLS in real terms. So NOW you will have a dynamic that will force your measure of the percentage that Federal Government Debt makes up of GNP to go UP.
Result? Serviceability does not depend only on your statistic. Risk does not only depend on your statistic. Inclination to lend to America does not depend solely on your quoted statistic.
The Bottom Line is that the Broken Money System is extracting Wealth from Americans and preventing new Wealth from being generated as in years past.
The pie is getting smaller and there are more people clamoring for a piece.
‘Investments’ are mostly only used to gamble, rather than to establish new enterprises and to fund new initiatives.
The Standard of Living will continue to fall for the average person, so long as the Structural Changes, which Paul Volcker and Ron Paul are promoting on behalf of Americans, fail to be adopted.
We really are lost in a Keynesian morass and we don’t’ know it and we don’t know why.
Unless we arrive in the Town of Recognition soon, it won’t matter.
Maybe not tomorrow, or even next year, but as Ludwig von Mises points out, the result is as inevitable as the sun rising tomorrow — and as article concludes, we will then have arrived in the Town of Hyperinflation, provided our bus driver at the Head of The FED is a compliant Ben Bernanke:
Del Lindley, I think you meant to say “lender” in that last bit? Sure, I agree, lenders always try to insist on getting something back that exceeds the purchasing power of what they initially lent to the borrower.
You probably meant to write:
You also wrote:
I am not sure I agree with you here.
I think I know what you are getting at.
Namely, if the inflation is quickly over and done with in a period less than the term of the bond we are talking about, the borrower (government) would benefit, because the money paid back to reimburse the bondholder is worth less than what was initially borrowed, and so long as the interest paid is less than the inflation during this period (that is, less than the debasement of the principal), the lender has suffered a loss in purchasing power which has thus accrued to the borrower (the government in our case).
The idea then seems to be in your post, that if price inflation is no longer being “manufactured” that the lenders in the market will go back to accepting a low rate of return for the next cycle of refinancing. Thus the government has benefitted by paying back LESS than the worth of what it got from the lender. Furthermore your implication is that the government can continue to benefit because the lenders will not ‘punish’ the government when it comes back into the market to borrow more money by selling more bonds.
I don’t think things quite work out this way. Usually once price inflation is embedded it does not easily just disappear. In other words, it does not cleanly last less that the “average term of the outstanding bonds”.
Another thing — think about this — what if the inflation is ‘manufactured’ over a longer period than the average bond term? Are you saying that the lender will always know what that inflation is likely to be? What if The FED creates a whole bunch of net-new money that only after some long period of sloshing around in the Economy manifests as price inflation? Say it takes 2 or 3 years for the Money Inflation to show up as Price Inflation. Will the Bond Vigilantes know what rate of price inflation is “in the pipeline”?
Is it realistic for ANY lender to know ahead of time when and where the resulting (price) inflation will show up? How does the market price Treasury Bonds when The FED is playing around like this? That is playing Fast and Loose with so-called Easy Money?
IMO the lending community will not know anything for sure until after the price inflation has shown up in the Economy. Only then will rates rise to meet the need to retain purchasing power. That is, Price Inflation will only have its effect on the interest rates the market insists upon for Treasuries after that price inflation shows up.
There are other factors at play as well — for example, productivity and technology. If the coming inflation is going to be high, but then magically we get really productive, and our technology makes things cheaper than they would have been, what happens? Price inflation does not manifest as it otherwise would have if those factors were going in the other direction.
In fact, this is the idea behind “Hedonics” (which I think is kind of stupid myself) which allows for CPI to be adjusted lower when the ‘quality’ of the product being measured has gone up in the interim. So if your Trinitron TV cost you $800 in 1980 but today a big screen TV costs the same but is 3 times as large, then The FED and other people in charge of measuring CPI (Consumer Price Index) can adjust that down, because the new TV is so much ‘better’. Silly, but true.
http://www.economicshelp.org/2008/07/is-inflation-under-of-overestimated.html
So it is not really correct IMO to suggest that “this benefit is effectively realized only when the inflation is manufactured over a time frame less than the average bond term.
In fact, is it not true, so long as the lender is already locked in to a bond, that WHATEVER price inflation occurs, during the term of that bond, that is OVER AND ABOVE the yield of that bond is a true LOSS to the lender? In fact, so long as price inflation is always increasing, and so long as the market does not know it will be always increasing, the borrower (government) will ALWAYS make away like a bandit relative to the lender.
So there is really no relevancy IMO as to whether the inflation occurs ONLY during the life of that bond you refer to as having the “average term”, or if this price inflation occurs beyond the life of that bond. Do you not agree?
Of course, I agree with you, that the government can NOT continue to fool lenders as price inflation starts to go up, simply because as you say, the government has to continually refinance its past borrowings. And the Bond Vigilantes will wake up sooner or later.
I agree with you here that in the end the government can do one of 2 things — the first is that it can FAIL, as you write, to “inflate-away” its obligations and it will be FORCED to become fiscally sane again. It will have to stop expecting The FED to “monetize the Debt”. It will have to balance the budget. It will have to pay back the Debt, in stages, very slowly at first.
Or it can do one other thing as the article suggests.
If any government, including the American one, can NOT pay back its loans, that eventuality will too, at some point, become clear to the marketplace.
What will happen then? Well here the article from Thorsten Polleit tells us what is likely to happen. There will be catastrophic hyperinflation at some point in the future. Say it occurs after maybe 20 cycles of new financing and refinancing that you have outlined in your post as ‘average terms’.
If this happens (the less likely of these 2 scenarios, I agree with you, and hope for America’s sake, and all of our sakes, that this is so) — then watch out.
The problem with America’s Central Bank’s approach, that is, The FED’s approach, in trying to assist to bring America ‘back’ from this recession, is that The FED does not know what it is doing. (Nor, for that matter, do any of the central banks know much about the harm they are all causing.)
The FED follows essentially a Keynesian template.
That is, stimulate, stimulate, stimulate, until the Stimulation ‘takes’.
Then the Keynesian template directs The FED to ‘back off’ by withdrawing this previous Stimulation. The Backing Off phase is needed, as the Keynesian Philosophy suggests, so as not to cause undue Price Inflation.
The Federal Government is hewing to this same line of course.
The problem with This Paradigm is that it has never ‘worked’ — yes, it appears to work, over and over, during shallower recessions. But those ‘workings’ are a mirage — and they do manage to fool most of us, most of the time. The bigger Tragedy, than just fooling us, is that these ‘workings’ set up a mindset, a world-view, at The FED and elsewhere, that the Keynesian Template is the correct one to follow. That this type of Intervention is the only one that will work. That indeed “We are all Keynesians now!”?
In reality, these past approaches of “Following the Cookbook Recipes” have created more and more bubbles, and more and more Malinvestments. That does not really become clear until in the Finale we get a complete Breakdown in this Approach — so called Stagflation — perhaps in this case, even HyperStagFlation. This is what this article by Thorsten Polleit is ultimately suggesting IMHO.
Because The FED and its ‘Fellow Travelers’ are essentially Groping-In-The-Dark, but also because they are following a Philosophy they intimately and intuitively BELIEVE IN, they will continue on their present path until they are presented with irrefutable evidence that what they are doing is completely wrong. At that point, just like in the smaller ‘Great Recession’ of the 1970-s, they might start to ask some more meaningful questions. But this time around, by THAT time, I fear, our “Great Recession” will be making rumblings that it wants to morph into a Great Depression.
Why, this time, could this happen? IMO, this is because we have had a worldwide Economic Downturn and Upturn all essentially driven by the same actions of the Monetary Authorities. There never was any ‘Decoupling’ although to some this appeared plausible. Just because China is stimulating 100 times as much as some other countries does not mean that She has ‘decoupled’. Far from that, She has gone further down the road to a Great Depression than anyone else.
So what is likely to happen in the near future and in what sequence?
To many it appears that “the recovery is taking hold”. Stock Markets have come roaring back. Economic activity appears to be accelerating. The Job Market is showing signs of Life. Optimism is creeping in, in some quarters.
IMO this will be short-lived. I sadly have to say, that there will be a double-dip downwards. The Pretenders to Monetary Knowledge (those like me, who just observe the Monetary Authorities) will, as in the 1930-s, BLAME the central banks for having started to remove Stimulus TOO EARLY, as those central banks will have by then seen some incipient price inflation in the Money System and will have started to Remove the Stimulus.
But we will all have been wrong.
The Stimulus NEVER had the power to help us in the first place. As I wrote, THAT was ALWAYS a Mirage. These Stimuli did manage to put off SOME of the pain, yes, but there was never any real ‘medicine’ in these Stimuli. They were all always, always and everywhere, Ersatz Stimulus Packages, Ersatz Medicine, Placebos to Placate Us. And very tragically, placebos can be deadly if they placate us enough so as to make us avoid taking proper action in time — we all ‘intimately and intuitively’ know that much.
What I then fear after the Double-Dip becomes apparent is the resulting Response of our Monetary Authorities.
Will they have, by then seen the error of their ways?
Or will they pour more accelerant on the Flames?
By then IMO it will not much matter if Thorsten Polleit is right with the prediction of more Price Inflation, or if the contributor Kaushik is right, and we get more Price Deflation.
As to Kaushik’s plaintive question: “The essential question is unanswered. What does the average person do to protect him/herself?” — I don’t have a good answer.
Survivalists will tell you to get some land where you can do some sustenance farming and hunting and fishing.
Some will tell you to buy gold.
IMO the best thing is to live modestly, eliminate any debts you have, downsize to the extent you can. Surround yourself with like-minded people who understand like you, that the central government and perhaps even some local governments may not be in a position to offer you much assistance. Sure this might not happen for another 5 years, or even a decade. But the trends are not reassuring. Try to be prepared for the worse you realistically expect. Look at the trends at the state level in places like California — were it not for the borrowing (and money-printing) capacity of the Federal Government, that would be the same story there too.
We will either have a Deflationary Depression or a Hyperinflationary Depression. An Ugly Choice to be sure.
A. Viirlaid,
Yes, I did mean to say:
“Nearly continuous refinancing thus allows the lender (the public) to insist upon rates that keep up with programmed inflation.”
Of course the government is the producer of debt and the public is its consumer, and it is the consumer’s value scale that ultimately determines the market price (the interest rate in this case). Thank you for pointing this out.
In regards to your other questions let me put my initial comments in the context of the original article. To begin, here is a rough distillation of Thorsten Polleit’s argument:
Source of the debt crisis:
1) Federal debt accumulates to pay for services that the electorate will not pay for directly via taxation—an easy way for politicians to buy votes.
2) Debt levels grow to the point were no one expects the debt to be repaid and any new debt buyer operates on the expectation of finding a “greater fool” at the time he decides to sell the debt. Debt funding becomes a “transparent” Ponzi scheme.
3) The spiral of increasing government debt is fed by the erosion of the private production structure and the tax revenues it yields to the government. Private sector erosion is used to justify more government growth.
Possible outcomes:
1) Debt service will eventually grow to become unsustainable. The political breaking point is determined by the breadth of the lending within the electorate. The government defaults on its debt.
2) The Ponzi scheme breaks down as no new debt buyers can be found to keep the scheme alive. Government debt becomes worthless and so no new funds from issuing debt can be raised.
3) Government keeps the Ponzi scheme alive indefinitely by intentionally reducing the magnitude of its real debt service via monetary inflation. Here monetary inflation is assumed to be linked directly to a fall in the purchasing power of money (PPM).
Thorsten Polleit concludes by suggesting that outcome (3) is the most likely because it is the only option that allows the government to maintain the status quo and stay in business.
The point of my initial comment was only to note that outcome (3) can be denied to government by purposeful action within the community of lenders. Specifically this action relates to the reduction in the average term of the debt outstanding—the government cannot mulct the new lenders out of their real return if the government is forced to refinance its debt on a nearly continuous basis. Early lenders who invested in the longer term structure, however, would not receive their expected real returns.
The average term of the outstanding federal debt is now about 50 months. I suggest that the ongoing contraction of this term is the new lenders’ collective response to guard against outcome (3) and a decline in the long-term PPM. I think we can say that this is the market’s way of keeping the government “honest” while a near-term deflationary environment keeps the rates in check.
I should also note that in the limit of continuous refinancing outcome (3) becomes indistinguishable from the other outcomes: a rapid and steep decline in the PPM is identical to a currency devaluation and bond default.
The preceding analysis is offered at an abstraction level consistent with Thorsten Polleit’s article. Specifically this means that we are both equating monetary inflation with a predictable and timely reduction in the PPM, and that the government has perfect control over the money supply. I believe that you know that these assumptions are flawed and so they cannot form the basis of any real-world analysis. For example, the lending public has no real sense of the abstract supply of money, but it usually does have a general sense of the PPM and its trends. All money-credit exchanges, to the extent that they can be made, must therefore be valued individually by an estimation of current PPM trends in addition to the pure discount factor associated with one’s time preference.
As I am sure you are aware through the money relation, the PPM is determined by both the supply and demand for money, and so there can never be a functional relationship between changes in the money supply and changes in the PPM. This would be true even if the money supply and the PPM were not abstract quantities. But since they are abstract we can only estimate them imprecisely and (probably given the political temptations) inaccurately. If this were not enough we have the additional complication that due to our fractional reserve banking cartel, it is the private commercial banks that have ultimate control over the level of circulation credit. Therefore even if the Fed increases the bank’s excess reserves, there is no guarantee (as we see today) that these funds will be leveraged to any extent while they exist. Consequently no one can really know—whether it is the general public or the bond vigilantes—how our primitive and biased estimate of the PPM will change over any significant period of time. That said I believe it is true that the public holds the CPI calculation in sufficient esteem to allow any dramatic change in its level to cause a corresponding adjustment in bond rates.
Remember that the obverse of the demand for money is the supply of consumer goods. This supply is of course is related to the health of the production structure. I believe that we (the public) possess a qualitative understanding of its health at any given time, but we are confused as to what practices constitute “medicine” and “poison.” That government intervention in the free market is popularly viewed as medicine will add to the downward bias of the long-term PPM and endanger our “American experiment.”
Well written, Del Lindley. Thanks.
I think you have also explained very well a dynamic that is observed whenever and wherever there is an ever-increasing rate of price inflation (ROPI).
Once ‘embedded’ as the pundits like to point out, this ever-increasing ROPI does lead IMO to what you outline — a reluctance to lend or hold money for long periods of time — indeed, the duration-time-preference for holding one’s own money or lending one’s own money becomes shorter and shorter. At some point that time can be measured in the minutes as opposed to months or years.
As the famous story in Weimer Germany goes, the poor fellow who ordered coffee in the café when he came in had seen a price of so many marks. When he got up to leave and pay, that price had almost doubled!
His comment to the waiter was met with a response and a shrug along the lines of “you should have paid the asking price when you came in, if you really had only expected to pay THAT amount!”
http://www.johndclare.net/Weimar_hyperinflation.htm
http://mises.org/daily/2347
http://crisistimes.com/hyperinflation.htm
http://en.wikipedia.org/wiki/Hyperinflation
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