Inflationomics

’Til Debt Do Us Part

Debt is still the #1 problem for the U.S. government, state governments, businesses, and individuals.  And this problem won’t go away as long as money is available to be borrowed at exceptionally low interest rates.  In short, more debt is being encouraged by the fed’s (and other central banks’) policy of low-to-no interest rates.

To pay off this debt, entities need more money.  This could be obtained by earning a profit, or by having the Fed create more paper currency out of thin air.  Which is politically easier?

Earning a profit requires lower costs and/or more income.  Both could result from fewer government regulations and taxes for businesses and individuals, but what government is going to reduce regulations?  That might mean government job cuts.  And what government has an incentive to earn a profit?  None.  In fact, governments have every incentive to spend more.  If they can’t live within their means, they can either raise taxes, or borrow more because of their ability to tax (which is backed by their ability to use force to collect whatever they believe they are owed).

Since the federal government hasn’t lived within it means for years, what’s another trillion dollars in infrastructure spending, or military spending?  And if taxes are cut, what’s another trillion dollars in lost revenue?  It seems as though the government has given up on the idea of balancing its budget and paying off its creditors…at least with dollars that have much purchasing power.  The bottom line:  the government goes farther into debt and our second choice—creating more paper currency out of thin air—looks more appealing all the time.  At some point, there’s no way around more money printing.

But when?  In my opinion, when the debt defaults become unbearable and the Fed is faced with a deflationary spiral.  The biggest question is, which defaults?  Student loans, state government commitments, or a black swan event (something else that is currently unforeseeable) like a foreign country defaulting on its loans and causing an international domino effect for the banking industry?  Or, perhaps the Fed will raise interest rates and trim its balance sheet causing a recession and bringing on a raft of defaults.

Student loans are like having a mortgage loan, but without the income to pay for it.  The problem, of course, stems from the fact that people aren’t learning how to become productive with the educations they are receiving in return for those loans.  In short, the educations aren’t worth the money they cost.  In many cases, the money spent on education would have been better spent on a productive investment instead.

According to Bill Bonner, Illinois is the first failed U.S. state. It’s been operating without a budget for the past two years. It has 14.6 billion dollars of unpaid bills and a $6 billion deficit.  And more states are expected to follow.

And then there’s the Fed’s policy of raising interest rates…for how long?  Until the defaults become unbearable?  We’ll see.

Bottom line:  the world is balancing on a tight rope with deflation on one side and the Fed’s (and other central banks’) willingness to do whatever it takes to prevent deflation on the other side.  Odds are, we’ll see more debt defaults followed by a massive central bank attempt to avoid the consequences that their low interest rates have encouraged. And I thought the Fed’s mission was supposed to be to smooth out the business cycle, not to cause it!

Robert F. Sennholz

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