The next crisis we face may be much worse than the housing crisis. It’s what I’ve talked about in the space before: sovereign subprime or too much government debt.
This may seem like a problem facing far-off Greece or Hungary, but it’s bigger and more problematic in the developed economies. Here, I’m talking about the big economies we typically associate with stability: Japan, Germany, France, Britain and the United States.
The issue is that such developed economies have borrowed too much money, like subprime borrowers, to live high on the hog today. This borrowing is going and has gone to generous social programs, defense, and, most insidiously, growing interest payments.
When the burden of paying debt, both interest and principal payments, get too high relative to incoming money (taxes) or an economy’s size (GDP), you get to a tipping point where there’s no where to go but down.
This problem is exacerbated by two additional issues: who did you borrow from and when do you owe them principal.
If you borrow from your own citizens, you’re in a better situation than when you borrow from foreigners, especially when those foreigners aren’t your best friend (hello, China).
If you borrow the money short instead of long term, you face the same problem as paying off a credit card versus a home loan–no credit card will give you wiggle room while you get your financial house in order.
Japan and Britain borrowed mostly from their own citizens. The U.S. borrowed mostly from Japan and China. Japan and Britain predominantly borrowed long term, the U.S. borrowed short term and must roll over most of its debt over the next several years.
The U.S. has an advantage over Japan, Britain, France and Germany, though: our economy grows faster and so does our population (both organically and from immigration). This gives us some wiggle room they don’t have.
Back to the tipping point issue. When interest payments get too high relative to economic production or tax revenues, those who lent you money want a higher interest rate. Guess what a higher interest rate does to those interest payments? Yep, higher and higher.
You can see why there’s a tipping point–once you reach a certain threshold, people start to doubt you can pay and want higher interest payments (or won’t lend you money), which creates a vicious cycle.
The developed economies of the world are entering that vicious cycle over the coming years. We stand on a knife’s edge and can chose, now, to stay on the good side or go to the dark side. And, we don’t have much time to chose.
If you tip to the dark side, what do you have to do? Theoretically, you can grow your way out of trouble, lower your interest payments, get bailed out by someone else, cut spending and jack up taxes, print money (inflation) to pay back loans, or default (also known as restructuring, repudiation, rescheduling, etc.).
The U.S. has been growing its way out of trouble for over 200 years. Unfortunately, when government spending grows to a certain percentage of the economy, your growth rate slows dramatically. We’re reaching that point, so we need to allow a lot of immigration, cut government spending, and reduce taxes to increase growth. I’m guessing the chance of any of those three happening is as great as finding a snowball near the sun’s core.
Is there any way we could lower the interest rate on our debt? You’ll have to ask Japan and China on that one, but don’t count on it.
Is it possible that any country in the world is capable of bailing out the U.S.? Please see snowball reference above.
Can we cut our spending and raise additional taxes? We could, but in a populist environment like we’re in, that will probably work as well as it has in Greece (please see riot footage as reference).
Can we inflate? This is the most likely outcome, and it won’t be a lot of fun for those who lent us money or for those on a fixed income here in the U.S.–and, by the way, that’s a lot of people!
Can we default? Like inflation, we can do it, but it won’t be pretty and will likely be a disaster for many.
Standing on the knife’s edge and looking at those six options, I would chose to knuckle down now, so we don’t have to go down the path of the six. I’m not optimistic that will happen in a democracy, so I’m planning on inflation.
So should you.
(I think we’ll still experience slight inflation/deflation over the next couple of years, but the turning point is hard to predict because our lenders will get to chose the timing).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.