Diatribes - Computer, Economic & Political

This blog is really just for me. If you find something interesting on it, leave me a comment. If you disagree with something, let me know what and why. In this blog I am just putting some of my thoughts for computers, the economy, politics, and other topics in writing.

02 October 2009

The US is too big to fail - and that's why it may

We've had to bail out companies that have made stupid decisions on the premise that if they went down, they'd take down a large portion of those around them. The problem with bailing them out is that if they know they'll be bailed out, they'll continue to make these stupid decisions.

The US Government—the federal government—is “too big to fail.” When the US has problems, there is serious suffering everywhere, not just here. I think the US has made stupid decisions based on the premise that the US can't fail, the world won't allow it. China will bail us out, or friendly middle eastern countries, or Europe, or someone. Unfortunately, if the US gets near failure, no one is big enough to bail us out.

Profligate Spending
We're in a hole. Other countries are in similar holes too, but we're in it bad and deep. The hole is debt. Now as far as I am concerned, it doesn't matter whether the government decides to fund spending out of debt or cash - I think they're functionally the same. The problem is the government spending. Spending is a problem for somewhat vague economic reasons like crowding out investment (which is a real issue), but also for more immediately visible reasons. At some point in the future, the debt we're incurring will become unmaintainable.

Recessions are great deals for governments, they can spend like crazy because everyone thinks it will prop up the asset prices, keep people in jobs, there is no political backlash, and governments can borrow the money to do this at practically zero interest—at least the US government can. For example, government treasury bonds were paying next to nothing recently.

The issue is the interest on the debt. We've overspent and the way it'll catch up with us is through interest payments. Interest is becoming a more and more significant part of government expenditures. It seems the government never pays back the principle on the debt either, it just rolls over the debt into new treasury bonds or pays it. The debt is growing faster and faster.

Two Ways Out
The first way requires voluntary sacrifice. People need to put up with high taxes and cut back government benefits. We need to accept cuts to Medicare, Medicaid, and social security for anyone under 50 and impose income caps on those receiving these benefits. We need to do more triage in Medicare and Medicaid. We need to make massive cut backs in national defense spending. Not $100M here and $100M there, but 50% everywhere. Call it a peace dividend or good sense, but we can't afford our massive military, the overseas bases, etc. We just can't afford it. We need to reduce foreign intervention, stop acting like the world's superpower, and pull ourselves more internally. Trade with all, allies with none. We need to build our productivity: invest more, consume less, do all kinds of politically infeasible things. We'll limp along with fewer benefits, higher taxes, and more humble foreign policy for a few decades and we should be out of the debt we've created. I don't think I have to explain why there isn't the political will to do this.

The second way out is involuntary sacrifice. This can come in one of two ways, the government can inflate the currency, or the government can inflate the currency then become insolvent. Inflation will make the debt much smaller, and payments on interest much easier to make. Of course it will make future debt more expensive (since interest rates include the expected rate of inflation). But for everyone benefiting form having debt wiped out, somewhere there is a debtor who is having their asset wiped out. Any fixed payment, bonds, retirement funds, CDs, bank accounts generally, accounts receivable, etc - will perpetually be worth less than expected and less than planned. Fortunes will be wiped out overnight, stocks and dividends will drop in value, and it'll be a total disaster. It'll wipe out savings and assets; income will have a short half-life—effectively giving further encouragement for Americans to save & spend more recklessly. It will cause massive layoffs, countless bankruptcies, and seriously harm everyone's standard of living. If the federal government becomes insolvent, we'll have anarchy.

When will this happen? As long as other countries perceive the dollar as “safe,” we've got time. Once we see interest rates for federal debt no longer serving as the gold standard, it is close. When interest rates rise and we're forced to borrow at high rates for essential spending, we're hosed.

What can you do to protect yourself? Move yourself or your assets to a more fiscally conservative country. Maybe Canada. Maybe. But if the US undergoes inflation or collapse, you can bet it'll affect countries and people everywhere. The US has gotten too big to fail, it is acting as if a bailout is coming, and although China & others have done their best, no one is big enough to bail out the US government.


Blogger Aaron said...

But for everyone benefiting form having debt wiped out, somewhere there is a debtor who is having their asset wiped out.

You mean a creditor, right? But I guess creditor wouldn't even be the right word in this circumstance, maybe investor.

I agree with much of what you say, though I wonder how unsustainable our debt is. There are numerous countries, such as Japan, that are far more indebted than us right now. It may reflect in their anemic economic growth, but it doesn't seem like they are going to be collapsing anytime soon, and they don't have the benefit of massive seigniorage. I agree debt is a huge issue, especially with the spending over the last year and any plans for a Health Care system, but I'm not sure it'll destroy our country.

The one positive thing you can take from this recession is that the savings rates have jumped, significantly. This is a big thing for investment in the future, and perhaps the Federal Reserve won't have to hold lending rates artificially low for investment purposes. I do wonder why, in particularly a banking crisis that this recession motivated people to save more, you'd think there'd be more hoarding like the Great Depression, but I guess we've spent enough US dollars to save banks that people won't be running on banks anytime soon. But why this crisis and not the one in 2001-2003? Or of the early 90s?

As for protecting your assets in a collapsing economy, Canada is no good. They depend enormously on trade with the United States and if we go down, so do they. I guess the best options would be real assets (which will still fluctuate) or perhaps a more stable currency, like the Euro.

Speaking of which, the transition away from the US dollar as the "gold standard" is already happening.

Former Federal Reserve Chairman Alan Greenspan said in September 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency."[6] Econometric analysis by Jeffery Frankel and Menzie Chinn suggests the euro may replace the U.S. dollar as the major reserve currency by 2020 if: (1) the remaining EU members, including the UK, adopt the Euro by 2020 or (2) the recent depreciation trend of the dollar persists into the future.

So it's a real possibility. One of my econ professors in Spain insuinuated that the real reason we went to war with Iraq was because they were planning on pricing in Euros, instead of a petrodollar. If oil began pricing worldwide in Euros, well, that would be a disaster for us.

02 October, 2009  
Anonymous Anonymous said...

"It seems the government never pays back the principle on the debt either, it just rolls over the debt into new treasury bonds or pays it. The debt is growing faster and faster."

This document (while old) will explain why:

It was written (in quite plain English) by the post WWII Fed Reserve Chairman, Beardsley Ruml (also adviser to H Hoover and later FDR & Rockefeller man) -- this is tthe guy who basically "set" the permanent policies for the Fed and the US Government during and after the war (established Bretton Woods -- which the article has some KEY points on that demonstrate the intention to eventually "default" etc.)

Have a fun read!

02 October, 2009  

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