Feb 24 2009

Paths to Repudiation

February 24, 2009

As readers of this blog and my newsletter are aware, I have laid out the case whereby the United States eventually repudiates its public debt. The means by which this happens is unclear. There are several paths to the same place however, and it’s not necessary to choose only one method of ultimate default. All the usual methods will do, and I am now confident we’ll witness most of them in the next five years.

us-savings-bond

For example, we now know that an industrial depression will collapse tax revenues to Washington. This is already in the pipeline, as States from California to Kansas cannot even issue their own tax refunds. So the first path to repudiation comes from a collapse of GDP.

We also know that flagrant monetization will not be allowed to go on forever. That too is in the pipeline, as the FED has expanded outright non-sterilized purchases of financial assets. They have backed-stopped trillions in assets already with Treasury lending, but have since moved on to outright purchases. It’s likely that any month now they will start classical monetization of Treasuries. The FED has told us so. Thus, the second path to repudiation will come via quantitative easing, and inflation.

Now comes the populist response to the financial crisis. This is the third pressure that will come to bear on both tax revenues to Washington, and Washington financial policy. One face of the populist response is Liquidationist. The other face is Keynesian and Interventionist. The Liquidationist movement, to the extent its successful, will promote default in the private sector. (It will also be associated with Tax Revolts). The Interventionist movement will seek to move default into the public sector. In the end, it doesn’t really matter which pipeline is the conduit for default. And here’s why…

Default in the private sector deepens the crisis, and further reduces tax revenues to Washington. Default and losses in the public sector forces increased monetization and Treasury borrowings. The result is obvious: an ever greater quantity of Treasury securities, backed by ever decreasing cash flow to the government, and topped off by ever increasing monetization of both Treasuries and Agency debt.

Nationalisation of financial entities such as Fannie Mae, AIG, or the impending takeover of Citigroup and Bank of America are no longer that important. The only dynamic that is altered with nationalisation is how exactly the debt will be mitigated. Again, in the private sector it’s liquidated. But in the public realm it’s mitigated politically. Fannie Mae and Freddie Mac are already political vehicles that will be used to mitigate private debt through rescheduling. If Citigroup is taken over, then all commercial loans, credit card loans, and other debt held by Citigroup will be mitigated by Congress.

Let’s be clear: United States house prices, as one example, will now and for years to come be known as “The Prices of the Previous Era.” There will be no restoration of those price highs for a long time. Accordingly, Congress once it is in control of Citigroup and Bank of America will do just as they are doing now with Fannie Mae and Freddie Mac–they will reschedule the debt.

The private sector debt in the United States exerts the same power over the banking system as the public debt of the United States exerts over our international creditors. Collectively, the debtors are in control. Not the creditors. This is why the the Creditors, not the Debtors, will be making most of the concessions in the years ahead. Whether the US public debt is inflated away, rescheduled, or repudiated–or some combination of all three–it doesn’t matter much. The process is already underway. And only an improbably quick return to a very high GDP in the United States could halt the process. We’d need a pace of growth that the United States has not experienced in decades. I don’t see a quick return to high GDP in the US anytime soon, do you?

-Gregor

This popular post is now available in .pdf version. Click here: Paths to Repudiation

• Comments
Author: Gregor Macdonald   Posted in: Debt  Policy  crisis   Tagged:          
  • wholesalekoreanclothing
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  • Wonderful article, just added the site to my favorites. Thanks so much.
  • gregor.us
    Thankyou. Looks like it only took about 3~ weeks for part of this essay to play out--repudiation via monetization.

    G
  • hard_medicine
    Joe,

    Russia has not so quietly reduced dollar held reserves while accumulating domestically mined gold. Their new commodity/energy deal with China will serve to weaken China's dollar reserves through the increase of tangible exchange. To suggest gold is 'for Rambos' reflects on how far we've strayed from common sense truth.

    if you've noticed the discussion has moved from the previous moral hazard of bailouts to the recent hand wringing over debt. Until the discussion centers on the abuse of fiat, those elected in whom you put so much faith in, will continue to print money in order to buy votes and retain centralized power. Speaking of centralized power, this crisis is custom made for Mr Obama.

    Forgetting the irony of absent presidential stereotypes and how those actions (crimes?) ushered in the present socialist let's try to understand what the root problem might actually be (regardless of party affiliation).

    In 1971 free enterprise authorities enthusiastically embarked on the theory of ‘fiat monetarism’ (which is by the way now disowned by its author- the repentant Milton Friedman). This theory has proven to be the most egregious violation of common sense in financial history.

    This license to print money out of thin air was simply too intoxicating for governments and central banks to endure. Instead of dutifully regulating capitalism they went completely mad with the unbridled power and greed it licensed.

    Central banks 'balanced' their government books, and oversaw private sector 'balancing' by creating real debt with fictitious money.

    As the direct and eminently predictable result, inventive greed accelerated through this easy money system.

    Let’s start with the fact that 60T dollars equals the GDP (‘Gross Domestic Product’ or the total value of goods and services) of ALL NATIONS WORLDWIDE. From that benchmark we can begin to understand the crisis.

    US banks hold at least 180T in derivatives (3 times global GDP!) which is a conservative estimate. Some believe it to be closer to 600T, with JP Morgan alone responsible for 180T.

    The BIS (Bank of International Settlements) puts derivative ‘worldwide trade’ at 1000T
    At this moment we are only working through the initial derivative collapse brought about by CDS/CDO (Credit Default Swaps or Options) which accounts for only 62T (with the housing bottom still years away, this is going to continue to be a problem for quite some time).

    For perspective the USA is approximately 10T in debt and about to add 1-3T more as soon as the vaunted ‘stimulus’ package(s) are paid for (this debt does not account for any derivative obligations).

    And finally, keep in mind derivatives are for the most part privately traded so they are difficult to track/record. Chances are derivatives are worse than reported given the nature of our rose colored oversight/media systems.

    Summary: Adding derivatives to the tune of global debts are now several times larger than all real assets on the planet. This has led to every lender/seller on earth chasing after everyone else's money… which is of course encumbered through serial debt obligations.

    I'm not suggesting a gold standard as I'm sure the shock of such discipline would send the planet off its axis, but I am suggesting a system in which monetary policy has an accountable commodity basket or tangible item with which to limit the insanity to where the elected inmates only rent (not own and run to ruin) the asylum.
  • richard
    The root problem, my friend, is that a significant portion of our population is greedy and nasty. Greediness and nastiness eventually destroys itself (see Roman Empire) only to be reborn from their ashes to start the cycle over again. The trick is to profit quietly. Shhhhhhhhh.
  • hard_medicine
    Thanks Richard. I'm not denying human nature nor the deteriorating society which encourages this sort of irresponsible debt...but...to excuse it as cyclical and ride it as a one trick pony to the bank....well that's both dismal and enabling. Don't get me wrong, I agree with the premise that "The one thing man has learned from history, is that man does not learn from history". I just prefer to rail about the ignorance rather than Shhhhhhh my way along.

    (As you suggest) this is not the typical cyclical ‘inventory recession’ of traditional ‘seasonal’ adjusting’ (every 5-10 years). This is a complete structural change of our economic and societal value systems. But whether or not this is our time to 'fall' remains to be seen. Be careful what you wish for. Regardless, our thinking will need to adapt to this new paradigm. Within that adaptation I'm afraid profiting will take a backseat to wealth preservation.
  • Kevin
    I enjoyed the article. I think you summed up what is going on right now in that we are doing a combination of all three.

    My queston would be Which is better for the average joe private sector liquidation or public sector rescheduling.

    I tend to go with Private but really don't know.
  • gregor.us
    Depends. For savers, deflation protects capital held in diversified money forms--say gold, silver, various currencies. But, deflation kills equities and dividends from equities. Public mitigation will further spark reflation, and opens up pandoras box of a currency crisis.

    The FED, and Washington want what they cannot really have; a perfect reflationary success that sparks just enough recovery in asset values and economic activity but does not blow up the currency. My view has been they will take this path because a deflationary path leads to blow up anyway.

    Others disagree. For some years, there have been those who think there is "intention" in globally powerful bankers to force cycles of inflation and deflation upon the public, as a way to accumulate wealth and power. I disagree with this Intentional Framework but have found there's no budging those who believe it.

    G
  • gregor.us
  • Gregor, I appreciate your views - but you've got it wrong.

    In August of 2008 I wrote and published a piece entitled "King Dollar" - which is completely contrary to your views on the US and the dollar. At the time, I was wildly attacked with hate email and the like - yet time has borne out my position, and further time will bear out the rest. I invite you to read it at www.talentseekscapial.com.

    The dollar and the United States will not fail, and will recover completely from this dip in the road - and that is all it is.

    Your math, and the math of those postulating the demise of the US and/or Dollar is fundamentally flawed. Our economy has a thirty year growth rate of 500%. Tax revenues have likewise grown in similar fashion.

    Applying that FACTUAL math, you begin to see how your math - and thus your thesis - is all wrong.

    You see, you as others are applying todays debts relative to todays GDP and tax revenue - not considering the future productive output of the US over time.

    Similarly, you have failed to consider the energy complex in your fiscal math. We export on the order of $ 1 Trillion per year of Capital - once we finally get it together on Energy - AND WE WILL - put a standard multiplier of 2 on that Capital, and over 50 years that is $ 100 Trillion in Capital to the US Economy.

    Those critical omissions in your fiscal calculus - as others - are why your thesis that follows is fatally flawed.

    You will never awake to a day - nor will your Progeny - that the US is not on top. The 21st Century will be dominated by the US.

    This so-called "crisis" was no accident ( please see my piece on my site as well " The Metrical Equilibrium of Housing" ).

    This has all occured for the reasons stated therein - the key one of which is the transfer of wealth from the hands of the many to the hands of the few.

    Bush, like many before him - and many who will follow - merely facilitated that end. The objectives are to keep people in debt, so as to part their wealth of their work product to a small handful - as has been the case for thousands of years.

    In the time of the Romans or the Eqyptians - that was done through force and violence. Now it done through the use of Debt - in a voluntary manner trhough deception and deceit.

    That is really what is going on - thus the sky is not falling - nor will it.

    My advice to you and your readers: Don't bet against America - it's a Loser's Bet.

    Best Regards,

    Charlie T.
  • gregor.us
    Thanks for writing. I will indeed read your article on King Dollar. I welcome all views.

    Although I did not mention Energy in this post, Energy is in fact my area. And while I agree with you that transition away from capital export for energy purchases would, obviously, make for a dramatic change in available capital here in the US, I have fairly developed views that suggest this won't happen anytime soon.

    You'll find elsewhere in this blog, however, that I am a big advocate for getting that equation turned around just as you say. But, as an advocate for that change, I feel strongly I appreciate better than most how difficult that change will will be.

    Best,

    G
  • I appreciate your thoughtful and respectful comments.

    Your tone is quite different from many others I have encountered - there are many who seem to have a latent anti-American attitude, as opposed to one of genuine concern and apprehension about America's future.

    As you indicated, though I am not in Energy per se, I am thoroughly versed in the issues surrounding Oil and it's production - geological, political and practical.

    And with regard to Mexico, unfortunately, I am more versed in the matter than many of its leaders.
    I invite you to E Mail me and I will share some matters with you in that regard.

    I agree fully with you that the change will very difficult - but it can and will be acheived. Why ?

    Because it must be - and one thing can be counted in America, ultimately we always do what must be done. History can leave no doubt in that regard.

    If you carefully analyze the activity of the Oil Majors, you can see they are preparing for the transition - because they know it's coming.

    There are countless ways in which we can turn the energy Complex around. Superconductivity in the electrical infrastructure is but one - ( with an estimated ability to deliver a 3 multiple on electrical power ). Magnetism is yet another.

    Iceland is a classic example of where we can be - and WILL BE - eventually, albeit likely with a more varied portfolio - but with the same principal - self-sufficiency.

    In any event, I respect your views and attitude - but I urge you to have more confidence in America -you won't be disappointed.

    Best Regards,

    Charlie.
  • richard
    Americans are not anti-American, we are anti-corruption. Because our political system is completely corrupt (a president from Chicago!?!) we are anti-establishment. But the establishment is pretty smart narrowing it down to two parties. Fortunately, greed kills itself and we will eventually have a new system.
  • Russ
    Charlie, your link didn't work so I have to ask instead: What is the basis of your "future productive output of the US over time"?
  • gregor.us
    Total Gov DEBT on Inauguration Day, 20 JAN 2001: 5,706,174,969,873.86

    Total Gov DEBT on Inauguration Day 20 JAN 2009 10,626,877,048,913.08

    The rate of change of Govt Debt to GDP is zooming now in the last 18 months, and will get us fast to a ratio of 100% as GDP collapses and Govt Debt soars.

    But it's no longer just the public debt.

    We now have to consider AIG and Fannie and Freddie. Those losses are no longer in the private realm.

    We are zooming towards the classical Public Debt/GDP levels typical associated with a sovereign debt, currency, and capital flows crisis.

    G
  • jimbo
    And the non-govt savings (which is just the other side of the accounting identity from the govt. debt) is zooming up, just as fast. After years of unsustainable private sector dissaving, brought about by too-low govt. deficits in the face of foreign sector desires for dollar assets, the govt. deficits are finally allowing the private sector to net save and restore their balance sheets. Once these savings desires have been satiated, households will begin to spend again, and we will wonder what the big deal was.

    Your inability to read a spreadsheet is causing you to worry yourself sick.
  • gregor.us
    I agree and I disagree.

    I agree that the savings rate will rise, and is in fact already rising, just as in previous recessions. That is textbook.

    I disagree, however, that in this particular recession, which is much more like a Depression (or whatever term suits you, Debt-Deflation, D-process, Demand Collapse, etc)--in this situation while Americans will attempt to save, they will at the same time see, in the aggregate, stagnant wages and high debt service. In other words, we won't be able to save much.

    There are endless disputes over what constitutes savings. My view is this: take average income in the USA and plug-in debt service AND higher unemployment and stagnant wages during the recession, and see how much is left over for savings.

    Remember, Americans weren't spending savings the last 5 years. They were spending future earnings via credit. The halt in spending produces no new net ability to save.

    Your inability to read a spreadsheet is causing you to worry yourself sick.

    I've watched this unfold since 2001. Interestingly, (and others have said this as well who have been tracking the situatiion) it's turned out to be even worse than I feared. I was an optimist!

    G
  • richard
    The concept of savings in an inflationary environment is a nullity. Try saving in Zimbabwe.
  • I think the risk of repudiation by the US close to zero, as the US could print money to repay debt. Last resort, the US could lend money to local banks to buy the treasury.

    Also, there is no currency that USD can depreciate against. I see the end game as rush to gold. Such rush can lead to hyperinflation. To end the hyperinflation, we would return to gold standard ("hyper gold standard').
  • richard
    Returning to the gold standard was what Greenspan wanted all along. Read his doctoral thesis. The only way to save the village was to destroy it.
  • Joe Pisarcik
    What do you mean 'end game'? End of what? Who is going to buy all this gold other than the people who read financial blogs? China would get nothing out of plowing its reserves into gold rather than US treasuries. Gold is only good for sitting in a locked room. If we got to the point where we need to exchange it physically, firearms will be much more important., and the very young, the old and the weak, which is to say almost everybody you know, will be starving, The world will belong to Rambos.

    The Chinese may hate us, but they are going to continue buying US treasuries for as far as anyone can see into the future (which I admit isn't very far).
  • gregor.us
    I think the risk of repudiation by the US close to zero, as the US could print money to repay debt.

    That's one of my definitions of repudiation. Why is it not yours?

    G
  • Joe Pisarcik
    II dig the haughty, all-knowing tone here, but when you tstate hat "it doesn't matter much" whether US public debt is inflated away, rescheduled, or repudiated, the question that automatically comes up is: Matter to who?

    Furthermore, it's a pointless exercise to talk about US monetary policy in isolation of the rest of the world -- relative values are all that matter, in the end, and looking around the globe, i don't see where else savings-rich nations can go. , They 're not buying US Treasuries because they love the rate of return. They're doing it to finance a market for their goods, and if that's not the US, who is it? Western Europe is being driven into insolvency by Eastern Europe, and the domestic markets in Asia just don't exist on an adequate scale.. Check out the Times' story on Sunday about how freaked consumers in the world's second largest economy are, and that was before the news today that exports had dropped 47 percent. I doubt most Chinese are planning their next trip to the mall, either.

    Oh, and one more thing: i'd love to know what evidence on which you're basing your moral certainty of tax revolts in the US. Is that a conclusion you've reached from reading other bloggers and $100-an-issue newsletter writers, or from talking to ordinary Americans who are actually considering such a thing?
  • gregor.us
    Joe, the capital inflows which you expect to continue from savings rich countries were, in large part, our own high rates of consumption coming back to us. I remember being in a macro discussion 5 years ago, and someone asked: "I wonder when they will stop buying our Treasuries?" Two of us answered: "When our consumption drops, and we are of less use to them."

    This arrangement is now broken. I can't decide if that's a good thing, considering that it was unsustainable. Or, if its a bad thing because of the pain involved. Both, perhaps.

    What are savings rich nations doing now? They are starting to de-hoard USD instruments. Whether it's China buying resources, or other EM shortening their duration of USTs into the short end, or completely giving up on Agency debt, like Russia has.

    Joe, do you have a forecast? Is it your view that the European banking system is insolvent, but that the Anglo-American banking system is not? Do you think the UK and US longer-dated government bond markets have a whole new phase of price strength coming up ahead? Are you forecasting that Asia will buy as much paper from us this year has they have?

    As for Tax Revolts, that is a pretty obvious meme sprouting up in the land. Though I don't find any embrace of it as a solution, in my blog post, nor "moral certainty."

    You seem like you have a forecast. I'd like to hear it.

    Best,

    G
  • Joe Pisarcik
    Yes, on the Internet, a tax revolt is an "obvious meme." I would agree with that. But so far, I've yet to encounter anyone personally who's not planning on paying their taxes, and I meet a lot of people in my line of work.

    As for a forecast, I don't really have one. It often surprises how certain everybody is of theirs. Mainstream economists get mocked for saying things like 'The recession will be over in the 3Q 09" by the very same people who say 'I see gold going to $3500." It's not the ideas behind these statements that irks me, it's the delusion of exactitude.

    I happen to agree that the value of gold will rise, but mostly out of simple fear. i have no idea of how much it will rise, and if someone tries toc onvince me they do by showing me a chart of how gold performed during the oil crisis or the Depression or whatever, I have no interest. They might as well show me an astrological chart. . I also believe that the US economy, for all its obvious problems, is much more flexible & quicker to heal than others in the world, and will largely muddle through this crisis, perhaps with some extremely frightening junctures along the way. The real dangers are the expansion of protectionism worldwide & a domestic crackdown on legal and illegal immigration (we depend mightily on both). I'm not too happy about the drug war in Mexico, either, and I'm surprised people aren't more concerned about that. But like a lot of people, I'm hoping Obama proves to be a strong enough leader to stand up to these challenges.

    The strength of the US economy, much as this will appall everybody who reads this blog, is the consumer who helps drive product innovation. Much of this has to do with the marketing prowess of the US, which is given no credit in circles like this either, but which is vastly stronger than any other nation's. That's what most Asian countries lack -- a finely developed understanding of how to sell stuff to their own people, and so their domestic demand remains underdeveloped compared to their production capacity. Maybe Korea is an exception.

    Sure, US consumers have over-reached, abetted by cheap credit & the folly of securitised debt, etc. But that's as much the Chinese' fault as its ours, and we will share the cost of it all with them. But the logic of cooperation between the two countries will endure. Let's say we American consumers cut our overall spending by 10 percent for an extended period, a colossal amount. Our market remains gigantic, and still of enormous value to Chinese and other Asian exporters.

    Meanwhile, our tech exports should regain strength in the years ahead. We destroyed our financial system, and that will take time to fix, particularly if they make it a crime to pay bankers well. We need brains on Wall Street more than we ever have. But the industry has to correct its incentives, clearly.

    Is that a forecast? I don't know. I just refuse to be so worried all the time, and I try to resist the vanity of predicting the future down to a specific price for a particular good. Here's my best guess at what to do: Try to keep my job and wait another few months (6 or 9), or the panic to pass, as they sort out the banks and automobile manufacturers, then start buying equity in good US companies. And in the meantime, yeah, a little gold couldn't hurt. But I wouldn't go nuts. If gold really goes crazy so does the world, and then what we'll really want is canned goods and clean water.

    Oh, and I forecast with total faith a huge surplus of good music. There are more great bands in America than any time I can remember. They all rose from the ashes of the dead record business.
  • Russ
    The strength of the US economy, much as this will appall everybody who reads this blog, is the consumer who helps drive product innovation. Much of this has to do with the marketing prowess of the US, which is given no credit in circles like this either, but which is vastly stronger than any other nation's. That's what most Asian countries lack -- a finely developed understanding of how to sell stuff to their own people, and so their domestic demand remains underdeveloped compared to their production capacity. Maybe Korea is an exception.

    Every statement in that paragraph is completely false.

    Product innovation is a 2-way street; the sentence in the paragraph seems to be based on some sort of American tribalism. The American consumer didn't drive the innovation of the automobile, the assembly line lowered the price to the point that the product could be produced at a low enough price to be sold to more people. The US was the last country on the planet to adopt widespread use of cell phones. More product innovations have been drive by the US military than by consumers. Once a product gets into the hands of consumers, THEN improvements are made. The last 25 years the only innovations in the US economy have come from financial "products".

    One can't plausibly travel to other parts of the world and not see effective marketing. What many other countries lack is a portion of the populace that has expendable income. That comes from the concept of capitalism - property rights and the collective desire to formally deed title to real property that can be leveraged. Like the automobile, the US may have been the innovator in this area but the US is no longer the only country doing so. Domestic demand may be underdeveloped in other countries relative to the US, but the domestic demand IS developing and the US advantage is shrinking (and we should be thankful the rest of the world is catching up to us). One could argue that the US is taking steps backward in its consumer position - as laws become more complicated, as the number of victimless crimes increases, and incarceration rates rise, the economic freedom of the consumer is weakened. The US consumer is deleveraging - in part by economic cycles and in part by legislation. It's no accident that expanded leverage was encouraged at the same time as bureaucratic red tape increased. The leverage is now shrinking, but growth (outside of black markets) will never resume until the cost of entry (aka innovation) shrinks.
  • Joe Pisarcik
    "The last 25 years the only innovations in the US economy have come from financial 'products'

    Ipod? Google? Facebook, with 140 million users all over the world. Name a country that has a hotbed of technological innovation that can hold a candle to Silicon Valley..

    Obviously, there must be nations other than the US that have expendable income, since our savings are so low. But look at the top global brands -- notice how many of them are American? Is that an accident? You see Crest in China, but when was the last time you brushed your teeth with Chinese toothpase?

    And if you think laws in the US are "complicated", you obviously haven't spent much time in Europe. Try to start a business there. Opening a bed & breakfast in Italy will take you 5 years, and you'll have to bribe half the people in town. Asia, for all its "growth", isn't all that much better for small business owners. That's why so many people still want to emigrate to this country. Because there is economic opportunity that is not available even in other relatively developed countries.

    Name a country, right now, where domestic demand is growing in real terms. You can't.

    Growth will *never* resume?

    The US was the last country on earth to adopt widepsread use of cell phones = false.

    If marketing in Japan is so "effective", how come the consumer economy there is so stunted relative to the wealth of the society?

    Look, if you want to see the US as totally screwed, you are free to do that. But the world we live in is relative, and you seem to have a pretty limited understanding of how life is elsewhere, although I'm sure you're whiz with reeeling off GDP data, etc. Let's look at it this way:.I wonder how many entrepreneurs in China are able to support themselves by selling expensive newsletters that apparently take the position that the domestic economy is a fraud. It's a booming business here in the US, testament to a pretty sophisticated economy tand maybe even a bit of good marketing.

    One last example of our "bogus economy." I live near NYU. In the last 10 years, it has refurbished its campus to a stunning effect, and is now one of the most popular universities in the world. Not the US, the world. Is that wealth "fake"? Is it based on "phony" financial innovation? No. It's real. And though the university stupidly had a bit of its money with Madoff, it's poised to thrive as much as any major institution can in the current environment.
  • richard
    Israel is the biggest hotbed of innovation in almost every category. Now you know why there are so many Israeli companies listed on our exchanges.
  • Joe Pisarcik
    I just looked at a list of Israeli ADRs & i could not identify a single one that dominates a major market. So while it is impressive that such a small country has so many dynamic tech businesses, i don't think it's fair to say it rivals Silicon Valley.
  • richard
    The number of patents coming out of Israel does rival Silicon Valley. Domination is tough without massive capital. It's a good thing we are buddies. Hopefully, Obama won't mess it up.
  • Russ
    And if you think laws in the US are "complicated", you obviously haven't spent much time in Europe. Try to start a business there.

    I agree with you on that point, but the trend in Asian economies is to reduce that red tape whereas the trend in western economies is to increase red tape. Try building an oil refinery in the US, then try building one anywhere else.

    In the last 10 years, it has refurbished its campus to a stunning effect... Is that wealth "fake"?

    Yes, it's fake. It's debt fueled growth. Most college campuses went through similar campus refurbishings, the only ones who could not were small private colleges. Debt-fueled growth is excellent so long as the debt can be paid on the direct revenues of the operations - as soon as it requires subsidization with taxpayer money then it is fake wealth. Perhaps NYU has managed its finances better than other universities, but putting up new buildings on campus is no different than building a McMansion - it is more a symbol of indebtedness than a symbol of wealth.
  • Joe Pisarcik
    well, your average citizen is not trying open an oil refinery. And the fact that some hotly developing Asian countries have little interest in protecting their citizens from industrial pollution is not exactly an argument in their favor.

    As for NYU, i don't know what your point is. They've spent their money on facilities and faculty that attract talented kids from all over the world, many of whom pay hefty tuition that i am sure is sufficient to cover whatever debts they may have taken on. What is illusory about that? What would be a better way to spend money, on an oil refinery?

    Debt is not an inherently bad thing, and it can fuel growth. In fact, growth without debt is extremely hard to pull off. You just have to be careful about not taking on too much, which obviously a lot of people failed to be. But to condemn the whole notion of debt is to ensure the doomsday scenario that seems to excite all of the commenters here.
  • InEgoVeritas
    Hi Greg,

    What about the effect on the financial planet if the US repudiates? Isn't it too big to fail to use the terminology du jour? The USD is the backbone of the intl financial system, I would assume the BIS, IMF, EU and most importantly the PBoC to come to the rescue of the US treasury in this case or am I being too optimistic? Also I've always wondered what is the point of buying CDSs on US debt, is it realistic to assume to be protected from such a terrible financial choc?
  • OBSERVER
    President Obama has the qualifications to deal with this head on. His abilities are unique and he is an historical President supported by EVER major and important media outlet. With his personality and abilities he can bring us back to prosperity. GIve it time. GIve the Change a chance. We can do it and we will and Obama has shown us decisive decision making, hard work and clear direction. Don't loose the faith.
  • richard
    Obama says what you want to hear, so long as Pelosi says OK. Obama has never had a job and his only success has been in Chicago politics, which is not renown for its honesty and kindness. He has the total backing of a bought off congress just like our previous and glorious leader. Our systems have come to the end of their usefullness. Buckle UP!
  • What do you think the media will do as repudiation unfolds? Where will the truth be found?
  • Gregor, thank you for your thoughtful response. You are correct -- my word "allow" is not the best choice of words. Perhaps "create a framework" would be better. Strangely enough, that framework would be applied to debt, not equity, thus enabling a multi-fold solution: more accurate pricing of debt and restoration of confidence in equity, which already enjoys the GAAP framework, which was deficient in its capability of presenting risks to asset values. I wonder if you've had a chance to read the new Wired piece calling for "Radical Transparency"? http://www.wired.com/print/techbiz/it/magazine/... if not. Would love to hear your thoughts on that. My question after reading that is: If hedge funds had this data framework in 2007, why can't the rest of the world have it now? It might not be nirvana, but at least it's better than hand wringing about "complexity." (Sorry for posting as a new comment - the "reply" button didn't seem to work.")
  • gregor.us
    Cheers. The most hopeful thing I can say is that, as someone who would prefer to lean Libertarian and live in a stable economic environment, this crisis may force interesting break-outs of free market behavior. As long as we don't descend too far into a political crisis as a result of the financial crisis--and we will indeed have some sort of political crisis--but as long as the political crisis doesn't jump the shark and stays within loose contours, we may emerge on the other side with all those good things like transparency, and perhaps with smart regulation and simpler laws.

    G
  • Russ
    I'm nearly in the same mindset as you, but I don't see how simpler laws come to be without a full-blown political crisis. Simpler laws eventually make their way into the tax code - and at this point in time simplification of the tax code will be looked at as a gift to the wealthy. The urge to complicate things hasn't died, there's far too many "jobs" created with complication. I can only think of one time in the short history of the US where the federal (and state) governments had no choice but to deleverage - the period following the Civil War. The Civil War was the result of the kicking and screaming in avoidance of deleveraging. THAT was political crisis. Every economic crisis since then has resulted in the federal government (and the states to a lesser extent) increasing its amount of leverage. Government leverage has reached its apex, and deleveraging is inevitable. The problem is the current president was not elected on an economically conservative (deleveraging) plank and it is not his guiding principle. (To be fair, his opponents and predecessors shared the same trait.) He is certainly capable intellectually of learning the opposite guiding principle, but the US presidency is not a job where one is afforded the luxury of taking time out to study and learn the merits of opposing principles. He may be left with no choice but to deleverage, but he has no experience in his lifetime to draw on. Such is the case with his entire cabinet and set of advisers - with the exception of the already marginalized Volcker. If Volcker were a younger man I could expect him to persevere, but I think our credit bubble lasted so long that economic conservatism is in such a small minority that it is insignificant. We may not have a political crisis to the degree of the Civil War, but horrible moments like the Pullman Strike are likely to be repeated to the point of commonplace. In times like these patience is a virtue, but the current political winds view patience as a sin. God bless us all.
  • gregor.us
    Hi,

    I actually have some hope that, as long as the inevitable political crisis which follows these financial crises does little damage to the foundations, we could see healthy free-market break-outs in the years ahead and that Tax simplification would be one of those results. If we got big simplification and transparency as a reward for the pain, it might be worth it.

    As we now understand, the world has become too correlated, and systems have become to massive (thus making them non-robust and vulnerable to cascading failure). So, as Taleb says, we need to get flatter again and we need redundancies. (we need to be less optimized, ironically).

    Right now, just wrt to the issue of the aggregate private and public debt of the US, my guess is that some sort of mass rescheduling will eventually unfold.

    Here is the tough part: there is this pile of debt, much of which came into existence when linked to previously high asset values--and then, there is the ongoing net energy problem, where all new sources of energy supply cost more energy to extract. So, you know, human innovation is a wonderful thing but the world does have some limits.

    This is one reason why I support Rail and Utility grade solar, and I also support offshore drilling to raise the capital to build Rail and new power generation.

    The bottom line is that if our creditors will give us more time, and we head towards investments that capture efficiences, then we can carry the debt. But I think both of those will need to occur in addition to a return to high rates of GDP.

    G
  • So if this did happen would being sort the Yen be a good thing?
  • gregor.us
    My only comment about the Yen at this time is: Finally! Finally there is an global asset that is behaving as it should. Despite the continued strength of private savings in Japan, ZIRP policy and a crushed export sector DEMAND a weaker Yen. And we're seeing it! Hooray!

    G
  • To answer your question directly, yes. One chance for a quick return to high GDP in the US anytime soon would seem to be an approach that allows equity to grow faster than debt in order to grow the output that GDP represents. Debt, in the form of asset backed securities, is what killed equities because too many big equity companies had too much ABS debt on their books. Financing GDP (plain old C+G+I) became more costly and C & I fell faster than G could grow. Once the market sets a real market price for ABS debt, the equity that ABS debt injured directly -- and all the other equity that suffered with it -- should recover. More important, competitive means to finance additional output -- i.e., equity -- has a chance to supplant the risky debt to which Wall Street was forced to resort when equity markets became too competitively priced to feed its voracious appetite for economic rents. One essential ingredient would be transparency, which I've blogged about for the past month. Alas, I don't have the capital or the information to execute on such ideas, but someone does. Hope they use it. (By the way, I mean genuine business equity -- not housing "equity," which is a misnomer for "a place to live." One place to start might be to reverse the tax preferences that favor less productive housing investment and discourage more productive business investment, including the triple tax on business earnings in the form of corporate, capital gains, and dividend taxes.)
  • gregor.us
    Hi. I couldn't agree more that equity has been innocent roadkill in this debacle. Of course, equity was also inflated by the credit bubble. I am speaking generally.

    I also agree that business taxes, in aggregate, are too high in the US.

    However, while I would be intellectually curious to see what kind of effect a radical cutting of business taxes might have, and certainly can't see how it would be harmful--I am equally if not more of the view that the credit bubble was 25 years in the making. I started worrying about it in 2001. And others more knowledgeable than I had already logged over 10 years of worry by then. The worry, I think, came from the sheer magntiude of the credit bubble.

    So I don't see how we can "allow", to use your term, an approach that promotes the growth of equity over the growth of debt. Oh, I certainly agree with this view and I believe I understand what you are saying. I just don't see how, from the current position, this is something the country or the economy can have even if we want it. We are still negotiating through the pile of the existing debt. I just don't see where the capital will come from to finance any expansion that comes soon. Later? For sure. Maybe years from now. But this year? I don't see it. Where is this unencumbered capital that is available to the US to finance a quick return to GDP growth?

    Again, I fully agree with your theoretical framework here. I believe it will happen after we cross through the crisis. However, I don't believe the crisis will respond to your theory. My view is that the crisis has its own script now that can be tweaked at the edges, but not fundamentally changed.

    But if that's not the case, no one, and I mean no one, will be happier than me to return to global growth. I despise this crisis with a passion.

    G
  • So in other words, this will have a massively negative impact on the living standards of US citizens relative to the rest of the world - at least relative to those with strong currencies.

    The 21st century will be the decade of Asia - which was inevitable anyhow, and is now being accelerated by what's going on in DC. In a few years years, China will look upon the US much like the US now looks upon France. I guess I can live with that - I don't see that we have a choice at this point.

    Do you see gold deflating before the massive inflation? In what timeframe? And what about oil?
  • gregor.us
    I think we'll look back on the 1982 to 2007 period (which happens to be the entire bull market in bonds) as the time when Washington was increasingly captured by those whom they were supposed to regulate. I think the house of cards took that long to build, and now we kind choose among 100 ways to "pay" for it, but pay we will. But keeping it simple, I see it that the built up capital in liquid form of the OECD and in particular the US has been not totally destroyed of course but chopped down now in this debacle. (Actually it was eroding for years, but the crisis just forced the accounting out into the open).

    I don't know what happens. I know that Asia has all these reserves but alot of that is USD. So China is getting busy now, spending those USD on resources.

    I think we are very close to the inflationary breakout, and the China buying spree is the second big signal in addition to the recent move by Gold. Even if Gold pulled back to 850.00 I think that would be the extent of it. So, I think we have already been in the petite deflationary phase of what is still a monster inflationary trend this decade, and I smell an end to it this year.

    G
  • Jeff Burton
    Outright repudiation does not seem likely, does it? What you've outline is implicit default, not an explicit default.
  • gregor.us
    That's correct. I have outlined functional repudiation, not outright, declared repudiation.

    These are differences that seem large now. But, will be viewed as unimportant several years from now.

    I have the same view towards those, for example, who say "the US can never default on its debt because it can just print money to pay off maturing issues."

    Uh huh. Sure.

    So again, why hoist a flag saying "I repudiate" when many other routes get you there anyway. After all, we have already seen chatter in Japan that maybe they should just forgive the debt they hold of ours.

    Best,

    G
  • RG
    Not having enough hours in the day to follow every piece of economic news, this statement of the "chatter in Japan" to "forgive the debt" is new to me. Can you elaborate a bit more, or provide links? This would seem to me to be a major event, even if it were to come true only to a fraction. What would the possible ramifications be?

    Cheers

    -RG
  • gregor.us
    Japan Should Scrap U.S. Debt; Dollar May Plummet, Mikuni Says

    Dec. 24 (Bloomberg) -- Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession, said Akio Mikuni, president of credit ratings agency Mikuni & Co.

    The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes “drastic measures” to help bail out the U.S. economy, Mikuni said. Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said.

    “It’s difficult for the U.S. to borrow its way out of this problem,” Mikuni, 69, said in an interview with Bloomberg Television broadcast today. “Japan can help by extending debt cancellations.”
  • Andrew L.
    Let's assume that some combination of these three flavors of default is inevitable. How does a U.S. citizen prepare for this default? Are the other currencies better? Bullion? And, in the repudiation scenario, what happens - does the government just not pay interest on maturing T-Bills and Treasury Bonds?
  • gregor.us
    The endgame will come when US Treasury debt is 1. rescheduled via a Club Meeting of creditors. 2 Forgiven. 3. Burns down in price, from inflation.

    As for how to invest or prepare for it, I avoid such talk on my blog as it could be construed as giving investment advice.

    I agree with those who are saying, however, that gold is going to 3500.00.

    G
  • You don't see alternative energy as the saving grace?
  • gregor.us
    Ha. Well, I do think the government can and will build lots of utility grade solar. I hope that helps, you know, that we have better power generation. But it won't mitigate the debt.

    G
  • nice looking new bills at least :)
  • really informative. wow
  • gregor.us
    Cheers. FWIW I'm not pleased to writing such a Downer, of a post. I'd prefer to be more optimistic and I refuse to give up my core optimism. However, these are Interesting Times and assertions such as these only 3 years ago would have seemed hyperbolic. I'm just playing chess here with the future, and I conclude the game is well underway, and Debt has the upper hand as we move out of the middle game, and can see the end game on the horizon.

    G
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