Saturday, December 27, 2008

The Problem that can't be named is named!!

You know we’re in a significant debt crisis when The New York Times editorial page yells “uncle”. It did so on Sunday, November 30, 2008 in an editorial entitled “Bailing Away”. The New York Times editorial page is not known for being queasy about government intervention, but here they are worrying about the inflationary effects of all this debt, most of which is financed by “the Treasury…borrowing money and the Fed… printing it.”

One commentator recently said that after finding the limits of a gold standard based financial system in the 1930’s we are now finding the limits to a debt based financial system. It is therefore ironic for a problem born in debt; mortgage debt in particular but too much debt in general, the solution being offered is more debt; government debt.

It is possible that some short-term marginal uptick in the economy will be forthcoming from massive government “investments” be they bailouts of private industries or infrastructure improvements. We may see some short-term rebound in the economy and stock market, but it is difficult to see how the long-term economic outlook cannot but be negative.

When F.D.R. began implementing the New Deal, the federal government was about 2-3% of GDP. Today the federal government is currently about 18-20% but may approach 50% in the next few years. In 1932 the public debt was about $16B in 1932 dollars, which is about $206B in 2000 dollars. By the beginning of the war the debt was about $48B or $565B currently. At the end of WWII the debt was $269B or $5T in 2000 dollars, about ½ our current debt of about $10.7T. An important difference is much of the debt in 1945 was owed to Americans. Savings Bond a.k.a. War Bonds were marketed to U.S. citizens to get most of the money that had been hoarded during the Depression back into circulation. Today about 25% of the debt is owed to foreigners.

It’s interesting to note that as a percentage of GDP, our current debt situation is NOT the highest it’s been since WWII. That distinction goes to 1950 when our public debt was 94.1% of GDP. In 2008 our debt will equal about 73% of GDP, which is estimated to be about $14T. However, in 1950 social security and medicare didn’t face the demographic challenge it does today; a challenge that amounts to a $55T plus unfunded obligation. Plus, with hindsight, we know the country was on the cusp of about 15 years of significant growth. Today, we’re one year into a significant recession; probably the worse since WWII, that will probably last into 2010. It is, therefore, very hard to envision we’re about to enter a 15 to 20 year period of 3-4% annual growth, the kind of growth, that only with a significant reduction of the federal budget, has any hope of retiring the accumulated debt.

The prevailing wisdom is that in the current economic environment, government must intervene, deficits and debt be damned. The proof given is F.D.R. and the raving success he had in the 1930’s. However, Roosevelt’s policies worked more against growth than in support of it. Going from 25% unemployment to 14% in 9 years with a median rate of 17.2% is not a particularly great record. A factor that may influence some of today's Republicans to support intervention as much Democrats is a political culture that increasingly sees government as the problem-solver of last resort. And as we all know, getting re-elected is more important than doing what you believe is right.

The end result of all this debt, which may, in the next few years exceed our GDP, is to insure the further devaluation of the dollar via inflation, which will reduce the attractiveness of dollar based assets, which will force interest rates up, which will increase the cost of servicing our debt, which may drive us into bankruptcy.

Only unfettered capitalism and peaceful coexistence with the rest of the world can save us. More on that peaceful coexistence part later.