From SC: “I have a question for you…What’s holding up the collapse?”
“For a long time now, I’ve been reading very cogent, lucid, and compelling warnings about the IMMINENT economic disaster ahead because of our massive national debt. Not only from essays by you, Bill Bonner, Doug Casey, et al, but from mainstream and not so mainstream media as well.
“I need no convincing. The arguments make every bit of sense to me. But I’ve been reading about this ‘imminent’ disaster since Reagan almost tripled the national debt. We’ve also heard the same warnings after debt increases by every president since then!
“So, here’s my question. WHAT’S HOLDING IT UP? This is not a wisecrack question. I really don’t understand why it hasn’t happened already. Is it the economic activity and growth that arises from all the borrowing? Is it possible that the debt is nothing more than red ink on a piece of paper? What and when, exactly, is the ‘breaking point?’”
My Response: I’ve been hearing predictions of another financial Armageddon since 1983, when I first got into the financial newsletter business. But just because something has or has not happened in the past does not mean it won’t or will happen in the future. The SEC reminds investors of that by making registered brokers and investment advisors state somewhere in every prediction or recommendation: “Past performance is no guarantee of future results.”
Let’s assume that I don’t contend that the Great Recession was a financial disaster of that magnitude. (Even though it resulted in a transfer of about $10 trillion from US middle-class and working-class households to the financial industrial complex and those that profit from it – the top 1%.)
Then, I’d agree with you: The case for the big reckoning – on the level of the Great Depression – has not materialized, despite the undeniably frightening facts and persuasive rhetoric.
What has happened in the past 50 years is a gradual but steady devaluation of the dollar’s buying power. Since the Nixon administration abandoned the gold standard in 1972, the dollar has lost 96% of its purchasing power.
That’s like two Great Depressions!
And that, according to economists (including the likes of Milton Friedman), is the primary reason why, in the past 50 years, the working and middle classes have become poorer while Wall Street and the top 1% have become exponentially richer.
All that said, and admitting that my knowledge of monetary theory and macroeconomics is very basic, I have two answers for you.
1. Since 1972, the Treasury Department and the Federal Reserve have had a responsibility they didn’t have when the dollar was backed by gold: to try to manipulate market prices to avoid hyperinflations and recessions by adjusting the Fed’s lending rate up or down (quantitative tightening and easing). Every country that has a fiat currency (i.e., a currency not backed by gold or, say, Bitcoin) has had to do the same thing. So, when it looks like the economy is slowing and heading towards a possible recession, the Fed lowers the interest rate, which makes it more attractive for businesses to borrow money and thus “stimulate” the economy. And when it looks like the economy is “heating up” and inflation (even hyperinflation) is a risk, they raise the rate to bring inflation under control.
The problem with this approach is that the government is required to balance its books every year. And when it spends more money than it has (the money it has comes almost entirely from taxation), it must borrow money from whoever wants to buy dollars. For decades after WWII, it was Japan and Germany. Then China became the US’s principal lender. Then hedge funds. This is why federal debt went from $400 billion in 1972 to $36 trillion today.
The US is the most indebted country (and economy) in the world, by a longshot. In a free-market environment (the environment in which Americans do business, earn a living, and buy things), the credit rating of potential borrowers determines whether money will be lent to them. Before you or I can borrow money from a bank or any lending institution to buy a car or a house or get a business loan, we must first prove that we are creditworthy. If we are not, we will not get the loan. (This rule was cleverly abandoned by unethical mortgage lenders and the government’s Fannie Mae and Freddie Mac in the years prior to the real estate debacle of 2008. It was that – lending billions upon billions of dollars to borrowers that were not credit “worthy” – that was the cause of the crash.)
If, then, increasing the debt by a factor of nearly 100 ($400 billion to $36 trillion) is a bad thing for the US economy – if it has turned us into the nation with the greatest debt in human history, even greater in relative terms than the Roman Empire’s before it collapsed in 476 – why haven’t we seen the predicted big collapse?
That brings me to my second answer…
2. Until very recently, countries that, for whatever reason, had a budget surplus and wanted to safeguard their money against economic risks such as inflation, had to buy dollars. The US government may have been sinking further into debt, but what choice did they have? After WWII, in the Breton Woods agreement, the US managed to contrive after-war policies, including the invention of the World Bank and the International Monetary Fund, to make the US dollar the default global security. (There is a great book – The Wealth of Shadows – that does a fantastic job of detailing this. See my review of it, above.)
And so, in 1978, when China changed its economy from a totally centrally controlled one to one that allowed for a substantial free market within it, and went from being the world’s poorest large country to the second-richest, it safeguarded all the trillions of dollars it was acquiring by buying US Treasuries. The same with Germany and Japan and a hundred other smaller countries that were producing budget surpluses. By 1972, the leaders of these countries had figured out the game. If they wanted to continue to grow their wealth by selling their cheap labor to the US, they had to buy the materials needed for that great economic expansion in dollars. And that continued until just recently.
What is different now is that half a dozen superpowers whose combined GDPs are larger than those of the US and England, France, and Germany decided that it was time to replace the dollar as the world’s global currency. China began the process by buying up gold. The second thing China has done was desist, as much as possible, from borrowing US dollars, and to pay for its needs using its gold stores (which further debases the strength of the dollar). The third thing China has done, along with oil-rich Arab nations like Saudi Arabia and with Russia, is move towards trade agreements that will allow them, as a group, to trade with one another using a new currency of their devising – probably a dollar-backed currency.
If they do that, the dollar will collapse. Big time. And the doomsayers will finally be right.
Here’s more info on why the dollar’s days are numbered.
As I said, I don’t consider myself to be an expert on macroeconomics or monetary theory. What I laid out above is what I came to after asking myself the same questions you asked me.
I’m publishing it here so I can be fact-checked by my readers who still believe that Maynard Keynes had it right. If they correct me, I’ll make adjustments. But for the moment, this is the only explanation that makes sense to me.
From PL re my recommended list of “how-to-succeed-in-business” books in the Sept. 3 issue:
“Several of the books on your list definitely had a profound effect on my life. For instance, Think and Grow Rich and How to Win Friends and Influence People.
“Another one that dramatically changed my life but didn’t make your list was The Magic of Thinking Big by David Schwartz. It is the one that made me realize that what I needed to do was find something that I truly enjoy doing and have the courage to believe that I could get my slice of the pie. So, if you do happen to make an updated list, I thought I would bring this one to your attention for consideration.”
