Thursday, January 31, 2013

Mo’ Debt, Mo’ Problems (Mo’ Keynesian Cynicism)

Christ, is Matt Yglesias stupid. Stupid or high, or maybe he’s just a cynical bastard—I really can’t make up my mind.
The U.S. Debt: Notice a trend?
[click to enlarge]

He just wrote a piece in Slate proposing that the U.S. government go into even more debt, ballooning the Federal debt to even higher levels than the “mere” 120% of GDP it currently is.

His “reasoning”? To take advantage of the lower interest rates currently prevalent in the bond markets.

Prima facie, Yglesias sounds reasonable. As he rightly points out,
[T]he inflation-adjusted yield on 10-year Treasury bonds was negative 0.56 percent. Savers, in other words, want to pay the American government for the privilege of safeguarding their money. For the longest-dated bonds we sell, the 30-year Treasury bond, rates were 0.51 percent. That’s higher than zero, but far below the long-term average economic growth level. [emphasis in the original]
All good up to this point.

But then in the very next breath—I mean, literally the very next line—he writes something of startling imbecility:
A sensible country would be taking advantage of that fact [of record-low interest rates] to finance some valuable public undertakings. Alternatively, if we think there’s nothing worth spending money on we could enact a big temporary tax cut aimed at reducing the unemployment rate and boosting the population’s skill level. [. . .] Another way of looking at it is that global financial markets are sending a clear signal to the United States. At a time when demand for goods and services is depressed, demand for American government debt is sky-high. The responsible choice is to let the supply meet the demand and borrow more. [emphasis in the original]
Right. Clever, even: To fix the situation of overindebtedness, just borrow more.

This thinking reveals the key blindness of Yglesias and other Keynesians: They completely misunderstand the economic moment the world is living in—and are thus oblivious to the rationale and the consequences of the policy decisions that have been taken up to now.

Let me take a step back and explain.

The reason that the global economy is in the sorry state that it’s in today is because of overindebtedness that has grown like a cancer since 1987. That year, in response to the ’87 Crash, Alan Greespan instituted the famed “Greenspan Put” of low-interest rates to prop up the economy during every downturn.

Disaster in slow motion: The Greenspan Put palliated the periodic recessions and financial shocks during the period from 1988 through 2005—but in exchange, it created an environment where the markets all expected low interest rates whenever anything dipped. This low-interest rate expectation had the dual effect of making people go into even more debt (since it was so cheap and was guaranteed to remain cheap), and of asset inflation (since returns on investment were realigned to the low-interest rate environment). In other words, assets—like houses and equities—bubbled, while people took on more and more debt that they would eventually not be able to service.

Good times for the Nineties and half of the Oughts, but it was bound to end in tears—as it eventually did: By 2006, borrowers got to the point where they couldn’t service their debts. So they started selling their assets (or losing them to foreclosure, in the case of housing), and shuttering businesses, which created huge unemployment. Falling asset prices and mounting unemployment—which meant less consumption—led to the very edge of a deflationary spiral.

This cliff-edge of deflation is what led to two key policies: The Federal government went into massive debt in order to finance massive spending, including the Obama stimulus package and the military budget, all carried out to prop up the GDP. And the Federal Reserve essentially went into money printing by way of the euphemism “Quantitative Easing”, while carrying out the literally unprecedented Zero Interest Rate Policy (ZIRP), done in order to make the massive spending programs possible, while supposedly encouraging more borrowing by consumers and businesses.

These twin policy decisions created the extraordinary situation we are seeing in the bond market today: On the one hand, huge emissions of sovereign debt being pumped out into the markets. On the other, record-low yields for these bonds, as the Fed acts as the surreptitious buyer of last resort, thus keeping bond prices up and yields down.

But Yglesias acts like this over-supply of Treasury bonds in a low-yield environment is something that came out of the blue—like a meteor shower or a sighting of the Virgin Mary. That disingenuousness is bad enough. To say that the Federal government should go even further into debt—by way of spending hikes or tax cuts—is downright cynical.

Why is it disingenuous? Why is it cynical? In other words, why do people like me freak out about the amount of debt that the Federal government is floating?

Simple: Because either the fiscal overindebtedness causes interest rates to spike, thereby crashing the country’s economy and bankrupting its government; or it leads to runaway inflation that spirals out of control and into hyperinflation, thereby crashing the country’s economy and bankrupting its government. A garden of forking paths, maybe, but it all leads to the same crummy destination.

The first outcome—spiking sovereign debt yields that break the economy—happens when the bond markets collectively begin to doubt a government’s ability to pay back its debt. This happens to small- and medium-sized economies—non-reserve currency countries. Their sovereign bond prices fall, yields spike, making it that much more difficult for the government to roll over its debt, until it finally bankrupts, while the local economy suffers catastrophic interest rate spikes that also bankrupts most businesses. We have seen this exact same scenario countless times in Latin American countries like Uruguay and Argentina. It’s currently happening to Spain, Portugal, Greece and Ireland. This movie is so oft-repeated, we can practically recite the dialogue.

The other outcome is, the reserve currency hyperinflates. This is what I think will happen—and I think the policy decisions the Federal Reserve has implemented will lead to that outcome. The mechanics of this end are relatively simple: Bond yields are “managed” (to the downside of course) by Ben Bernanke and the Federal Reserve by continued Treasury bond buying via QE, while ZIRP continues unabated, until prices begin to spike, triggering inflation. Since Bernanke and the FOMC have a hard-on for ZIRP, they will not raise interest rates to halt inflation—any hint of inflation will be rationalized away. So as inflation festers (as it currently is) and then rises (as it likely soon will be), and then suddenly turns over into something uncontrollable, the Federal Reserve will not be able to rein it in. After all, the only way to halt inflation, as Paul Volcker showed in 1980, is to drastically raise interest rates. If this weapon is taken off the table (as the Fed has with its declaration of “ZIRP 4EVER” tattooed across its institutional forehead), then any jump in prices—say a shooting war in the Middle East that suddenly raises oil prices, or a failed grain harvest raising food prices—will rapidly spin out of control.

These two outcomes—economic death by interest rate spike, or economic death by hyperinflation—are inevitable in an overindebted economy. This is why you do not want to be running unsustainable debt, as the U.S. is currently doing—it’s called “unsustainable” for a reason, specifically these two reasons.

But Yglesias, genius that he is, is calling for even more debt. Because the debt is so cheap! That must mean that the markets want even more Treasuries—so give them to them! And use the borrowed money to fund even more unsustainable government spending! Even more unsustainable tax cuts! Right?

Right . . .

Look, I don’t want fiscal austerity and reduced government debt out of some atavistic urge to economic Calvinism—I’m a Latin American Catholic: I believe in sex, drugs, and a forgiving father confessor.

But I recognize where excessive debt ultimately leads—and I want to avoid it. That’s why I want the deficit reduced—nay, eliminated. If that means a draconian austerity package? So be it. Better two-three incredibly crappy years of misery, followed by a revamped economy loaded for bear, than this slow, unending grind to the bottom.

Yglesias and his ilk either don’t understand what will happen because of the fiscal overindebtedness—or don’t believe it will happen because of some weird irrational belief in “American economic exceptionalism”—or know it will happen eventually, but choose to play the short game in hopes of currying favor today with one or another faction of the establishment; Yglesias is an inside-the-Beltway fringe-player, after all.

Which is why I can’t make up my mind if Yglesias is stupid, high, or just plain cynical.


  1. GL

    I guess the reason why we need printing more is to allow this system to continue a bit longer :-).

    This system has to end in hyperinflation. There are no two ways to it. You can cause the hyperinflation now, or you can cause it a few years later. The better choice is to let it continue.

    This way more people will arrive to the conclusion of converting their wealth in gold, before the inevitable, and more people will survive. As it is most middle class people are going to end in tears.

  2. I would very much be in favor of using the low interest rates to swap short term debt for long term debt. Debt for persistent non emergency consumption – as opposed to investment – is a poor choice. Servicing the debt works as a steady drag on yearly expenditures. National debt serves as a wealth transfer from taxpayers to bond holders and a wealth drain out of the economy when a large amount of the debt is owed to foreigners.

    Here's a hint: privatizing the debt of bankers is a corrupt and poor reason for acquiring debt. Having an effective 6% - 8% tax on corporations just doesn't work with corporations like GE paying nothing. America should cut about $400 B out of it's defense-security budget. America should adopt a Single Payer health care financing system spending no more than 11% of GDP on medical expenses like 20 other wealthy countries do in stead of paying 17-18% of GDP like it currently does. In a $16 T economy that saves it conservatively about $900 B per year. Yearly deficit solved along with a nice surplus. Of course it's a bit more messy than that but you get the point.

    But America won't do any of this because Americans currently live in a childlike world of magic and fantasy of their own construction. And both liberals and conservatives are quite happy with it. Yglesias is just the latest example on the liberal side. Neo Cons and most republicans still dream of cost free world empire with other people's kids always paying the price while liberals just love ObamaCare which was dreamed up by a right wing think tank and is pro corporate to a fault. Yglesias fits right in.



    1. Unna (and GL),
      I think you both miss a key counterpoint to Matty's claims. Who do you think is buying all of this debt?

      It is not the Chinese, or Germans, or American people eagerlying paying to have the gov't hold their money at these rates. The Federal Reserve is printing the money to buy them. No one is giving us cheap electronics or cars for this paper loans...we're just making up dollars and loaning it to the gov't for nothing.

      For every private, corporate or foreign CB sucker willing to make long term loans to the US gov't at these rates, I agree, give them all the debt they are willing to buy. The problem is that already there are not enough suckers to support the current torrent of debt issuance, nevermind increased debt issuance Matty advocates for. Roughly 70% of new debt issuance is being bought by the Fed. There are only enough suckers for 30% of the existing flow of crap debt. GL gets this, this is what he means by the Fed policy leading to hyperinflation.

      But the key and immediate response to Matty's stupidity is, "Who do you think is buying the existing torrent of crap debt that you think we should increase?" And the answer is, "no one is." It is coming out of the rapidly declining credibility account of the US dollar. And credibility, like virginity, is very difficult to recover once lost.

      To GL's point...this will end badly.

      Daedalus Mugged

    2. Daedalus,

      Don't disagree with anything you say. Just wanted to point out that there are many ways to move towards a balanced budget without becoming an economic “Calvinist” as GL said. Jonas has a good list of things that could be put on the credit card. If the Fed is, in effect, monetizing debt, might as well monetize to build something useful and permanent – put people to work, maintain work skills and a work culture, get young people out of the basement and on to a job. Doubt it will happen.

      I confess, I find it hard to get my head around the final outcome of Bernanke's buying so many treasuries. Yes, I understand GL's inflation argument. Our former housing bubble boy Mark Carney, in the UK now, appears to be ready to target GDP. Wonder how much money he'll have to print to do that? Which is only an admission of how weak many Western “real” economies must be, even after years of printing.

      Will TPTB really ride this over the cliff of an inflationary depression? Can inflation really happen while labour has no pricing power. Can TPTB really keep all that printed money bottled up forever in financial assets? With Obama in the process of institutionalizing his “right” to kill enemies of the state, is the stage now set to declare “Austerity Now, Austerity Forever” and mop up all that liquidity at the expense of the general population? Is it true the TSA is really buying all those bullits? So many questions.


  3. To end the charade, you would need a populace that understands "there ain't no such thing as a free lunch."

    The current U.S. population has a critical mass of citizens demanding "free" health care, "free" phones, etc.

    The non-European descendants are having more children and voting in ever increasing numbers, and they all demand free lunches from our politicians--PLUS our wealthy oligopoly demands free lunches in the ever-increasing periods when their insane derivative trades don't pan out. And the politicians are acting in a perfectly rational manner--in order to get themselves re-elected. Expect the Fed, the banksters, the ignorant lower classes and the politicians to SACRIFICE and make the right call to avoid eliminating the middle class while destroying the world's economy? Impossible.

    The financial collapse is unavoidable. The plane is aimed directly at the ground, we're flying at 500 mph, we're only 1,000 feet AGL, and we're flying INVERTED.

    Buckle up.

    1. Today a large percentage of this debt is now owned by the fed, why not just write it off, it is just paper money. Then raise interest rates to curve inflation.

    2. Regarding the Flight image you are using - I remember the pilot of this flight also was drunk and drugged, but boy what a pilot! What a perfect crash landing!

    3. Good point! Write it off they should. Iceland stiffed the bankers. They are way better off for it. Why didn't Greece? Why didn't Cyprus? In fact... what was the real reason those governments went into debt with the troika in the first place? What purpose does all this debt serve? Is it even about the money? Or is it about power and control?

    4. I understand that doing this with an economy the size of the U.S would have serious concequences...for the entire world, but in the end what choice is there.

      As far as I am concerned, it is not about money and has not been for a long time now. I look at the idiots listed as richest men according to Forbes magazine and laugh, they are dinosaurs compared to our 'rulers'.

  4. "...and I think the policy decisions the Federal Reserve has implemented will lead to that outcome [hyperinflation]"

    While generally correct, you should put one more layer on top of your thinking:
    What kind of inflation would result in the majority of US population becoming uneasy? Only strong inflation in basic things such as food or energy, which cannot be almost limitless diluted or lowered in quality (such as clothing and cars). Well the US is the biggest food producer per capita, and has many oil exporting countries in their shirt pocket. If still any remaining inflation makes the masses of the people restless then the government handouts can be increased. Until it comes to Thatcher's quip "...eventually you run out of other people's money."
    So as long as the rulers are unscrupulous enough, and the people who still own/earn some serious assets accept being the source of gov't OPM, this can go on...

  5. Perpetually rising indebtedness, low interest rates, special tax rules (shortsale tax forgiveness), ceiling lifted on residential investment unit ownership (for investment by wallstreet), phoney Basel III/Dodd-Frank rules not yet implemented, and mysteriously low housing inventory while real estate agents/market participants lie to us that the market is healthy and in recovery. Where is the normalcy of rewarding well-behaved consumers who play by the rules? Those of us who live within our means and don't buy at the top of the market, knowing the inability to perpetuate this madness of ever-appreciating real estate assets will bail us out of over-leveraging our personal balance sheets?
    This market is infuriating!! Those of us who have behaved, and waited out the market to defer ownership until the bubble burst, we find ourselves now competing to purchase yet-overpriced home against the same assholes who got us into this mess, credit only slightly 'dinged' by over-endulgence that allowed them to 'walk away' from their obligations. The confluence of the above factors to artificially boost our economy has left me feeling hopelessly deceived by the government and bankers who have exploited the system, not to mention consumers who have played part in this quagmire and now leave us taxpayers and shareholders with the bill in hand. I have lost faith in the system, we are serious victims and it sucks.

  6. Gonzalo, I have a Hyperinflation FAQ that I think refutes Mish and other deflationists. I wonder if you could comment on it?

    PS Your captcha is too hard! I am a real human but find it very hard to make out the letters.

    1. It really doesn't matter what Mr Yglesias says.

      Yesterday our political leaders told us they will conduct drone attacks against American citizens who are involved in ongoing plotting against the United States. Our leaders get to decide what constitutes ongoing plotting.

      Perhaps what I am saying here will be defined as ongoing plotting.

      Those of us who obtain our news from non-traditional news sources are defined by the Department of Homeland Security as domestic terrorists. This rule has been on the books for 4 years.

      Gee, I wonder how many of us are in this category?

      Meanwhile, our financial leaders aren't just fiddling as Rome burns. They are hosing everything down with gasoline.

      We have a bifurcated housing market. The little guy is locked out of the foreclosure purchase market since big blocks of houses are only available for purchase by the biggest buyers. Bargain foreclosures are being bought en mass by hedge funds.

      Those with no connection to the local community will own huge swaths of the housing stock. Simon Legree is a creampuff next to these guys. We will have suburban slums.

      To those who are attempting to restore trust, good luck to you.

      Care for some totalitarianism and economic oppression with your popcorn?

      K Smith

    2. Haha. It isn't about the money. They can print as much as they want and borrow it at zero percent interest. It is only about power and control. It is an end not a means as Orwell put it so well.

  7. I think what Yglesias means is that we should borrow now while we can and use that to invest in projects to change the country for the future. The collapse will come, everyone knows it, so better borrow and make the investments for the future now while the money still buys something. Let's say they borrow the money to build high speed shuttle trains up and down the coasts connecting all the major cities located there. Build a nation wide high speed optical fiber network. Build high tech education facilities. Upgrade the irrigation system, waterways and roads to last for many years to come. Build subways and efficient public transport for all major cities. Upgrade oil and gas pipelines country wide. Build a natural gas distribution network country wide etc. All these things will be there after the collapse as well and will be a godsend for the industry and the country's ability to compete in the world thereafter. Only they can't wait around for the collapse to happen as the dollar won't buy any of this by then. So better make the investments now while the dollar at least buys 'something'... Soon it will be too late...

    1. The borrowed money will be used for more wars and tax reduction. How is that going to help the situation?

    2. Anonymous, might as well just go bankrupt then? Would spare a lot of lives and unnecessary hardship..

      Sadly, it seems you may be right. They are using the money to build a police state and expanding their wars and military presence all over the world. It's insane! If only the people could wake up, stop the madness and take their country back from the tyrants currently running it.

  8. Hi Gonzalo, any update on your hyperinflation thesis? You were certain it would arrive by 2011, now we're into 2013. What's your current view?

  9. A Catholic who believes in sex and drugs -- then go to the confessional booth and get it all waived away? Sorry, but you are wrong Mr. G. You can't do wrong things (listen to the wordless word inside and not the excuse making rationale of the voice in your head) and go to a person who has been ordained only by another man and not necessarily by God, who will tell you to say 3 Hail Mary's and be on your way. Clean up your act. Regards, Paul.

  10. ....These two outcomes—economic death by interest rate spike, or economic death by hyperinflation—are inevitable in an overindebted economy,...

    why cant the fed erase a big chunk of usg debt?
    just burn the actual bond paper?

    1. Why? You worthless peons might get a bit uppity if you didn't have a crushing debt burden to service. Your masters on wall street get the QE. Shut your mouth and vote for the next stuffed suit.

  11. Dont people get that eventually a tipping point occurs to every economy? Look back in history and you'll find a tipping point, past which point there is no going back. We have reached that point and only tragic economic crash will awaken our buried with their heads in the sand "intelligentsia". I only hope it hurts them the most.

  12. Gonzalo, one of the most insidious effects of low interest rates is on employment. I have not seen too much written about this, but I have taken a couple of decisions based on that. Is very simple. We were deciding in an automatic bagging machine that needed 1 operator, vs two semi automatic bagging machines that had to be manned by a crew of 3 or 4 depending on the throughput.

    On one side, you have a steady flow of salaries discounted to today.
    On the other side, the investment on the new machine.

    There is an "option" value in keeping the employee, that is: it is easier to fire a person than to sell an production asset (the value of the option to abandon), however very few times this is taken too much into account since you don't consider the possibility of abandoning a production unit when you are planning your investment.

    The key parameter for the decision was the discount rate, because that was how you discounted the futures payment to employees. Low rates, one more machine "investment" to boost GDP, 2 or 3 fewer long term jobs.

    So, Keynesians are right about keeping interests low. It promote investments. But they forget that the easier investment is to cut the labor force by automating or moving assets to lower wages countries.

    Add to that, that all the policies for "helping the middle class" makes it more risky to have an employee (future restrictions fire, lawsuits, increasing health care costs, forced increase in minimum wage, etc) than a machine.

    So when they promote keeping low "low interest rates" and "government spending" and "borrow more" to "boost the economy" and "create employment" the are actually pushing private decision makers to do exactly the opposite.

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  21. There are so few brilliant thinkers both able and inclined to write about money related things other than how to steal at a faster rate than they are being robbed that it's downright tragic you aren't writing more on this otherwise fine Blog of yours.

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  25. Everything GL writes is interesting. My interest lies i under what conditions will GL change his theories? In other words, how many years would have to pass or what debt threshold would have to be crossed for GL to state that his views were wrong and the Keynesians were right? What would make GL accept the Keynesian model? Because if there is nothing that could cause his views to change then his theories are not falsifiable and they are just a belief just as much as those who oppose him are. Then all this is not based on a type of science but is belief and dogma.

    1. Very simple: If real GDP growth accelerates enough that debt-to-GDP ratios actually start falling across the Western world, that would demonstrate that Keynesian's were at least somewhat correct about the need for high government spending to grow out of recession and debt. Don't hold your breath.

  26. Is Gonzo still alive? Maybe not. There's a rumor that he's suffered from esophageal cancer since last summer. Which explains why he hasn't been on RT for a long time.
    R.I.P., Gonzo.
    We hardly knew you.

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  28. Gonzalo, what has happened to you? There were times where you did 3 posts per day and now it seems you are doing 3 posts per year. I have a model and simulation of hyperinflation. Could you look at it and comment?

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  30. Surely the Cyprus business deserves a post??
    And FFS will you do some housekeeping here and clean up the spammers!?

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  34. Ok, I am now officially giving up on Gonzo. With everything that has happened since Januaray...not a single post. Good bye, this blog really used to be great!

  35. Common sense dictates that spending more than you take in eventually destroys the budget. Austerity is always the result of profligate spending. Either austerity or destruction of the currency and the stability and strength of the nation.


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