Up Against a Wall of Debt

Discussion in 'Economics' started by Tom B, Nov 2, 2009.

  1. Tom B

    Tom B

    November 2, 2009
    Up Against a Wall of Debt
    By Robert Samuelson

    WASHINGTON -- The idea that the government of a major advanced country would default on its debt -- that is, tell lenders that it won't repay them all they're owed -- was, until recently, a preposterous proposition. Argentina and Russia have stiffed their creditors, but surely the likes of the United States, Japan or Great Britain wouldn't. Well, it's still a very, very long shot, but it's no longer entirely unimaginable. Governments of rich countries are borrowing so much that it's conceivable that one day the twin assumptions underlying their burgeoning debt (that lenders will continue to lend and that governments will continue to pay) might collapse. What happens then?

    The question is so unfamiliar that the past provides few clues to the future. Psychology is crucial. To take a parallel example: the dollar. The fear is that foreigners (and Americans, too) lose confidence in its value and dump it for yen, euros, gold or oil. If too many investors do that, a self-fulfilling stampede could trigger sell-offs in U.S. stocks and bonds. People have predicted such a crisis for decades. It hasn't happened yet. The currency's decline has been orderly, because the dollar retains a bedrock confidence based on America's political stability, openness, wealth and low inflation. But something could shatter that confidence -- tomorrow or 10 years from tomorrow.

    The same logic applies to exploding government debt. We have moved into uncharted territory and are prisoners of psychology. Consider Japan. In 2009, its budget deficit -- the gap between spending and taxes -- amounts to 10 percent or more of gross domestic product (GDP). The total government debt -- the borrowing to cover all its deficits -- is approaching 200 percent of GDP. That's twice the size of its economy. The mountainous debt reflects years of slow economic growth, many "stimulus" plans, an aging society and the impact of the global recession. By 2019, the debt-to-GDP ratio could hit 300 percent, says a report from JPMorgan Chase.

    No one knows how to interpret these numbers. If someone had predicted 20 years ago that Japan's debt would rise so spectacularly, the forecast would doubtlessly have inspired this alarm: Japan will pay crushing interest rates as fearful lenders demand high returns to compensate for the risk that government might default or inflate away its debt. Instead, the opposite has happened. Japanese investors -- households, banks, insurers -- have absorbed 94 percent of the debt, reports JPMorgan. Interest rates on 10-year Japanese government bonds have dropped from 7.1 percent in 1990 to 1.4 percent now.

    Superficially, it's possible to explain this. Japan has ample private savings to buy bonds; modest deflation -- falling prices -- makes low interest rates acceptable; and investors remain confident that new and maturing debt will be financed.

    The American situation is similar. Despite huge deficits, interest rates on 10-year Treasury bonds have hovered around 3.5 percent. In time of financial crisis, investors have sought the apparent sanctuary of government bonds. But the correct conclusion to draw is not that major governments (such as Japan and the United States) can easily borrow as much as they want. It is that they can easily borrow as much as they want until confidence that they can do so evaporates -- and we don't know when, how or whether that may happen.

    Wealthy societies everywhere face a similar dilemma. Debt is ballooning from already high levels. The Congressional Budget Office reckons the Obama administration's planned budgets would increase the debt-to-GDP ratio from 41 percent in 2008 to 82 percent in 2019. Higher interest rates would aggravate the debt burden. Anticipating higher rates, the CBO estimates annual interest payments on the federal debt at $799 billion in 2019, up from $170 billion in 2009. Even the size of exposed debt is unclear; adding Fannie Mae's and Freddie Mac's debts (effectively guaranteed by the government) to Treasury debt would raise the total sharply.

    But containing debt by spending cuts or tax increases would involve wrenching and unpopular measures that might, perversely, weaken the economy and worsen deficits. In Japan, the existing value-added tax (national sales tax) of 5 percent would have to go to 12 percent, says JPMorgan, along with deep spending cuts. Against choices like that, some advanced country might decide that a partial or complete default, though dire, would be less damaging economically and politically than the alternatives.

    Deprived of international or domestic credit, defaulting countries in the past have suffered deep economic downturns, hyperinflation, or both. The odds may be against a wealthy society tempting that fate, but even the remote possibility underlines the precariousness and the novelty of the present situation. The arguments over whether we need more "stimulus" (and debt) obscure the larger reality that past debt increasingly constricts governments' economic maneuvering room.

    Copyright 2009, Washington Post Writers Group

  2. The US will continue devaluing it's currency and will continue to "repay" it's debt with worthless paper. This way it'll pretend no default will ever happen.
  3. It is funny how history can repeat itself so soon. Look at the housing market. People were able to realistically afford a much larger house than normal because of the "teaser" rates they were given. As long as the rates stayed at the teaser level, they were fine. Once the rates reset higher, and the house didn't gain in value as the brokers told them it would, they were stuck with an albatross around their necks.

    Many gov'ts are following the same pattern. As long as the central banks keep the "teaser" rates, gov'ts will borrow like crazy. The difference is that the banks couldn't care less about the homeowners because even if the homeowners can't pay the higher rate, the gov't will bail the banks out. There is, however, no one to bail out a gov't that can no longer pay interest on debt. So, it would seem the central bank would be inclined to keep rates low for an extended time, as in Japan, so interest can be paid and the economy won't collapse. America isn't at the point yet where it can't handle a small rate raise, but that time could arrive in the next few years.
  4. Mainly because when it is their money, Congress and political leaders are more likely to be careful with their own family's money. When elected to represent our interests, they throw our futures down the toilet with reckless abandon.

    We NEVER under ANY circumstance should let the Fed Govt run deficits. Many states/cities are required to balance their budget. The Fed Govt is run like a crack cocaine addict with 100 IV tubes mainlining cocaine...

    The eventual withdrawal will be severe, and possibly fatal...