The Debt Crisis Revisited

      Wow! My recent posts about the debt crisis Point of No Return (February 18) and Gotterdammerung for America (February 25) (available at www.mllg.us) elicited many questions and comments from readers. Following are my responses.

Question: Your current position differs from what you wrote in the past; explain.

Some readers have long memories. I wrote in 2010 and 2011 that the debt crisis would arrive in the early 2020s and possibly sooner. Now, I project it will arrive in the mid 2020s, maybe sooner. The difference is entirely explainable by (1) the budget sequester passed in 2013; (2) nine years without a recession; and (3) the lowest interest rates in history. There is another key difference: in earlier years I believed the crisis was still avoidable; now I believe we have crossed the point of no return. Fundamentally, nothing has changed except the timeline – thanks mainly to the sequester.

Question: What about Japan; isn’t its Debt/GDP ratio above 200%?

Japan’s ratio is 235%; however, it has pension and other assets, which partially offset the debt part of the equation and lower the ratio to around 100%. The NIKKEI 225 stock index nearly hit 40,000 in 1989; currently, it is around 21,200 – a drop of 47% that has persisted for 28 years and counting. Economic growth has barely averaged 1%; they have chronic deflation and now more deaths than births each year. They have avoided default mainly because Japanese citizens are willing to buy government bonds to finance the deficit. However, Japan has paid a steep price for its debt crisis.

Question: Hasn’t Greece avoided default despite a ratio way above 90%?

Greece’s ratio is around 175%. It has staved off default because it is small (GDP size of Massachusetts) and was bailed out by the EU, which imposed severe austerity in exchange for the bailouts. The US is far too big to be bailed out and if we go under, we drag the rest of the world with us. If Greece were on its own, it would have defaulted and would now be a third world country. Moreover, Greece has suffered; its economy has shrunk, pensions have been cut nearly in half and there is societal upheaval.

Question: Isn’t the US okay as long as people keep buying Treasury bonds?

Yes, witness the situation with Japan – which likely is unique to that country. When US debt reaches a level where it can’t be repaid, why would anyone buy more bonds? The very nature of a debt crisis means the debt can’t be repaid without default, devaluation or financial repression that forces bondholders to accept less than full value.

Question: Is a soft landing possible?

Translation: can we suffer a debt crisis with minimum pain and disruption? The debt ultimately must be reduced via: (1) less spending; (2) higher taxes; (3) inflation; (4) repudiation; or (5) a combination. However, the magnitude of the spending cuts or new taxes would be devastating. A crisis could take the form of a sudden cataclysm or a slow motion train wreck. One way or another, the debt must be purged and every possible method results in a crisis that will fundamentally reshape America.

Question: What do you really believe will happen and when?

If something cannot go on forever, it won’t. No nation has recovered from 90% without economic and social upheaval. The US will surpass 90% within a few years and the ratio will continue to skyrocket after that. The point of no return is 90%; that does not mean the crisis begins the day we reach 90%; it only means disaster can’t be avoided. The ratio may hit 125% or even 150% before the bottom falls out. Government will attempt fixes but they will be too little, too late. A painful readjustment process will purge the excess debt from the system. When it is all over, America will be a different country. Some readers have expressed a more sanguine outlook; I hope they are right.