Few topics have as many complete misconceptions as debt. Some people believe that the national debt is causing inflation. Others believe it’s not that big of a problem and will just go away. Both are wrong.
I’ve written this article to explain why the US government is in debt, why it’s different than Greece, and what a debt default will look like. It won’t be pretty.
I don’t predict the end of the world because I really don’t predict much – I’m a “permaskeptic” which means I’m humble when it comes to the future – just like investors should be.
Before I begin, let me first say I’m a firm believer in staying cynical about all things political — I don’t think our deficits are going to get incredibly smaller anytime soon, unless someone radical like Ron Paul becomes president, and even that would be almost impossible because of congress. So let’s talk about the national debt.
Why Paying the Debt Matters
The debt matters because the US has to pay interest on that debt. If the US suddenly decides to not pay interest on that debt, then that debt – which is essentially long-term and short-term treasury bills – becomes worthless.
This all will send the financial markets into a race to the bottom. That means people lose incredible amounts of money. That means businesses start to lose funding. That means credit is likely to dry up. That’s very, very bad.
Some people believe that the debt being defaulted on isn’t that big of a deal, and we have nothing to fear. This is simply false. The markets this last year showed signs of freaking out at the very idea of a default — and there wasn’t even one.
So the question of a default should be obvious: the debt has to have its payments kept up. But what does this mean? What’s wrong with having debt in the first place?
Why We Have Debt at All
Debt is often referred to by investors and economists as “liability”. And there’s a reason for this — debt is the great magnifier. It magnifies risk and profits.
It also allows for us to do what’s called “time arbitrage”, which means we’re essentially trading something tomorrow for something today. It’s the drug of choice for now-centered people who either can’t or don’t want to wait to pay for something with savings.
When it comes to economies, debt often creates bubbles. That’s why most economists believe that deficits add a superficial “shot” in the arm of the economy during a recession.
Liberal economist John Maynard Keynes concluded that this means that government spending and deficits are great for recessions. Unfortunately, he was a fool — he firmly believed that groups of people were smarter than the people that made up the group. You can see more about his thoughts here.
But that’s why deficits often go up during a recession. The presidents and senators and representatives are fed the idea that if they just spend more money and get into more debt, the economy will bounce back. Just a little more spending, they always say — and of course, it’s just never enough.
What the Problem Really Is…
The problem with the debt isn’t that it’s creating inflation right now. We’re not actually printing new money to pay off the debt with. Quantitative Easing is sometimes considered to be this, but it’s a little different — I’ll explain why in a future article. QE is such a failure it’s not even inflationary.
No, the problem with the debt is that it has to be paid. If the debt continues to become a larger percentage of our GDP every year, then the interest will grow, until we have to do one of the following:
- default,
- raise taxes, or
- print our way out of it.
That’s pretty much it. Eventually, our government will have to make the choice.
The first option sends our economy off a cliff. The second option sends our economy off a cliff. The third option sends our economy off a cliff.
This isn’t just theory, or interesting tidbits of trivia. This is real. Countries that ignore their national debt are on a one-way ticket to economic doom. While the European crisis is a little different, it still has some lessons.
Does the National Debt Cause Inflation?
No, it’s not causing inflation right now. Deficits don’t even cause inflation. Right now, we’re essentially borrowing the money we’re spending by issuing new treasury bills. This means we’re sucking money from around the rest of the world — if we promise to pay it back, plus some more money.
Inflation is being caused by the Federal Reserve system which is a completely separate issue than the national debt. There’s a little overlap sometimes, but not currently nearly as much as some people believe.
Are We Just Like Greece?
We’re not just like Greece, because our government has the ability to print new money. Greece doesn’t. They’re using the Euro, which is a currency they’re sharing with a bunch of other nations — and they’re not in a position to just print their way out of nominal money shortages.
This means we have one more tool to commit our own economic suicide with — the printing press.
Some economists believe that we should just print out way out of debt. That’s actually their strategy. In other words, they want to create inflation. I can’t imagine anything more dangerous than an attempt to print a trillion or two more in brand new money every year — the markets will freak out even more than they did in 2008.
That’s one reason I believe that around this time — as in, around the time the government tries to print its way out of debt — we’ll see high periods of instability and massive inflation. Some believe we’ll even see hyperinflation, though I don’t actually believe that’s possible without some other huge catalyst as well.
Either way, the markets will probably make the last few years look like a calm stroll through the park compared to the destructive insanity that will be unleashed. It’ll be a good time to have a strong, stable portfolio.
What If The Debt’s Gradually Cut?
This is an interesting question, and, unfortunately, I think it’s absurd. I don’t think it’s realistic. Still, some people believe that the Tea Party will be successful and spending will be slowed down.
First, the only person I know of who actively has spent time cutting government spending is Ron Paul, and gamblers are putting his odds at becoming president at about 2%.
Others, like Romney and Santorum, have a long, long history of exploding government spending. Santorum even said, “I am no longer a deficit hawk”.
Meanwhile, JFK wanted us to go to the heavens, and Obama apparently wants our national debt to follow suit, because he seems dedicated to sending it there.
But political narcisism aside, what if our debt begins to grow slower than our GDP grows? What would the impact be? Well, as long as our GDP keeps growing, that would actually essentially delay the “debt bomb” from ever exploding. We’d always be in debt, but it would be less of a problem than right now — and we’re not defaulting because of the lack of the ability to pay.
The only thing that could somehow trigger a default at that point would be if investors suddenly stopped buying treasury bills. Honestly, there’s absolutely no reason that would ever happen. Even I’ve owned treasury bills and I’m a “buy gold and guns” kind of a person.
So in the end, the debt bomb will essentially only realistically blow up if our debt grows faster than our GDP. Is this happening? Absolutely. Our debt has doubled in the last 3 years. Our GDP, well, hasn’t.
Something very, very drastic has to change — and that change has to be a change in spending, not in taxes. I’ll be writing about this over the next few weeks as well.
One More Time: The Future Isn’t Certain
I say this constnatly, because it’s essentially the most important principle in economics — the future just isn’t certain. Anything could happen. I’m sure I could be wrong. But even if I’m right, we’ll probably see a debt bomb go off during our time here on this earth. It won’t be pretty.
The United States is the leader of the global economy, and where our economy goes, the world follows. That’s why it’ll pay over the next few decades to have a portfolio that’s ready for anything — a portfolio that can profit from inflation and deflation, prosperity and recession.
I just finished writing a 19-page report explaining exactly how to do this. I’ll be emailing readers about this in our free email newsletter within the next 24-48 hours — sign up here to learn more.
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