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Pick your poison


When you put yourself into the position that many of the western central banks have done with massive unsustainable national debt near, at, or well past 100% debt to GDP, you leave yourself vulnerable to any shocks that come along. And believe me, there are many shocks in the pipeline.

The main problem here is that central banks throughout the western world are dependent on private capital, via the bond market, to make up the difference between tax receipts and day to day spending. They have all been doing this for decades, so the annual deficit has each year added to the national debt which has grown relentlessly. This is why the debt levels are so high. The patience of the bond market has been sorely tested and will soon reach a breaking point. When this breaking point arrives, few will be prepared to buy any more treasury bonds and their prices will plummet. The interest rate, its corollary, will soar. The central banks will then find themselves in a bind.

There are three, and only three, ways out of this bind.

1/ An individual, who finds himself in debt, can do the responsible thing which is, try to reduce his spending, raise his earnings and accept the fact that he will have to grind through this for many years in order to repay his freely accepted debts. On a national level this means raising taxes, reducing entitlement spending and biting the bullet, accepting that things will be tight for years until the debt is down to a manageable level. All the while begging the forebearance of your creditors to allow you the few years breathing room needed to bring tax receipts and spending in line. This is the path that Ireland has chosen. The absence of demonstrations or riots in the streets of Dublin shows that the Irish people have accepted this grim burden.

2/ Another individual may say “There is no way I can pay this, I’m filing for bankruptcy”. On a national level this means defaulting on the debt, saying to your bond holders that they have to accept pennies on the dollar, or nothing at all. Take it or leave it. Along with shafting their bond holders, they are now in a position that they can no longer go to the bond market in order to finance their deficit (the difference between what the government spends each year and what it receives in tax revenues) which means they have to suddenly bring their spending and tax revenues in line so that they do not need to go to the bond market to make up the difference. This means that tax rates soar, entitlement spending plummets and no national consensus is there to accept this new reality. Hence, riots on the streets and stories of extreme hardship abound. This is what Greece has done.

3/ The final option is monetisation. This option is not available to individuals, only to sovereign governments with control of their own currency, so not Ireland or Greece, being tied to the Euro as they are. Monetisation is basically printing as much money as the government needs and ignoring the need to get spending in line with tax receipts. This is the most dangerous choice as it inevitably leads to hyperinflation as the market is swamped with currency with no actual value to back it up. I’m looking at you America.

So there are the three choices, pay the debt, repudiate the debt or inflate the debt away. There are no good choices, only varying degrees of bad.

Pick your poison.


Pushing Granny off the cliff

Granny 2

Margaret Thatcher once said that anyone who can manage a household budget can manage the national budget.

Now, we keep hearing about the US national debt expressed in terms of the ratio of Debt to GDP which at around $16T, is now about at the 100% mark. But the Debt is owed by the US government and it does not have the entire GDP running through its coffers, what it has are tax receipts which are considerably less at currently around $2.1T and ongoing spending of about $3.2T. The interest that the US pays on this debt was $454 billion in 2011 and since it is increasing rather than paying down its total stock of debt each year it can be viewed as akin to an interest only loan. US unfunded liabilities are around $238T


So, let’s follow Maggie’s advice and convert these figures to layman’s terms by lopping eight zeros off the end so that they look something like a household budget.

The annual income is now $21,000 which is about what someone on minimum wage would earn. The members of this household are having a tough time at the moment and their annual outgoings are currently $32,000 and they are making up the difference by bunging $11,000 on to one of those ‘low teaser rate’ credit cards every year. So they are borrowing over half as much as they are earning.

They have been in the habit of borrowing to subsidise their lifestyle for many years now, though it’s gotten a lot worse these last few years. The end result is that they now owe $160,000. This means that their debt to income ratio is 762%. They are paying about $4,540 each year out of their earnings just to cover the interest on this ever increasing loan which will go up another $11,000 or more this year. Their effective interest rate is around 2.8%.

For now.

But the looming problem on the horizon is that granny is about to enter a nursing home and has no savings, so the bill for her living and medical expenses are going to be about $2,380,000 over the course of her remaining life.

This profligate family’s lenders are one day going to pull their heads out of the sand and work out the math on this situation. As we have seen with the PIGS, this realisation can happen very quickly and when it does, the interest rate demanded can rise very sharply indeed.


That nice Stavros family down the road saw their interest rate go from 5.5% to 12.5% in the space of a year and it is currently at 17% one year later. Their own family got in a spot of bother back in 1981 and saw their interest rate spike to 15%. But their total debt at that time was at a much more manageable level and they were able to placate their lenders with promises to mend their ways.


If it were to go to that level again, their annual interest payment would go up to $24,000 which is $3,000 more than they currently earn.

Yes, every penny they earn would be used to cover interest and they would still be $3,000 in the hole. So no money to pay little Johnny’s tuition, no money to pay the ongoing medical bills, no money to pay for the security company, no money to give to uncle Fred who has been out of work for a few years now. And as for granny, well, I hear the view up on Lovers Leap is great this time of year…

And you thought that it was that nasty Paul Ryan who was going to shove her off the cliff, what with his outrageous plan to “balance the budget”, pffffff.

Deathmatch:- FED v MATH


Inflation is always and everywhere a monetary phenomenon

– Milton Friedman

Those of us who are concerned about the near doubling of the US dollar money supply over the last four years are sometimes asked “So where is this inflation you keep banging on about”. Good question.

The formula in classic economics proposed by Irving Fisher in 1911 is



M is the quantity of money or M1

V is velocity of money, i.e. the number of times each dollar changes hands each year on average

P is the price level, and

Q is the quantity of goods and services produced (inflation adjusted GDP, defined as Real GDP is used as a proxy)

What we are interested in here is inflation, or the increase of P in the formula above. If we rearrange the formula to isolate P, we get

P = MV/Q

So let’s take each of these terms in turn and let’s see what’s been happening to them these last four years, using the official government figures from the St. Louis Federal Reserve.

M1, the money supply has risen by about 70% since 2008 from $1.4T to $2.4T as can be seen in the graph below


This is entirely due to massive Quantitative Easing by the Fed. The next term is V, velocity of money which has slumped from 1.96 to an historic low of 1.56 according to the government chart below.

Velocitu of money

Lastly let’s look at Real GDP which is what economists use as the standard proxy for Q. Real GDP is the inflation adjusted value for GDP, which is entirely sensible. This has dropped and risen to essentially the same number since 2008. Let’s call it $13.2T to $13.5T.

Real GDO

Since we are interested in the change of price P, i.e. inflation over this time period let’s look at figures for each of the two years 2008 and 2012.

P2008 = (1.4 * 1.96) / 13.2 = 0.208

P2012 = (2.4 * 1.57) / 13.5 = 0.279

Percentage change in price P over 4 years (i.e. Inflation) is (0.279 – 0.208) / 0.208 * 100% = 34%

To annualise that to an annual average inflation over four years we get the fourth root of 1.34 which is 1.076 or 7.6% annual average inflation over the last four years.

The official Consumer Price Index (CPI) over these years has been –

2009:  -0.34%
2010:  1.64%
2011:  3.16%
2012:  2.14%

Multiply these out and we get (0.9966 * 1.0164 * 1.0316 * 1.0214) = 1.067 or a cumulative 6.7% over the four years. We can get the average over four years by adding each of these figures and dividing by four which gives (0.9966 + 1.0164 + 1.0316 + 1.0214) / 4 = 1.0165 or 1.7% pa

So there we have it, the classic formula predicts an annual inflation of 7.6% pa while the Fed reports an average of 1.7% pa.

If the classic Monetary Exchange Equation is correct then we have a large discrepancy to try to explain.

Has the Fed been under-reporting inflation by about 6% per annum since the start of the crisis?

The looming US debt crisis


One of the main reasons I’ve started this blog is my concern with the level of debt undertaken by the US government. Though I’m not a US citizen or resident, because the US makes up over a quarter of the world GDP and is the world’s reserve currency, anything that happens there will have a huge knock-on effect worldwide. This debt is currently at around $16 Trillion and it will be $22T or $24T by the end of the new Obama administration. This is unsustainable and according to Stein’s Law, “If something cannot go on forever, it will stop“.

My fear is that it will stop by hitting a concrete wall, sparking an economic collapse and the Second Great Depression (GDII). All of this new debt has to be financed from the bond market. US national debt is already at 100% of GDP and will rise to 150% within this administration. In a normal capitalist system, the banks and insurance companies that purchase the majority of government bonds would demand a higher rate of interest to hold these risky bonds. However, if the interest rates were to rise to the level that they should do to reflect the actual risk, the annual interest payments would far exceed annual government revenues from taxes, leaving nothing for day to day expenditure. No amount of tax increases can come close to covering the shortfall, and under the current administration, no cuts in spending will be allowed. The US has painted itself into a fiscal corner and there is only one way out:- Inflate the money supply so that the debts become payable in debased dollars. And I’m not sure even this will work.

It’s not politics, it’s maths.

Quantitative Easing 1 (Tarp), 2, 3 and 4 (to infinity), is Ben Bernanke pumping money into the system in order to deliberately cause inflation, while denying that that is what he is doing. And Wall Street says nothing because they are making a fortune in a stock market that is booming due to this printed money

This all started in the late 70’s when excess credit caused the stock market to boom. When this crashed in 1986, the Fed expanded credit which caused the second-to-last property boom which crashed in ’91. Further credit caused the stock market to boom again, feeding into the internet stock mania of the late 90’s, which in turn crashed in ‘01. Doubling down on more monetary expansion caused the stock market and property value superboom that ran from ’01 to ’07.

This should have been our wake-up call. But no, what was decided was that we should quadruple down on this insanity. This has caused the stock market to double again from it’s ’08 low leading us to where we are now:-

Way out on a fiscal limb with no way back and with the branch creaking in the wind.

And all the time the US national debt has grown and grown.

Unless we get somebody sane in the Federal Reserve to stop this endlessly repeating cycle, the stock market will crash again sometime soon. If the Fed continues with excess credit, this torrent of freshly printed money will surely find the only outlet left, which is gold and we will see a further and possibly final boom cycle in this last remaining market.

I believe we will see 1970’s levels of inflation at 20%pa or more (remember that 26% pa for 3 or more years is the academic definition of hyperinflation) starting shortly and lasting for a decade or more. And that is a best case scenario. We have already plainly seen this inflation in food, commodities and energy.

What the US is doing, is being done double in Europe, and Japan is a disaster waiting to happen.