The world is hopelessly insolvent

We need to face reality, which is the whole world is hopelessly insolvent. There are only 3 ways out: a) growth; b) inflation; c) default.

 

Everyone is hoping for growth. Growth is a factor of population x productivity. Population is a headwind in all developed economies. It's probably least worse in the US because of immigration, but I see that as reversing with the current political environment. So the entire burden is then on productivity. Productivity of capital has a really low bar to hurtle because of low interest rates, but as interest rates rise (due to inflation and the Fed response to it), productivity of capital will decline (i.e., you'll need a high ROR on capital to justify investment). What about labor productivity? Well where's the inflation coming from NOW? -- housing and medical. What's going to happen to building when interest rates go up? Right -- construction will take a big hit and construction workers will be out of work. What about medical? This is rather murky. We now have 60,000 Americans dying annually from opioid addiction. That means millions are addicted. So we spend a lot to address this problem, and costs go up. The then there's demographics -- 10,000 people per day are retiring and that means a lot of medical costs for the diseases of old age. So how much of medical inflation is due to these 2 items and how much real societal benefit comes out of this -- keeping old people alive and re-hab for addicts? Are we really getting better health care or is it just getting more expensive?

 

Maybe we are getting value for our medical outlays and that's 18% of the economy. But 70% of the economy is consumption and consumers currently are purchasing goods and services with debt. That won't continue as folks are laid off and wages can't keep up with inflation.  SO MUCH FOR GROWTH.

 

Inflation won't work for reasons I've given already, in brief because it will quickly get out of hand, but the Fed's ability to fight it will be much reduced because debt creation will be impossible in the face of collapsing financeable opportunities.

 

DEFAULT. Well that's the most likely outcome. Gov'ts can't really default, but they can change the rules. Govt services and promises will be cut back. We'll end up with something like NHS in the UK -- universal health care but not very good. Retirement eligibility for Social Security will be raised. Subsidies will be cut. We'll have to reduce our global military foot print and curtail our military adventurism.

Comments

George N Romey Added Nov 13, 2017 - 10:31am
The US is already monetizing its debt through Fed purchases of treasuries.  In the interim the Fed uses printed (well actually digitized) money to buy stocks, bonds, gold futures-whatever to keep the markets propped up.  The entire system has become rigged to prevent the meltdown that should occur when the economy can't grow.
 
At some point this will probably come to a head.  What we see happening in Puerto Rico will occur on the mainland in one fashion or another.
 
The thing is that the central bankers are really good at this game.  We could live under this dual faced economy for another 10 plus years.
Leroy Added Nov 13, 2017 - 10:33am
Excellent article.  I believe default is the only way out as well.  There is so much debt that interest rates can't go up much because governments can't afford it.  It is why interest rates are so low to begin with so that governments could afford more debt.  Inflation and interest rates go hand in hand.  A sharp increase in interest rates or inflation will break the bond market.  The bond market is way bigger than the stock market.  We have already seen unsuccessful attempts to increase interest rates.
 
After a decade of debt-fueled growth for the sake of growth without improvement to the overall economies of the world, we have zero chance of growing our way out of it.
 
Bush the Junior set us on the debt trajectory of no return;  O catapulted us well beyond any realistic hope of ever coming to terms with the debt.
 
Housing prices are already unaffordable to many.  Rental fees are said to be even more unaffordable.  Underfunded pensions and obligations are to the point were retired teachers and government employees are being paid more than active ones.  We have to resign ourselves to ever increasing taxes and fees for fewer and fewer services.  I am more worried about deflation than inflation.  If people can't afford the things they need or think they need, then the prices must come down.
George N Romey Added Nov 13, 2017 - 10:39am
If Trump's tax reductions take hold the deficit will explode to somewhere between $1.5 trillion and $2 trillion a year, unless there is significant (late 1990s type) economic activity that results from the cuts.  The Fed is already monetizing the debt so politicians although they won't say it are like "so what."  We're just print our way out of any mess.  Worked before.
John Minehan Added Nov 13, 2017 - 10:40am
Ever read John McDonald's novel The Green Ripper (1979)?
 
It is a thriller about the character Travis McGee. 
 
The novel begins with Meyer, a recurring character in the McGee series and an economist, talking about how unstable the world economy is due to unproductive debt. 
 
McDonald was a Harvard MBA and a very bright man.  The opinions Meyer expresses were not out of the mainstream for Economists in the late 1970s.
 
But . . . .
 
Growth and productivity (which had been, at best, anemic) rebounded sharply in the 1980s.  Wall Street and The City developed new kinds of financial instruments that let people syndicate debt. 
 
While Africa and Latin America suffered the effects of widespread defaults, Asia (and particularly the PRC) became the economic engine of world.
 
It is tough to predict the future.  As a first approximation, things never go as well as you hope or as bad as you fear.   
 
 
   
 
Dave Volek Added Nov 13, 2017 - 10:44am
We should have defaulted a decade or two ago. The 1993 book "The Great Reckoning" predicted that a worse than a Depression-like collapse was imminent, and that really hasn't happened yet.
 
I took a beginner's course in monetarist economics. While I was somewhat bewildered, I recognized that governments with their own currency have tools to handle debt that the world's biggest corporations do not have. 
 
The next question is: can these tools be used to what seems to be infinity? 
 
In the end, money is an abstract concept. It depends on a common value that two parties believe the money is worth.
Even A Broken Clock Added Nov 13, 2017 - 11:08am
Economic activity has changed significantly since the computer revolution took over. No longer do you need growth through the production and consumption of physical items. Now economic growth is promoted through the consumption of digital items, be it a music subscription service, or cell phone service, or internet access, or television subscription. While all of these have a physical component (think cloud computing centers), the physical component is much less than what would occur in the manufacturing and sale of physical items.
 
The old paradigm of limited growth being available due to limits of resources seems to be going away. Similarly, with debt, it is considered far differently than it used to be. George mentioned Fed purchase of treasury instruments. What I expect in the future is Fed purchase and redemption of the underlying debt. Since it is only an accounting issue to deal with credits and debits in a Fed system, they could do this with minimal effect on the economy. Right now the debt just keeps getting rolled over, so actually eliminating it through the Fed system would represent a huge change in tactics. Look for this as an option that gets floated sometime in the next few years with new Fed leadership.
Leroy Added Nov 13, 2017 - 11:10am
"The next question is: can these tools be used to what seems to be infinity?"
 
China is testing that theory.  Debt is already at 300% of GDP.  That is debt that it knows about.  It keeps waving its magic wand and decides that long-term debt can be classed as equity.  The can keeps getting kicked down the road.   China's bout as the number two and possibly the number one economy soon will be short-lived.  India will win in the long term based on population.  The Chinese economy will collapse.  It is already written on the Great Wall.  It is just a matter of time. 
David Russell Added Nov 13, 2017 - 11:28am
ZIRP will continue forever.  But forever means "until inflation kicks in."  When that happens,  there will be no stopping it, as the Fed can only create more money by issuing more debt, but debt will find no viable loans in an inflationary environment because all assets which have been appreciating to date, will be devaluing because inflation increases the discount rate and thus suppresses all asset values.   Fed policy will be ineffectual to stop that.  Fiscal policy will also be stymied because it will have to be based on debt, which won't find buyers (and you can't raise taxes to fight a financial crisis)
Autumn Cote Added Nov 13, 2017 - 11:47am
Please note, the more personal responses you offer the more likely your articles will remain popular and commented upon.  
John Minehan Added Nov 13, 2017 - 12:51pm
The PRC can get away with what it does because it is the emerging economic hegemon. with One Belt/One Road, etc.
 
The US could get away with its issues as it was the dominant economy.  Let's see how long that lasts.
 
Remember the book on the 2008 Economic Crisis, Confidence Men?   
 
Apt title, that. 
Edward Miessner Added Nov 13, 2017 - 2:32pm
Good article. But I think the feds will continue to monetise the federal government debt long after the US$ loses its reigning status as the reserve currency... which means we'll do a stealth default through a rapid or even hyper inflation.
 
John Minehan is on the ball when he says China is emerging as the new global with its One Belt One Road initiative. What is our government doing? Intimidating countries with threat of invasion if they try conclusions with us!
Dino Manalis Added Nov 13, 2017 - 3:50pm
Immigration has helped the U.S., while more growth is pertinent and fiscal restraint is needed.  We need to gradually convert public pensions into 401K plans and invested conservatively.  We need to tighten our belts without hurting the economy and the poor, like Clinton/Gingrich achieved.
Stone-Eater Friedli Added Nov 14, 2017 - 2:39am
Growth will kill us. Economic growth kills nature, and population growth does the rest.
Leroy Added Nov 14, 2017 - 8:43am
"The PRC can get away with what it does because it is the emerging economic hegemon. with One Belt/One Road, etc."
 
Quite honestly, John, it sounds Asia's version of "Make China Great Again" by reliving the past.  If it ever comes to fruition, China will become the dominant world economic and military power.  I don't see the nations of the region voluntarily giving up their sovereignty.  China has already committed billions of dollars, but it will take trillions every year until completion.  It will take private investment to make it happen.  It will never happen with China's lack of transparency.  It doesn't even have a real currency.  And China is already massively in debt.  I just don't see it happening.  If it were an economic advantage, it would have happened already.
David Russell Added Nov 14, 2017 - 11:39am
Immigration is a dying issue:  We don't want them here (for fear of terrorism) and they don't want to come (because we make them feel like terrorists).   With the defeat of the Caliphate, domestic terrorism should get worse.... perhaps a lot worse.  
 
Moreover, the ugly truth is that labor is too expensive, everywhere and is quietly but steadily being replaced by capital, technology, robotics and other forms of automation.    Immigration therefore is shifting from being a benefit to being a liability.
 
 
Utpal Patel Added Nov 14, 2017 - 3:58pm
There is no such thing as hopelessly insolvent.  All of your proposed solutions would make us solvent again.  However I agree that we can’t grow our way out of this mess.  Default also isn’t an option because we’d be defaulting on the elderly, as they are the entity we’re most indebted to.  They also vote.  So there is no way they will allow their benefits to be cut.  There really is only one option and that’s to print more money.  Printing money / monetizing the debt is always the path of least resistance for countries that spend too much.   Inflation is also a back door way to cut services without actually being on record making cuts.  I had hope we could cut spending and manage our debt, but lost all hope following Trumpcare’s failure to pass. 
Edward Miessner Added Nov 14, 2017 - 5:11pm
Utpal, you are exactly right. Monetisation of the debt will be the way to go and that will cause a huge inflation that will basically impoverish everyone save the top 1%. Funny how they always seem to prosper despite high inflations, great depressions, wars and huge tax burdens on their income. Life's always better when you own the politicians, can employ people who always seem to know what's around the bend economically, and have enough money to further increase your stash of money no matter what.
Leroy Added Nov 14, 2017 - 5:27pm
A great opportunity awaits us all if we have the wisdom to place our bet on the right horse.  Where there is chaos, there is the opportunity.  The common man can make a fortune if he is willing to take the risk and is right.
 
But, most likely, the common man will be slaughtered.  No, it is not a conspiracy of the rich.  It's plain stupidity and greed.  Savings are near all-time lows while the stock market is at all-time highs.  The common man has finally decided to take part in the booming market just as it has reached its peak.  There is little left to be made, but there is much to be lost.  Once again, retirees will be decimated.  Once again, the rich will be blamed.
George N Romey Added Nov 15, 2017 - 10:24am
Leroy the rich know the scheme is going on and they know how to profit.  The little guy thinks man I missing something, the market is great, so he/she gets in not understanding its been rigged.  However, this time is different.  Because of alternative news many more Americans know the stock, bond and real estate markets are bubbles waiting to pop. Its the dumb asses watching the Russians are coming on CNN and MSNBC that are too stupid to see the end is nearing.
 
Just like the 1930s many will profit handsomely.  Remember FDR knew Joe Kennedy was a crook.  Rather than prosecute him he made Kennedy a deal to be in charge of the SEC because a thief knows the trade.
 
Why do you think so many of the rich have a stockpile of precious metals and homes on far away islands. 
Leroy Added Nov 15, 2017 - 11:24am
"Printing money / monetizing the debt is always the path of least resistance for countries that spend too much."
 
How does printing money into perpetuity solve the problem?  Doesn't it just kick the can down the road a little longer?  Japan has not been successful in inflating its debt away.  I suggest that we will enter a period of deflation rather than inflation.  If we can't grow our way out of it, ultimately, default is the only answer.
George N Romey Added Nov 15, 2017 - 1:36pm
Printing money does that, kicks the problem down the road. Central Banks have achieved a gift for putting off the day of reckoning. However one day it will spiral out of control and then the IMF will come in with SDRs. More Monopoly money to replace the existing failed paper,
Edward Miessner Added Nov 15, 2017 - 2:41pm
Leroy, George,
 
"There is little left to be made, but there is much to be lost.  Once again, retirees will be decimated.  Once again, the rich will be blamed."
 
"Because of alternative news many more Americans know the stock, bond and real estate markets are bubbles waiting to pop."
 
And yet most people have no choice but to continue to invest in the stock market and go long because of the way their 401K, 457G, etc. workplace-based retirement plans are set up. My personal experience is that I had six different funds to choose from, each one heavilly or wholly exposed to the stock market. What exposure was not to the stock market, was to the bond market. Presently they are being propped up by Central Bank quantitative easements but quantitative tightening is coming and when that arrives down the pike these markets will all collapse and the retirees and people saving for their retirement will take it in the shorts.
David Montaigne Added Nov 17, 2017 - 10:28am
The most common way out of economic problems, the way that Germany attempted and the way America succeeded - is to have a world war.  Don't be surprised if economic collapse is quickly followed by (a hopefully non-nuclear and somewhat limited) WWIII.
My research points in this direction, check it if interested: https://www.amazon.com/Nostradamus-Islamic-Invasion-Europe-Montaigne/dp/1546435840
George N Romey Added Nov 17, 2017 - 10:34am
David that's how it happens. Politicians have no answers to problems or are hamstrung by their financial handlers from working together.  So they start with "look over there at those horrible people" (pick your country).  Forget about you can't get a good job those people over there are out to kill you!  Hence starts the road to war. Given what WW1 and WW2 were like for the time (millions dead) I doubt any resulting war will be limited.  And the likely as in WW2 someone will finally push the button or drop the bomb.
Edward Miessner Added Nov 17, 2017 - 12:23pm
Well once WW3 breaks out expect a billion people to perish. Are you ready for global mass exterminations? Ugo Bardi says they're coming no matter what. Use those nukes and soon enough all 15,000 will be used. This will cause many more billions, perhaps all 7.6 billion human beings, to perish.