The Debt Bubble

My Recent Posts

Encouraged and asked by Katharine I have put together a summation of the current situation with debt.  In short, the world is floating in debt, possibly soon drowning in debt, developed and developing countries alike.  Central Banks around the world have been giving out near free money over the past decade.  Corporations that have access to all this cheap money have used it to buy their competitors, repurchase their stock and pay eight and nine figures to their C team.

 

As far as the US federal debt. Its now over $20.6 million.  That's $20,600,000,000,000.  Just ten years ago it was half that but now with mostly weak economic activity during this decade long period.  Remember not all Gross Domestic Product has a positive impact on the economy and/or society.  Today the debt to GDP is about 105%, approaching a dangerous level. Our highest percentage was just under 119% at the end of World War 2 but a robust economy afterwards brought that down to under 60%.

 

We issue debt just to pay the interest on the current debt.  We haven't applied a penny towards principle in at least half a century.  We have come to monetize the debt, or simply print money to cover the new debt.  The Treasury hits a button and billions instantly appear in the accounts of the Federal Reserve.  The Fed in turn takes that money and buys new issues of our debt.  Since the US maintains its own currency it can make money appear out of thin air.  However, nations that have tried this in past haven't fared so well.  Since there's so much of it being printed the currency loses value.  In our case all that made up money isn't really hitting the general economy.  One reason the big banks and Wall Street are doing so well but not consumers (I'll talk about the banks later).

 

Yet the US isn't in as bad shape as other countries.  China is at approximately 250% as the country has put displaced manufacturing workers to work on public works projects.  In addition, more and more rural inhabitants are showing up in the major cities expecting a better paying job than the farm.  China already suffers from too many males and not enough female partners due to its previous one child policy.  Got to keep all those horny young men busy or they might just revolt.

 

Japan also comes in at around 250%.  An aged population means there isn't enough younger workers to support all the old retired people demanding a litany of services.  Greece is at just under 180% while France looks much better at 85%.  The Brits are at 90%.  All mentioned had much lower percentages just a decade ago.

 

In the US states and municipalities cannot run deficits.  However, that has not stopped them from using accounting gimmicks and other financial wizardry to fill the gapping holes.

 

Finally, US citizens have followed the lead of their government.  Consumer debt of every type increases every minute of every day with never a second of decline.  As of today, mortgage debt is at just under $15 trillion, student loan debt at over $1.5 trillion, credit card debt at more than $1 trillion with another $571 billion in other types consumer debt.  Consumer debt has risen 141% over the past ten years or so and has been the primary driver of consumer spending since the 1980s.  Prior to that most Americans only financed large ticket items.  A typical car loan was three years, today its approaching seven years.

 

Mortgage debt is growing the slowest as there has been a decline in first time home buyers.

 

You might think bankers and lenders are quite worried about the trajectory of consumer debt.  In fact after the Great Depression bankers were painstakingly careful about making bad loans.  In the 1980s and 1990s all that began to change.  Securitization meant bankers could bundle like loans into a security and sell it off to investors for a hefty fee.  The investor gets an income stream from the repayment of principle and interest but usually assumes the risk of loss.  Investors depend upon one or more of the three rating agencies to tell them how good the loans are within a portfolio.  However, the rating agencies do not have the capacity, resources and knowledge to understand what might be within those securities.  But since the money's good they rate it anyway.

 

Investors might be dumb but they sure aren't are stupid.  By 2006 with mortgage losses soaring they stopped buying the crap being sold to them blessed with the highest of credit rating.  The bankers not ready to give up on the massive fees envisioned Plan A.  Under Plan A the bankers would continue to originate garbage loans and hide them away from their own shareholders and regulators through off balance sheet arrangements. Its as if those loans didn't exist.  The belief was that the investors would soon come around again and beg for more.

 

Plan B assumed at worst the Treasury would hand them a bail out and more importantly the Federal Reserve would buy off all those junk loans for stated not market value.  Plan A didn't work out so good but Plan B worked like a charm.

 

So where is all this going?  Unless Trump's tax plans really ups the ante on real economic activity and living wage jobs we could be back to adding another trillion plus to the debt.  At the end of the Obama era the deficit was just under $600 billion a year, down considerably from the $1.8 trillion in 2009. 

 

As long as the US can print money without loss of value of currency, or known as inflation, and maintains status as world's currency the game can continue.  No empire has ever been able to continually build debt and the US is trying to be the first.

 

As long as investors continue to buy collateral debt obligations (various types of consumer lending loans) and default rates don't roll off the charts Americans will continue to live on plastic and afford cars by repaying for them over years and years.  As 2008 exhibited even when a small amount of loans go into default all hell breaks lose.

 

The last part of debt is derivatives.  Derivatives are simply an insurance policy against losses, in this case the loss when borrowers do not repay loans.  Derivatives are unregulated and do not require insurers to hold a "reserve" against future losses.  The insurers can handle small numbers of losses from their cash flow. However, when we get into a situation like 2008 there again won't be enough to pay off lenders and investors that insured against credit losses.  Last time Uncle Sam (or really you) made all those insurance claims whole.  Currently there is approximately $1 quadrillion (that's $1,000,000,000,000,000) in outstanding derivatives.  If just 15% go bad that would be $150 trillion needed to pony up for losses.  The bail out of 2008 and 2009 in total was around $14 trillion so you get the picture.

 

If all of this looks like one big crash coming you would be right.  Debt only works when it gets repaid.  What kind of event we are looking at one day in the future at this point is unconceivable.  And it will be a total global fail.  Some of the mega super rich have bought and developed islands.  They will simply go off to their island with enough staff to harvest and maintain the island.  These mega rich won't be enjoying a lavish jet set lifestyle but they will be quite comfortable.  The rest of the world won't fare so much.  Not to mention the chaos might lead to world war, this time the major powers having nuclear weapons.

 

There is a condensed version and there is more too it, particularly as it comes to our debt based monetary system.  More to the point since the Federal Reserve was created the dollar has lost 95% of its purchasing power, and on purpose.  The gap has been debt and debt is profitable to the bankers, particularly when they have a backstop from you and me.

 

 

Comments

Kaushik Venkatasubramaniyan Added Feb 21, 2018 - 2:41pm
Japan's debt is to itself not to foreigners, it's a net creditor nation which is the reason for it's currency's demand in foreign exchange markets which in turn feeds back into it's stability
Tom C. Purcell Added Feb 21, 2018 - 2:42pm
The U.S. often seems like Israel's cash cow.  Once the milk stops, Zion will just have a feast.
 
George, great article.
Dino Manalis Added Feb 21, 2018 - 2:53pm
President Clinton credited deficit reduction for prosperity in the Nineties.  Trump has to push for careful gradual deficit and debt reduction and elimination without hurting the poor or the economy.  For example, federal assets have to be sold or leased, while early retirement should be gradually raised to 64.
Dave Volek Added Feb 21, 2018 - 3:00pm
Well written George. I believe there is a day of reckoning, but maybe the managers can stall the day for a decade or two. All they have to do is make us believe that money has value.
 
If we owe the debt to ourselves and pay interest to ourselves and then we default on ourselves, is it really debt in the first place?
Doug Plumb Added Feb 21, 2018 - 3:23pm
re "Since the US maintains its own currency it can make money appear out of thin air. "
 
The United States does not have any money. The money that it has is owned by the Federal Reserve, a private company and the Fed collects interest from every dollar in circulation. The Fed is in no way required to operate in the interest of the United States and can freely raise or lower interest rates. Its never been audited because the government doens't have the authority to audit it. "Auditing the Fed" is just a play for the news.
Politicians can borrow as much as they wish - the only obligation the Fed has to US government is to allow it to destroy itself.
The Fed was created to use up and destroy the United States. We forget that Talmudic law permits anything that the Jew wishes against the non Jew.
Now that almost all countries are under the control of a Jewish money system, there is no need to preserve the muscle that created this situation.
Its really getting late and time to wake up. The only way out is to call the law on the money and for everyone to see its not really money, but "war script" given to people in an occupied land.
Even A Broken Clock Added Feb 21, 2018 - 3:59pm
Anyone else have the vision of someone spinning bunches of plates on sticks, all the while with the Sabre Dance from Kachaturian playing in the background? The juggler keeps adding plates and sticks, and has to rush feverishly back and forth, applying more energy to keep the system going. Then, at some point in time, a dish is missed, and goes crashing down to the ground and starts a cascading failure with dish after dish falling from above.
 
That's the image of a debt laden society with reserve currency status trying desperately to keep the whole thing in the air.
Bill Kamps Added Feb 21, 2018 - 4:30pm
Debt only works when it gets repaid
 
George, this isnt necessarily true when it is sovereign debt.  As you correctly state, as long as countries and people buy our debt, we can continue to create money to pay our interest, and not have to pay down debt. 
 
Can this go on forever? well forever is a long time, as Yogi Berra would say.  Can it go on for a very long time, sure.   It could easily go on another 100 years or more.   Lots of variables here.
 
The reason people like the US debt, is because we are the best house in a not so great neighborhood.  Our debt is the best, because our economy is the most transparent, and most sound.  While China will attempt to dethrone us, and they may at the margins, their lack of transparency will mean people are always nervous about what they are being told.  Any country that builds cities without residents, as investments, has dubious fundamentals, certainly more dubious than ours. 
 
Can Russia dethrone us?  well Russia's economy is smaller than Italy's, so you might as well ask if Italy or South Korea could dethrone us, because those economies are larger than Russia's.
 
So MIGHT their be a crash in the US  debt, well anything is possible, but it is not likely in the near future.  Right now interest rates are still very low, which means  that people are lining up to buy our debt.  They are only now rising to what would be considered low levels.  An under 3.2% yield on the 30 bond, is very low. 
 
Until trade can be done in the Yuan, there really isnt much threat to the dollar, or the Euro for that matter.  Both of these are world currencies that can be exchanged in any bank in virtually any country that matters.  Until other currencies can be exchanged in many banks, those currencies cant be used for much trade.
George N Romey Added Feb 21, 2018 - 5:57pm
Well yes Bill.  What the federal government should do given this debt will never be repaid other than from issuance of new debt is simply print (or more precisely push a button) whatever funding between what is taken in and what is received.  Right now this is nothing more than a façade.
Katharine Otto Added Feb 21, 2018 - 6:17pm
George,
Good article.  Well written and understandable.  Thanks for writing it. 
 
There are several points related but beyond the scope of your article.  One is that China and other foreign countries are shunning US Treasuries.  Foreign purchases of US debt have fallen from six percent of GDP in 2009 to 0.9% in 2012.  Also, there are several countries that are trying o bypass the US dollar completely, including our most noteworthy enemies:  Iran, N. Korea, Venezuela, and to some extent Russia and China.  China and Russia are moving toward a gold-backed currency, which will make their currencies more valuable.
 
Gold purchases by central banks soared from 77 tons in 2010 to 437.7 tons in 2011. 
 
As other countries vie to buy oil in their own currencies, the petrodollar may lose its hold and its status as the world's reserve currency.  The market for dollars will fall, and that artificial market for dollars (so far necessary to buy OPEC oil) will collapse.  Not only will US dollars be cheaper, but there will be less perceived need to trade with the US as dollars won't be needed to buy oil.
 
I'm just an amateur so may be off-base in my assessments.  Fact is, the reason Nixon took us off the gold-conversion standard in 1971 was because US spending was out of control, and other countries wanted their promised gold before we ran out.  The world sees our out-of-control spending similarly now, I suspect, which is why other countries are looking for ways to bypass the dollar.
George N Romey Added Feb 21, 2018 - 6:50pm
Katharine you are correct and its the real reason behind a hostile attitude towards Russia, China and Iran.  All three have tired of US hegemony.
 
We've spent over $6 trillion in the Middle East since 2001.  Add in the trillions upon trillions wasted on endless wars and skirmishes since the Korean War and the military in general and over half of the debt would be gone. 
 
Part of the reason for abandoning the gold standard in 1971 is that the Federal Government needed to spend more than it could.  The Great Society, the Space Race and the MIC meant we needed deficit spending to the nines.  And with a fiat currency we got it.  In 1970s the US ruled supreme on the economic front with no close second.  Today we are still in the lead but China is on our heals, albeit they've got many of their own issues. 
opher goodwin Added Feb 21, 2018 - 6:56pm
George - Money is one of the fictions we buy into. What happens when people lose faith in it? Does civilisation collapse?
Doug Plumb Added Feb 21, 2018 - 7:00pm
re "If we owe the debt to ourselves and pay interest to ourselves and then we default on ourselves, is it really debt in the first place?  "
 
No debt exists. People ignoring the basic truths is the problem. There is no deficit.
Doug Plumb Added Feb 21, 2018 - 7:02pm
Opher, law and money are the same thing. The top court is the exchequer - the central bank. It has to be that way and there is no other way unless you want to be passing around counterfeit currency in an anarchy with no law to stop anyone from robbing you.
Doug Plumb Added Feb 21, 2018 - 7:25pm
@Katherine re " including our most noteworthy enemies:  Iran, N. Korea, Venezuela, and to some extent Russia and China. "
 
They are the enemies of our banks. They haven't done a thing to you or I.
Leroy Added Feb 21, 2018 - 11:41pm
Excellent article, George.
 
You can add state pensions to the list as well.  Where does it all end?  How will it ever unwind?  The bond market dwarfs the stock market.  It takes only a small change in interest rates to send the bond market reeling. Interest rates need to rise but, if they do, it will send the bond and stock market down.  We are hanging by a thread, it seems.
 
If every major country is printing money, is there that much risk to the dollar?  Everything is relative.  As Bill pointed out, the US economy is horrible, but it is better than all the rest.
 
I have zero concerns about China.  I know it has said that it will convert RMB into gold, but has it said at what rate and is that rate guaranteed?  I will convert your dollars into gold for a small fee.  I don't see the big deal.  Even if the rate is guaranteed, it means nothing.  There is no rule of law in China.  The One Road, One Belt initiative sounds like Make China Great Again by reliving the past.  The only way Europe is going to ship perishables by rail to China is via climate controlled rail cars.  At that rate, air freight is competitive.  What else does Europe have to offer other than cheese and wine? Oh, I forget--stroopwafels.  European branded cars are already being manufactured in China.
George N Romey Added Feb 22, 2018 - 12:39am
Leroy things are juiced up. Interest rates can’t be normalized. Consumers can’t spend from earnings. Supposedly there a big turn in the job market but we might be too far gone in debt.
Leroy Added Feb 22, 2018 - 2:04am
It makes sense to go into debt with today's low-interest rates.  Credit card debt is another matter.  All my cards have an astonishingly high-interest rate.  My wife doesn't understand why I can't just put things on a credit card.  I used them as a convenience, not the finance a lifestyle I can't afford.  I would rather get cash back.  If I could get a ten-year loan under three percent, I would certainly finance a car purchase.
Flying Junior Added Feb 22, 2018 - 2:51am
Today's low interest rates are mostly variable.  The prime rate goes up, that's how much your line of credit goes up.  Let me know if you can find a car loan for less than 4.99% or a fifteen-year fixed mortgage for less than 4.65% APR.  Even at 4% interest it is not a bright idea to incur debt.  I know.  The last time a bank officer tried to entice me into this trap I made a friend.  We both had to laugh.  People who fall for these credit traps are surprised when it becomes a burden just to pay the interest on as little as $30k in principal.  That said, if young people want to own a home, they take out a mortgage.
 
The thing that is about to happen is that interest rates are going straight up.  Through the roof.  It had to happen.  But with the monster in charge it is aggravated.  I would advise you to pay off any debt you have incurred as soon as you can.
Leroy Added Feb 22, 2018 - 3:12am
My fifteen year fixed mortgage is below three percent.  It may not be possible today and not again for the foreseeable future.   Seemed like a no-brainer to me.  It the market crashes, I might be screwed.  There's really no choice.  You can hide money under the mattress, then fifteen years from now, it is worth half or a third as much.  Put it in the bank and inflation will eat it up.  It's only marginally better than hiding it under the mattress.  There's really no choice.   Bonds are about the riskiest things you can buy right now.  The Chinese market will collapse.  The only thing saving it now is the suspension of trade for companies liable for margin calls.  That will depress the US market.  Hard gold wears a hole in my pocket.
Flying Junior Added Feb 22, 2018 - 3:16am
I wish you well.
 
Bury me with a twenty dollar gold piece in my pocket so the boys will know I died standing pat.
Thomas Sutrina Added Feb 22, 2018 - 8:46am
George the biggest difference today then in the past is that all nations have huge debts so their is no safe place to put your wealth.  The Great Depressions and the 2008 Depression happened because one player, in both cases the USA, made a mistake with their debt.   Debt is like a bunch of soap bubbles when one pops the all start popping.
Bill Kamps Added Feb 22, 2018 - 9:26am
While I would agree with George that the current situation is not healthy, that is very different from taking action assuming economic failure is imminent.  People have been predicting this kind of collapse for 50-60 years or more, and so if you put your money into gold in the 1980s, you would have suffered a very volatile ride and may easily have lost a lot of money waiting for the collapse.  This is particularly true given the opportunity costs you would have ignored.
 
So while  George may be correct that there will be a day of reckoning, WHEN that day will come makes all the difference.  If you plan your financial life around this day of reckoning, it could very well not happen within your lifetime.  Predicting something will happen "some day" and saying it will happen in 5 years are two very different things.  The Sun will explode some day, but probably not within our lifetimes, so no action needs to be taken.
 
This is not to put words in George's mouth that he is predicting when things will radically change. 
 
The message being, we shouldnt underestimate the ability of countries to continue with the status quo.  Money is just a means of barter, and its value relies on the system's faith not in the money itself, but the economies that  back the money.  People compare the US debt to GDP ratio to that of Greece, but which debt  would you rather own, US debt or Greek debt?  the answer is obvious. 
 
We think of debt as an obligation that must be repaid, because personal debt is that way, as well as state and local debt.  However, sovereign debt is not.  Sovereign debt  does not need to be repaid as long  as there is confidence in the issuing government.  When governments fail, like Venezuela or Argentina have, then no one wants that debt, and their interest skyrocket.  This sets off the negative spiral.
 
At the moment the US benefits from a virtuous circle.  People want US debt because the dollar is the trading currency for the world, and because it is the safest and most liquid place to park very large amounts of money.  It is difficult to change one part of this statement, without changing both parts simultaneously.  Locally other currencies are used, and can be used, but not globally.  So if you trade with Mexico you may keep some Pesos  on hand, but you dont want too many in case you need those  funds  to trade with Canada, in which case the Pesos are useless.  You want most of your money in dollars or euros. 
 
When people say the Russians, or Chinese are trying  to dethrone the dollar, they are partly correct and partly not.  They can use  other currencies on a limited basis, but they cant do just ANY international trade with those currencies.  Walk into a bank with some Yuan or Rubles, and see what they say, they wont give you dollars for them.  Do the same with Euros and you will see the difference. 
 
To be honest the dollar and economy were in much more danger in the late 1970s when inflation was out of hand.  We had 30 year treasuries yielding almost 20%, and gold was skyrocketing.  These are danger signs for the economy,  Even with those extremes, the economy pulled through.  Currently these danger signs dont exist, though they may  come back as we now are nearing the end of the deflationary cycle that has brought interest rates down for the past 40 years or so.
 
Dave Volek Added Feb 22, 2018 - 10:25am
Bill
Nice response.
The managers of the economy have more tools at their disposal than even the biggest corporations and banks. And somehow the world muddled its way out of 2008 when the logical response was a much bigger cascade of financial failures.
 
I can't say I understand how it works, but still something is not right in my mind. The day of reckoning might be soon or it might be two generations from now. I think it's best for average people to plan that it won't happen in their lifetime. If it does, then most of us will be living in a different world regardless of whether we saved for retirement or not. 
Pardero Added Feb 22, 2018 - 11:15am
I have concerns about the debt and am attracted to candidates that are fiscal hawks. Unfortunately, not enough people share my concerns or candidates like Rand Paul would have received more support.
Leroy Added Feb 22, 2018 - 11:21am
I remember in the early eighties discussing mortgage rates with a friend's father.  We were amazed that he had an 8.5% mortgage.  It seemed like a pipe dream to be able to afford a house.  The mortgage company was calling them trying to entice them to pay off the loans.  I had a car loan of 18%.  An 8.5% mortgage would make housing unaffordable for most people today, all things equal.  We have seen an explosion in home prices and square footage.  I believe this is due to low mortgage rates.  People live in bigger and nicer houses that in the early eighties.  If interest rates do head in that direction, Americans will have to reduce their expectations or take on more debt.  Anecdotal evidence suggests they will do the latter.  Judging from my extended family, most people only care whether or not they can afford the payment.  They don't care about the interest rate or the length of the loan.  I have one niece whose husband works as a security guard.  They bought a house that would seem to be well beyond their means.  Her sister, not to be outdone, bought a more expensive house.  He also works (worked) as a security guard in the same place.  I haven't asked, but I imagine that they are a  little worried, now that the cash cow project was shut down.   There's little opportunity to make that kind of money with their skill sets.
Dave Volek Added Feb 22, 2018 - 11:30am
Leroy
Yep, reducing expectations seems not to be an alternative many people consider.
 
My mother moved into an old folks home. She had a nice middle class house, and having done a few repairs over years for her, I knew it was in good shape and a good buy. My wife and I considered buying it from her. We could have just afforded the mortgage (after selling our townhouse). But it would have been obvious we would become slaves to the bigger mortgage. One little mishap in life, we would be in financial distress. So we stayed in the townhouse. Maybe someday we can afford a bigger place, but not now.
 
It's funny the western world does not think in this way.
 
Doug Plumb Added Feb 22, 2018 - 11:36am
re "People live in bigger and nicer houses that in the early eighties. "
 
TV shows nicer bigger houses with "average" folk living in them. This makes people feel inadequate. They aren't talking with their neighbors and aren't close to family. TV is their friend.
Most conversations are superficial and talking about your house is a nice superficial conversation. If you have more square footage then you are more respectable.
George N Romey Added Feb 22, 2018 - 12:17pm
Well that’s the issue, interest rates can never be normalized and the Fed can’t unwind it’s massive bond and Treasury holdings. The latter is horrible for savers and why the stock market is so juiced up. Along with the impact of HFT.
 
This could decades to unwind, it could take a few years or less. Lots of fault lines out there. And just like 1929 and 2008 the same type of characters will swear up and down all is well up to the day of the reckoning.
 
And to Bill yes interest rates were at 20% in the late 70s and very early 80s but we were far, far less dependent on debt.
Bill Kamps Added Feb 22, 2018 - 12:18pm
Dave in the end the economic system is held up by confidence, not by tangible things.  Money has no intrinsic value except that people will take it in return for goods and services. 
 
Debt is a serious thing when you are not a government, because you are not able to create new money.  Similarly with state and local governments.  However, with Federal governments debt becomes just another tool for managing  the economy.  As long as people line up to loan the US money at very low interest rates, it makes sense to give them debt. 
 
Everyone  who talks about the US  debt talks about paying it back. But that is not even a good idea.  If the US debt were paid off tomorrow, where would all these countries  and companies park their money?  Suddenly there would be $20 trillion in money that needs a place to go to earn interest, and that place doesnt exist.  US Treasuries exists to provide liquidity and equilibrium for the world economy.  There is not enough gold, silver or other instruments in the world to park the $20 trillion.   If US Treasuries disappeared the price of everything might skyrocket, because that $20 trillion will have to buy something, it wont vanish, it will be looking for a place to go.
 
US Treasuries are the most liquid place to put a country's, or company's money.  Hundreds of billions are traded every day, meaning there is always a buyer for your Treasuries and you dont have to worry about selling them at a discount to get rid of them. Imagine if your billions were in Mexican Pesos and you needed to sell them, who would buy them?  Only Mexico is a potential buyer and maybe they dont want them that day, then what?
 
 
 
 
 
 
George N Romey Added Feb 22, 2018 - 12:42pm
Of course the debt in whole can’t be repaid and it’s not the kind of debt people or companies take on. However, there are fault lines all over the world including the unthinkable amount of derivatives. What happens when something that begins overseas immediately shows up on Wall Street in the form of multiple trillions in derivative claims?
 
If we simply make the claims whole like we did in 2008 that could be tens of trillions in money that would need to be created out of thin air. Then what happens to the Federal debt? Notice I’ve not talked about unfunded liabilities that currently take the debt over $75 trillion.
 
Kaushik Venkatasubramaniyan Added Feb 22, 2018 - 12:47pm
Bill Kamps
 


Bill Kamps Added Feb 22, 2018 - 9:26am





At the moment the US benefits from a virtuous circle.  People want US debt because the dollar is the trading currency for the world, and because it is the safest and most liquid place to park very large amounts of money.  It is difficult to change one part of this statement, without changing both parts simultaneously.  Locally other currencies are used, and can be used, but not globally.  So if you trade with Mexico you may keep some Pesos  on hand, but you dont want too many in case you need those  funds  to trade with Canada, in which case the Pesos are useless.  You want most of your money in dollars or euros. 
 
 
Isn't that down to military supremacy? How long is that sustainable for? Isn't the fear of it being lost the cause for all the conflicts today?
Kaushik Venkatasubramaniyan Added Feb 22, 2018 - 12:50pm
Bill Kamps Added Feb 22, 2018 - 12:18pm



 
There is not enough gold, silver or other instruments in the world to park the $20 trillion.   If US Treasuries disappeared the price of everything might skyrocket, because that $20 trillion will have to buy something, it wont vanish, it will be looking for a place to go.
 
Isn't that simply suppressing true value of goods and gold? How long can that last..and is it even desirable?
Bill Kamps Added Feb 22, 2018 - 12:52pm
George, I would agree derivatives are a dangerous thing. In the early 2000s people SAID that investors knew what they were buying, when they bought derivatives they really didnt.  Worse they were rated incorrectly, which allowed them to be bought in place of treasuries and other less riskier instruments.  If the  derivatives are leveraged, and if they are rated incorrectly, then they become more dangerous.
 
A big part of the problem with derivatives is that they are so complicated they really CANT be rated correctly.  No one really knows if they are B+, or C- in rating, and these things matter a lot for the money they attract.  If you think you have a B+ rated security and it turns out to be a junk bond at C- then your whole risk model is wrong.  If it is C- and rated C- then all is fine because people will balance the risk.
 
Hopefully, while there are a lot of derivatives out there, people have diversified more so single entities are not so heavily weighted in them.  Hopefully also people are more skeptical of their ratings, since they are so difficult  to properly rate. 
Katharine Otto Added Feb 22, 2018 - 2:05pm
You have generated an interesting and informative thread, George.  Lots to think about here, but I do question some of the assertions.  For instance, there is an assumption that the Fed has all this power, but all it can do is fiddle with interest rates.  It can't actually create jobs or businesses, but only through its banks make the loans to businesses who do.  Yes, it can create money out of thin air, to finance government, but if it can't sell the bonds, the money is worthless.
 
Bill Kamps, the way I understand our debt-backed dollar, when debt is repaid, the money disappears.  It doesn't get re-spent.  So an enormous debt re-payment would shrink the money supply, not expand or even re-distribute it.  Therefore, it's not like a coin, or even paper money, that buys its value every time it changes hands.  If our (in the collective but not personal sense, Doug Plumb) enemies wanted to gang up against us, they could call for a massive sell-off of US treasuries and watch the Fed flounder.  That would reduce the national debt in a hurry, maybe.
 
Flying Junior, I don't see interest rates going up, simply because the Fed is having a hard time lending the money.  I don't believe the treasuries are selling fast enough to keep up with government spending, plus interest. That may be why the Fed is buying back its own treasuries.
 
The dollar and/or other currencies may collapse tomorrow or never.  In any case, it makes sense to stay out of debt.  When money gets scarce, for any reason, the debt stays the same.
George N Romey Added Feb 22, 2018 - 2:26pm
Bill my observation is that investors are lazy and cheap. They want someone else to do their due diligence and if at all possible for free. Investors still depend upon ratings from the 3 agencies. The same 3 agencies that keep out competition by buying off politicians. I know, in the late 90s I was involved with a company trying to break into the business. We were told no.
 
Assuming these investors are sufficiently diversified or know what they are doing is like assuming you can safely pet a rattlesnake.
 
Moreover, if there is a global fail outside of the US (China, Greece) it won’t matter if you are into commodities or condoms. The same thing was said about real estate, be diversified by region or even country. That strategy didn’t work so well.
 
What’s more concerning is the never ending build up of consumer debt. A loss rate of just 5% would send investors to the hills and banks bankrupt without the massive fee income. That is the real abyss facing us.
Kaushik Venkatasubramaniyan Added Feb 22, 2018 - 2:39pm
We can keep it going for a very long time. Remember Rome lasted 6 centuries
Doug Plumb Added Feb 22, 2018 - 3:56pm
re " For instance, there is an assumption that the Fed has all this power, but all it can do is fiddle with interest rates. "
 
It can collapse the economy overnight.
Doug Plumb Added Feb 22, 2018 - 3:58pm
re "The dollar and/or other currencies may collapse tomorrow or never.  In any case, it makes sense to stay out of debt.  When money gets scarce, for any reason, the debt stays the same. "
 
The debt still grows because it still wants interest. Also, scarce money can increase rates.
Cliff M. Added Feb 22, 2018 - 9:00pm
Just look at what is happening again.After the financial disaster which was supported by huge bailouts a different but similar bubble has been created. It worked out so well they are doing it again. Letting the highest bidder control fiscal policy is getting uglier by the minute.The owners of fiscal policy will attempt to clear the table which they pretty much have done already and continue to pillage and exploit until they are thrown out of power.
Katharine Otto Added Feb 23, 2018 - 11:19am
Doug,
You are right, about the debt accruing interest.  That's even more reason to stay out of debt, if you're an individual.  As for the government acquiring debt in my name, without my knowledge or consent, I feel no obligation to bail it out.  Unfortunately, I stand alone in this position.
 
Also, the "economy" is a Fed/government creation.  If the "economy" collapsed, it would render the Fed irrelevant, and maybe the government, too.
 
George,
I read recently that household debt is actually decreasing.  People burned in the 2008 meltdown have perhaps learned how dangerous debt can be.  I believe it was a NYT article that mentioned household debt has dropped from something like 110% of disposable income to 95% of disposable income.  How credible is the NYT?  I'm not sure that's a statistic, if true, that the bankers or government want us to know.
 
 
Bill Kamps Added Feb 23, 2018 - 11:33am
Bill Kamps, the way I understand our debt-backed dollar, when debt is repaid, the money disappears.  It doesn't get re-spent. 
 
Katherine, you are not really correct.  If you buy the Treasury bonds, or the Chinese government buys them, then when they are paid off, you get money in your hand that you can go spend on something else.  The money does not vanish.  Someone is buying these bonds with real money.  We pay those bondholders interest, and then when the bond term is up they get paid. 
 
Now if the buyer of the bonds is the Federal Reserve, then yes it is more of a funny money kind of thing.  But of the $20 trillion in debt that the US has out, only about $3 trillion of that is held by the Federal Reserve.  The rest was bought with real money by real people or countries. 
 
If our enemies wanted to gang up against us, they could call for a massive sell-off of US treasuries and watch the Fed flounder.
 
People cant "call for" a massive sell off of Treasuries.  The Chinese could decide to SELL their Treasuries, but then the question becomes what do they do with that money?   They have to put it into something, what something?   They have CHOSEN to put their money in Treasuries not because they like the US, or are supporting our government, they put the money there because in their opinion it is the safest place to put it.
 
 
 
Bill Kamps Added Feb 23, 2018 - 11:52am
Kaushik,  I think of Treasuries and other financial instruments are providing liquidity for trade.  If we didnt have money, we would still be trading goats, and that is pretty clumsy to ship 1000s of goats to pay someone for a shipload of grain. 
 
So we have money.  We next have the problem that every country has its OWN money.  So how do we trade in the world?   Everyone could keep a pile of every country's money, and use that to trade with those countries.  However, that also is very clumsy. Currencies change in value a lot, some countries trade with a lot of other countries, some trade with only a few.  Some governments are more stable than others, and on and on.
 
Better to have a few currencies, the most trusted currencies that most banks will accept, and those can be used to trade with.
 
Currently those currencies are the Euro and the Dollar.  At  one point it history it was the Pound Sterling because in those days the UK dominated world trade, an was the strongest and most stable government.
 
If Mexico wants to buy something from India, they change Pesos and Rupees into dollars or eeuros and do the deal.  India does not want a pile of Pesos, and the Mexicans dont want the Rupees.  Both happily will take euros and dollars because everyone  else will take them.
 
No  one really chooses which currency to use, it is a matter of convenience and trust.  People want to use a currency where the government is stable, where there is transparency, and where the economy is large enough to support a large amount of currency in circulation.  So while the Swiss Franc is stable, there arent enough of Francs to run world trade.  The Euro was created partly to achieve the critical mass needed to make it a world trade able currency.  While there is a lot wrong with the EU, the Euro as a currency has been a success.  I can walk into a bank in the US with a stack of Euros, and they will happily take them and give me dollars, people can wire my bank Euros, and my  bank will give me dollars.  Most other currencies  wont work that way.
 
People buy Treasuries because they are a very liquid and very safe place to park money.   No interest payment has ever been missed, and no bond on expiration has ever not been paid off.  That is what the buyers of bonds care about.  They also care that the US government is stable, that it cant easily be overthrown, and that even if a nutcase gets elected to President, the Constitution will stay in place and the  country will stay much the same. 
Bill Kamps Added Feb 23, 2018 - 12:06pm
George, our fundamental disagreement comes from that you think the US financial economy will fail.  If some banks are too big to fail, then so are countries.  Not all countries though.  If Greece fails, it wont set off a chain reaction, because not that many people own Greek debt.  That is why Germany had to step up to help them, because Europe were the big owners of Greek debt.  The US didnt give a shit, it would not destabilize the world economy. The Greek economy is smaller than Harris County Texas, and no one will care if some Harris County bonds fail, other than the bond holders.
 
China is too big to fail, and so is the US.  People will step in and help to right the  ship, as was done in 2008.  
 
The only way I see things failing is if a SERIES of miscalculations happen. It is possible but not likely.   For example, letting Lehman Bros fail, I think was a miscalculation because it called into question what ELSE would be allowed to fail.  Morality, and law breaking aside.  People worried if Lehman could fail, would Citibank fail? or Bank of America?  then there would be serious problems.  Letting Lehman fail set off a bit of a panic.  Had they let a few others fail, then YES the world economy would have had serious problems and would have spiraled down more than it did.
 
The world economy is not propped up with fundamentals, in the sense the money is really worth anything.  So doing balance sheet analysis doesnt make a lot of sense, no balance sheet looks good from that point of view.   The world economy is propped up with trust and faith.  Faith that people will give you something for that money, because in the end that money is just paper or entries on a computer somewhere.  If the faith and trust gets destroyed, then the economy gets destroyed.
Katharine Otto Added Feb 23, 2018 - 12:12pm
Bill,
You're right that cashing treasuries in generates real dollars that the seller can spend.  What I meant was that the Fed doesn't automatically re-sell the same Treasury.  That particular issuance disappears.
 
When I suggest a massive sell-off of Treasuries, I don't claim that anyone can arbitrate that.  It's like a boycott.  It would be voluntary.  As soon as Putin came to power in Russia, he began to de-dollarize.  Russia now has the least amount of debt denominated in dollars, and it prohibits dollars in Russian seaports.
 
The dollar has a predominant role in the IMF foreign exchange reserves, since 1981.  However, the yuan has recently been included in the SDR with an initial share of 10%.  The US has 40%, Euro 31% and yen is 8.3%.  
 
In Iran, sanctions have forced it to bypass the dollar.  Since Europe has removed sanctions, Iran now trades in Euros.
Kaushik Venkatasubramaniyan Added Feb 23, 2018 - 12:21pm
Katherine,
 
The overthrow of Saddam Hussein and Mummar Ghadaffi was about snuffing out any challenge to the US$'s standing the predominant Reserve Currency. Saddam had switched to trading his oil in €€ and Gadhaffi had started planning for a Gold backed African Dinar which given Africa and Middle East's abundance in oil could have set off a chain reaction against the US$
 
Fiat currency causes war..every time unless we use a basket of currencies with no discernible dominant Reserve Currency
 
 
 
Bill Kamps Added Feb 23, 2018 - 12:30pm
When I suggest a massive sell-off of Treasuries, I don't claim that anyone can arbitrate that.  It's like a boycott.  It would be voluntary.  As soon as Putin came to power in Russia, he began to de-dollarize. 
 
Yes a sell off is possible, but not likely.  First Russia has an economy the size of Italy.  Would you care if Italy boycotted the dollar? no a lot.   Even so Russia will still happily convert your dollars to Rubles. 
 
One of the particular problems that Putin had was that during Soviet times the Russians, kept a lot of their wealth in dollars stuffed in mattresses, literally.  At one point more $100 bills were in Russia than were in the USA.  When I went to Soviet Russia I never converted currency because you could buy anything with a dollar.  Now you need to convert.  So Putin had to get those dollars converted that all these people had. 
 
Iran also, not a very big country.  Euros are used in trade, as widely as dollars though not as often.
 
People hold dollars in their own self interest not because they  like us.   China has 90% of their reserve currency in dollars, and this probably doesnt make sense from a diversification point of view.  So countries will make adjustments. 
 
However, the yuan has recently been included in the SDR with an initial share of 10%.  The US has 40%, Euro 31% and yen is 8.3%.  
 
Purely from a practical point of view this makes sense.  China has a third of the world's people, they should have a seat at the table. PLUS making their currency more widely used will slow their ability to manipulate it, and devalue it for trading advantage.  People holding Yuans wont want them devalued.  This helps China's trading partners, which are many countries. 
 
The world economy may not rest on bedrock, but it stays stable because people want a system based on currencies to work, not because these currencies have intrinsic value, they dont.  The economies that stand behind the currencies have value, our Constitution that gives us relative stability has value, paper money not so  much.
 
George N Romey Added Feb 23, 2018 - 12:32pm
Katharine that is due to fewer mortgages being issued. Rent is not included in debt percentages. All other types of debt are rising.
 
Bill China is directing more of its surplus into its own development. The Chinese President wants to create a middle class and that takes $$$$.
Kaushik Venkatasubramaniyan Added Feb 23, 2018 - 12:37pm
Bill..
 
China has a third of the world's people, they should have a seat at the table
 
No. China has 1.5 Billion people out of a total world population of 7 billion so it's proportion is less than a quarter while the Indian sub-continent for example has 1.75 billion people (incl India, Pakistan, Bangladesh) which is a quarter of the world's population. 
 
I guess what you mean is their share of World Trade which is much higher than the Indian sub-continent.
Bill Kamps Added Feb 23, 2018 - 12:43pm
Kausik, yes I mispoke about the percentage, it is more like 20%.
 
You are correct, what is more important is China's share of world trade, which has grown a lot over the past few decades.  
 
All things being equal, countries with large populations like China and India should be large players in world trade.  So we should not be surprised that China's economic power has risen.  It would also be not  be surprising if over the next decades something similar happens in India. 
 
 
 
 
Bill Kamps Added Feb 23, 2018 - 12:44pm
Bill China is directing more of its surplus into its own development. The Chinese President wants to create a middle class and that takes $$$$.
 
Makes perfect sense they do this.  I think it is a good thing. 
George N Romey Added Feb 23, 2018 - 1:05pm
Yes for them it is. They’ve invited us in but Congress is a no go. I wonder why (snark)?
Bill Kamps Added Feb 23, 2018 - 1:26pm
George, in general it is a good thing if the world wide middle class grows.  Are there issues with China yes  of course as there are with lots of countries.  But it doesnt mean their growing middle class is a bad thing.

Recent Articles by Writers George N Romey follows.