Debt Crisis 101

Lets imagine a 18 yr old rich college kid. His parents have tons of money, they send him to an Ivy league college with a credit card. He spends his college years buying everything he wants, big screen tv’s, nice furniture and having big parties and his parents pay for all of it, no questions asked.

4 years later, he graduates college and becomes some apprentice lawyer, not making much money at the beginning. He has his own credit card now, and is on his own. What do you think his spending habits are going to be like? I think we all realise that most young kids would continue their spending habits as before, and rack up a bit of debt. Hell, adults do it now; its called ‘Keeping up with the Jones’. So our college kid racks up a bit of debt, and because he wants to seem independent and wants to show his parents he can take care of himself without their help, so he makes the minimum payments each month.

Now after a payment or two, he might think his debts are under control and that he’s proved to his parents that he’s financially capable. Then goes on another spending spree to celebrate. Same process, he might make the minimum payments again, or get a second credit card and pay off the first credit card. Rinse and repeat. Eventually, his initial debts which are accruing interest each month, will no longer be affordable and he won’t be able to make those minimum payments, or he might not be able to get a third credit card due to bad credit. He is not yet making enough money and might not for a year or two, but he’s confident that one day he will so there’s no immediate problem. Imagine that…

Now look at American and European governments, and ask yourself what’s different. Seriously, there is very little difference in how the way fiscal responsibility works. In order to lend to governments, investors which are usually other countries, central banks or big institutional investors need some assurance they can get their capital back with interest also. If there is no assurance, people will stop lending to them.

The credit crisis was of course, the precursor to this debt crisis. As during the credit crisis, all that toxic debt carried by private companies (debt which was subsided by government) was going to sink these too big too fail companies, so the governments just bought it all up and carried it onto their books, increasing their debt portfolio dramatically.

But, these countries governments were swimming in debt to begin with and already running deficits every month and every year, and of course paying the minimum repayments on their interest and paying off existing debt with new debt. At the previous levels however, it was manageable and there was no cause for immediate concern. Then started all the constant stimulus and bailouts, the governments continued to accrue ever more debt. When they couldn’t sell enough debt, they just printed it. Even money printed out of nowhere is loaned at interest from a private central bank to its government. Right now at the fed, between 0 – 0.25% and in the EU, at 1.5% and that extra money inflates the currency robbing people who save their money of purchasing power.

So with all this extra debt streaming in, the already running deficits that governments are running and you begin to see how similar it is to that college kid. Eventually, they will not be able to repay even the minimum repayments and then what happens?

This moment is happening soon. Japan is at 200% debt to GDP ratio, the USA is around 100% and climbing each month, some of the European ratios are over 100%. What’s going to happen when these governments can’t pay back their debt? That will be a major strike in the confidence of the global economic system, where trillions of dollars of government debt are held around the world in pensions and other benefits.

Trillions upon trillions of dollars are invested in these government debt traps, and the global economy is going to sink. That capital needs somewhere to go, and when it doesn’t have any place, bad things are going to happen, and a lot of it will disappear.

I’m sure that politicians know this, they have legions of economists and other smart people working for them, there is no way for them not to know. Yet, because the Global financial system is based on confidence, no politician can tackle any of these problems for the following reasons:

Reason 1:

They will immediately be voted out of office by an electorate that refuses cuts. People know cuts have to be made, but no one can touch their entitlements, so of course nothing gets cut. There goes the myth of politicians being public servants. The majority are in it for themselves and nothing more.

Reason 2:

Their comrades won’t support them for fear of their electorate voting them out of office. Again, politicians are self-serving.

Reason 3:

The global economy, and all the stock markets in it is based on confidence. A company can have great financials , P/E and other good financial indicators but still have a poor stock price, or it can be the other way around. Think Enron, Lehman brothers before they collapsed. Stock earnings and prices are based on future expected growth, so today matters less than tomorrow. The same goes on an international basis and for fiat currencies. The value of a dollar today is based on future value it can bring, and next years expected tax revenue to repay that borrowed dollar with a wee bit of interest.

I think this exposes a fundamental flaw in fiat currencies, confidence is essentially a zero sum game. There are very few things that we can remain confident in being consistent over a long span of time. The moon, sun and stars, coming and goings of the seasons, our need of food and water, and the resources that power our civilisations. What else can you say with absolute confidence will be around for all time?

So when confidence disappears, and the biggest economies are unable to borrow enough money to fund themselves and their entitlement programs, what’s going to happen? I’m not looking forward to that day. Look what happened in 2008. Lehman Brothers, which insures America’s mortgages, went belly up. The global economy was bought to its knees, because all the fancy shmancy derivative packages they sold couldn’t cover the payouts when growth in the housing market stopped. The governments picked up all that debt, so what happens when the government stops being able to absorb that toxic debt, as they call it. The stock markets are going to tank everywhere. Even though stock markets aren’t a real world functional aspect of economies, and they are casino’s basically that are better traversed with human psychology than P / E and other financial jargon, they represent everything on the economic stage.

Politicians have shown us repeatedly that they will do everything to keep the status quo going. History is full of examples. Thus, we can almost be assured that no course of action will be taken to prevent until its too late to do anything, not that they have many options at this point, short of politician genocide.

At the end of the day though, it’s not the government’s fault alone. while they bear some of the blame in this circle of madness. We are equally to blame for allowing them to do as they please. The way our democracies are structured, it’s a recipe for corruption and disaster. Politicians are an extension of the society which they represent. They are paid too much, get freebies others slave for, are put on a pedestal, are allowed to receive bribes in the form of lobbying and are rewarded by the masses for saying what they want to hear, instead of the hard truth they should hear. Thus at the end of the day, the types of people who are attracted to these positions tend to more leeches than public servants, tend to paint rosy pictures where there aren’t any roses and aren’t afraid to lie for the perceived ‘public good’.

All lies eventually come out, it is inevitable. Lying for the sake of short them stability forsakes the longer term viewpoint. This is what our civilisation is transforming into. Short term capitalism, never thinking more than a quarter or two ahead. Long term economics be damned. Such a shame.

9 comments

    1. Thanks a lot! Don’t forget, that you can sign up for email updates in the top right, so when I publish a new post, you’ll get it immediately.

  1. Simply wish to say your article is as amazing. The clearness in your post is just nice and i could assume youre an expert on this subject. Well with your permission let me to grab your RSS feed to keep updated with forthcoming post. Thanks a million and please keep up the rewarding work.
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    1. Thank you very much. It makes me happy that people like my work. I’m not an expert, I just read a lot. Thanks for the compliment anyway though 🙂 Feel free to take the RSS, or sign up for email updates. Whichever is easier for you.

      Merci beaucoup.

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