Is There Any Way Out from the Burden of Government Debt?

Summary:  One in a series of thought-starters about this era, the end of the post-WWII era.  A harsh but accurate analysis of the lust for savings and austerity that has — too late — gripped the West.  And a pessimistic forecast.

Excerpt from Global Macro Investor, Raoul Pal (an A-team hedge fund manager), June 2010:

Budget Deficits — missing the big picture

All this nonsense about focusing in  on bringing down budget deficits is just trying to stick a plaster on a mortal head wound.  There is simply no room for another recession.  If there is a recession, which I think is highly likely, then the deficits will explode further and it’s game over because there are no monetary policy tools available except for the highly unproven QE {qualitative easing}, and not enough creditors to buy the debt.  Sovereign default, here we come.

Austerity measure will insure default

The second major problem with the IMF method is that it imposes austerity measures on the country in question to rein in spending and increase tax collection.  On paper it sounds great but it is hopelessly idiotic.  The problem is private sector debt, and an austerity package will just mean that the private sector will definitely bow under the weight of taxes and lower spending, and government will have to bail them out.  Sovereign default, here we come.

No way out

So what’s the way out?  Err, there ain’t one.  It’s game over.

Pal is über-brilliant, but this is excessively pessimistic (IMO).

First, economic impacts are largely a function of the rate of change.  Working off the excess total (private plus public) debt over a generation would be painful.  Debt deflation over ten years might be terminal for western governments (but not our societies).

Second, monetization of the debt (sustained qualitative easing) is untried but theoretically possible.  Monetization of debt has almost no immediate consequences during a recession, where there is surplus labor and industrial capacity.  The severe hangover — inflation — comes during only during the recovery.  It’s the price of successfully managing to work off excess debt.  In theory the only limitations on the ability of government’s to monetize debt is doing so to the point where:

  • the currency collapses (more likely when a nation relies on foreign funding, like the USA), or
  • social cohesion implodes, and the government can not internally fund the debt.

In this, as in so many things, social cohesion is the key factor.  Domestic debts are a zero-sum factor within a society.  The problems result from the unequal distribution of debt and wealth, encouraging people to see themselves as winners or losers independent of the overall national success.  That’s usually a delusion, one that leads to disaster only over a few generations.  Our Latin American brothers proved this beyond any doubt during the 20th century.   “Rich as an Argentinian” they used to say; nobody says that today.  Class warfare is lethal, which is why Solon the Lawmaker is the true founder of Athens’s greatness.

For more about this see this FM reference page:  Financial crisis – what’s happening? how will this end?


Originally published at Fabius Maximus and reproduced here with the author’s permission.

One Response to "Is There Any Way Out from the Burden of Government Debt?"

  1. CHRIS DAVIS   June 12, 2010 at 4:49 am

    Anyone that believes $100000/yr pensions granted to fifty-year-old teachers in California or policemen in New York or lazy Greek bureaucrats will be paid in current dollars/Euros is simply dreaming:the money isn’t there/wasn’t there/won’t be there. At the same time,who should trust in the integrity of a currency or bonds of a country that can’t even regulate something as basic as residential mortgages?The only bet is whether panic concerning potential defaults causing a deflationary collapse precedes the inevitable inflation required to dilute the overhang of debt.