Wednesday, April 21, 2010

The Corrosive Nature of Debt

Let's assume that our government, federal, state and local has an income of $5 trillion. This is equal to a third of our federal Gross Domestic Product. While their income is $5 trillion they have outstanding liabilities of maybe $100 trillion in stated and unstated debt. So our government is leveraged 20-1 above their income level. This is a government created liability that is directly owed by the taxpayers of our nation.

This includes the stated debt of federal, state and local entities of perhaps $20 trillion and their unstated promises of maybe $80 trillion. If you don't agree with the numbers then what are they? This is my point. No one knows and no one seems to care.

But we know that our government holds an extreme amount of debt and is desperate to borrow much much more. So as our government borrows more money to increase the debt to taxpayers, what is the expectation?

Common sense tells us that there are 3 and only 3 outcomes that can happen when an entity borrows money:

  • You can borrow money with the expectation of paying off interest and principle in the future. This debt would be used to amplify investment gains with the expectation that principle and interest will be paid back in the future with investment gains. This is called "speculation". An investor is making a bet on the future. It is a win or lose proposition.

  • You can borrow money with the expectation of only paying interest in the future. This is immediate gratification. Mortgaging your future to live better in the present is "debt servitude". Historically, "debt servitude" has been used by the more financially incompetent members of a society.
  • You can borrow money with the expectation of never paying the principle or interest off in the future. The is called "fraud". It is robbing present resources from others to pay for your excesses in the present.

So there are only 3 expectations when someone borrows money: Speculation, Debt Servitude or Fraud. You can either plan on paying all of the money back, or just the interest or nothing.

The type of debt depends on one's motive. Every society has many examples of each type of debt.

The first type of debt is speculation. Most people borrow money to make a single bet. And they have high hopes that this bet will be a winner. Our government has made bets in the past. They borrowed money to pay for World War II, the interstate highway system and putting a man on the moon. These investments have been winners. The speculation by our government was a good bet.

The second type of debt is normally created from the first type of debt. A speculator will win some bets and then they become comfortable speculating with future resources. This is called , "gaming the system". This gambling will become a habit. Then instead of the risk being one roll of the dice, it becomes a continuous recurring daily event that actually becomes a risk payment instead of a bet. This is "debt servitude". It's more of a drug than a bet. One individual is choosing to rob resources from their immediate future to give all of their future gains to another. It doesn't really make economic sense for anyone to live this way. It is just the immediate gratification from the drug of debt.

Unless you are a criminal, the third and last level of debt morphs out of the second level. As you game the system more and more then the drug of debt becomes a compulsion. Your risk payments will increase to the point were you can't make your interest payment out of current income. You choose to start paying the interest payment with more debt. This level is unsustainable. Our government and most of our households with a mortgage are at this level. The drug of debt has created a nation of junkies and dealers with our government being the biggest junkie of them all.

A whole science has emerged to explain how insurmountable debt is a good thing for our nation. Economists tell us that debt is presently no problem because we can make it go away with "magic inflation". So they are saying that we can get ourselves into "debt servitude" as long as at a later date we are able to make it go away with "fraud". The Economists also explain to the government how hiding debt off their balance sheet is a good idea and allows them to borrow more to buy more of the debt drug. So no one has any idea of how large the debt is.

We are misstating our debt so no one knows how much we hold. We are presently in a situation where we need to borrow money just to pay the interest on the loan so our nation has started a Ponzi scheme. And the game plan of our politicians is to keep the deceit going until we can create the "magic inflation" that will bring our nation back to the old "debt servitude" from our present period of "fraud". So we will use fraud to extricate ourselves from fraud. We are thinking just like a junkie.

It is beyond all reason, logic and math but in our country's drug induced state it makes all the sense in the world.

But I can tell you for a fact that "junkie economics" will not work. It has never worked in the thousands of times political tyrants have tried it in the past and it won't work now. First our country will hit the debt wall where the market will force us to slow down our creation of debt. This will collapse asset prices. Then interest rates will rise and collapse asset prices even more. Then we will have the magic inflation that will inflate us out of debt but it will only inflate our asset prices up to the values they were before. We are thinking exactly like a junkie. Avoiding pain now for a higher level in the future.

"Junkie economics" doesn't work for political tyrants any more than it works on the street.

Our plight compares perfectly with that of a junkie. We are now giving away trillions of dollars to the debt dealers in our financial sector for just another hit of the debt crack pipe. The money has been stolen as happens with all hard core junkies. Our nation is stealing money from our kids.

We are creating untenable debt in our children's name to be paid back at very high interest rates to hostile foreign nations. I am not even sure that a homeless crack smoking wino on the street in Washington DC would do something like this to his children.

But each day our government officials must create more of this unsustainable third level of debt so our nation can get one more hit of speculation from it's drug of choice. It is unconscionable and illogical but it happens thousands of times a day on the streets of every major city. But like I said before, I believe very few junkies would make the choice to sell their children's future into debt servitude to their enemies. As a country we have found ourselves at a lower level of morality than the junkie on the street.

How do we get out of this mess? Well I would suggest that the first step would be to look in the mirror and see the mess we are in. How does a government borrow 20 times their yearly income? And then lie and say that some of it doesn't exist. How can we say that the obligation of Social Security, or Medicare or the Pension Guarantee Corporation or a thousand other state and local obligations doesn't exist? Why would a government do such a thing?

It's time to look in the mirror and to make some hard choices. We have lived the last 20 years on debt and it could take 40 years of onerous payments to get back to the same standard of living that we had in the 1980's. This would be the choice to end the debt servitude.

Now try to focus and think about what it was like to live 30 years ago. Only one member of the household had to work. Health care and housing were very affordable. Our financial sector was much smaller and our education system was top notch. We had a solid middle class. Our currency was sound and our nation was strong. Our country had one third of the debt load that we currently carry and we were able to record it honestly. Our government and our financial sector didn't have to use Enron style accounting to misstate their debt. We absolutely had a higher standard of living because we weren't in "debt servitude".

But we have borrowed and borrowed and then borrowed some more to speculate as the bets have become more and more absurd. Then 20 years ago we started to borrow larger amounts of money to service the debt. We have borrowed so much that we must lie to ourselves about our debt load. We can't even look ourselves in the mirror anymore. Today our government, our financial sector and our households with a mortgage must commit "fraud" just to service the debt. Mathematics tells us that this will get worse as interest rates go higher.

Anyone that says we are better off today than 30 years ago must be a junkie or a Wall Street economist. And here I must apologise to the junkie for the comparison.

Even if we choose to live forever in our present debt servitude then we will still have to slow down debt creation from present levels. This will lock all future generations into a lower standard of living than we have now. That standard of living will get lower and lower as interest rates rise. It's simple accounting math and basic logic but it is far beyond what the economists at the Federal Reserve can possibly understand in their drug induced state.

So we are still at a juncture where we can choose a sustainable path. Hard work could make our country strong again. But what are the odds that a drug crazed junkie could do anything but beg for their next fix.

Our country will find out that debt addiction is exactly like drug addiction. It brings forth insurmountable choices, each with very bad outcomes. Our choices will probably be made for us as hostile foreign nations put us farther and farther into debt servitude.

Presently we are selling our children into debt servitude to China and The Middle East for more of the debt drug. The funny part is that this debt servitude will be just the start as we continue to sell off all of the priceless gifts that were given to us by our forefathers. Sound currency, sound government and finally our basic freedom. All of these cherished heirlooms lost for one more hit on the crack pipe of debt.

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