Ignoble Deficits And The $33 Trillion Global Government Debt Bubble?

``Let us be clear, the Dow rally is not squaring Obama's economic circle. His policy of big government is — at best — guaranteed to retard economic growth. The bigger the government the more resources it commands and the more resources it commands the fewer resources there are for capital accumulation. Even without the suffocating effects of increased regulation the increased demand for resources will in itself reduce the amount of entrepreneurial activities. And it is entrepreneurship that drives economic growth while savings fuel it. Obama's policy — deliberate or not — is one of severely curtailing both. Gerard Jackson Dark clouds hover over US economy

It must be an uncanny feeling for an incumbent President to warn on unsustainable deficit spending when the present surge in deficits has been a product of no LESS than HIS own doing see figure 3.

So from our end, such moralizing looks very much like chutzpah more than a sincere declaration to curb profligate spending.

Figure 4: Heritage Foundation: Change We Believe In-Exploding Deficits

But rhetoric aside, we understand that action speaks louder than words.

And where the US government seems to have opted for an inflationary path, underpinned by a political structure increasingly becoming dependent on an inflationary mechanism, inflationary dynamics tells us that policies will be directed towards achieving such end.

Hence what the government wishes for, is what we most likely will end up with-i.e. to the extreme ends. This is the fundamental bubble character of inflationary dynamics.

Remember, mainstream economists and policymakers favor rising prices over falling prices. The former is equated with “growth” while the latter is construed as a dreaded menace. Hence, the embedded inflationary mindset of policymakers, supported by the coterie of experts, requires policies that can engender an accelerating pace of monetary inflation to keep prices continually rising in order to create the illusion of prosperity.

And as Ludwig von Mises wrote in his magnum opus Human Action chapter 20 section 6, ``The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.”

Hence, like the Ponzi finance operating in a pyramiding framework, inflation begets accelerated inflation to maintain a trajectory of surging prices, until of course, like the previous bubble based on US housing industry which had been financed by mortgage securities and the subsequent alchemy of designer structured finance products, everything screeches to a halt-out of the unsustainable nature of such debt driven policies.

Political Goals and Present Administrative Requirements Don’t Match

The current deficit spending isn’t only a US phenomenon, it has been global. That means much of the world has been frontloading expenditures through governments to replace “lost demand”, in the hope that their respective economies will see a normalization of growth trends from which should enable them to pay off these liabilities overtime.

According to analyst Satyayit Das, `` In 2009, governments around the world will have to issue US$3 trillion in debt. The US alone will need to issue around US$ 2 trillion in bonds (a staggering US$40 billion a week!). This compares to around US$400-500 billion of annual debt that the US has issued in recent years. This debt must be issued at record low interest rates.” (bold highlights mine)

In other words, two thirds of the world government financing for 2009 will emanate from the US. And present policies to compress interest rates haven’t been merely for mortgage refinancing but also to enable the US to secure low interest rate debts.

Yet in the past, Asians through China and Japan because of the huge accumulated surpluses had been the biggest buyer of US sovereign debts. Asian economies virtually stockpiled on US treasuries for political ends- to keep their currencies competitive for export purposes.

Foreign ownership of all US treasury issuance comprise some 28% according to Wikipedia.org see figure 5.

Figure 5: Wikipedia.org: Ownership Profile of all US Treasuries

Japan and China owns about 45% of the treasury portfolio held by foreign and international investors.

Since Japan and China has undertaken even more intensive government stimulus efforts as shown earlier, this trend doesn’t guarantee a repeat of the same dynamics where savings rich Asian governments will continue to recycle their surpluses on US treasuries.

This implies that the deficit spending of the US government will have to be funded by local (household and corporate) savings.

Yet, this places the US government at a dire predicament or its policies at a crossroad-the policy thrust has been to promote borrowing and spending (or less private sector savings) at a time when government requires the same savings to finance its deficits! So policy goals and present administrative requirements don’t match.

So if there will be a lack of financing from abroad and equally insufficient source of financing from local savers then the US government will most likely have to print its needs away!

$33 trillion worth of Global Government Debt Bubble?

Moreover, one analyst, Neil Jensen of Absolute Partners suggests that the financing needs of the world could have been understated see Figure 6.

Figure 6: Absolute Partners/safehaven.com: $33 Trillion question

Mr. Jensen who uses the research work of Harvard Professors Carmen Reinhart and Kenneth Rogoff on previous banking crisis as benchmark for his own work, says ``The true cost is important, because it has to be financed through new bond issuance, and it is my thesis that the sheer size of this tsunami will eventually overwhelm the world's bond markets...Using the official IMF estimates, the twelve most industrialised of the world's G20 countries (in my book known as the Dirty Dozen) will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis.”

``However, if you (like me) believe that IMF underestimates the true cost of this crisis, Reinhart and Rogoff offer a more realistic approach. Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn't even bother to produce a worst case scenario - it all got too depressing!”

So reverting to basics, we go by Dr. John Hussman’s definition of inflation (bold highlight mine) ``Inflation is not driven by monetary expansion per se, but by growth of government spending, regardless of how it is financed. Inflation basically measures the percentage change in the ratio of two “marginal utilities”: the marginal utility of real goods and services divided by the marginal utility (mostly for portfolio and transactions purposes) of government liabilities. [the torrent of bond issuance in the above example-my comment] Think ice cream cones – the first one has a very high marginal utility, but the second one you eat has a little less, and so on. So increased supply tends to depress marginal utility, while scarcity raises it.”

So it is not deflation we should be worried about but massive inflation!