By Karl Arnold Belser
21 April 2015

The central banks in many countries are assuming a large amount of debt in order to stimulate their economies. I discussed this issue in my post Minsky Moment and Secular Stagnation. I want to discuss possible outcomes in this post, and i admit that I am motivated by an article by john Mauldin in his Thoughts from the Front Line titled Half a Bubble Off of Dead Center.

I stated in my Minsky Moment post that the Quantitative Easing (QE) in which the government prints money and takes on debt to cover the liability of the new money, has helped the United States mitigate the economic downturn cause by excessive real estate lending to unqualified buyers.  

I also noted that the recovery has not been particularly strong, and I believe that the underlying issue is lack of demand due to secular stagnation. The central banks cannot create demand.

The question is: Are the governments of the world going to be able to pay back the debt? If not, what happens?

John Mauldin has addressed this issue in several books and in his news letters, to the point that he has cried wolf too often, which is how I interpret his remarks.  John has invested in gold as a hedge against inflation and rented when he should have bought a house.
However, I don't believe that his warnings are false. I just think they are early, and in investing being early is the same as being wrong.

John, in the above article, introduces the idea of a singularity, or in other words and irrevocable collapse. This is true pessimism because what might, in fact, happen is a Minsky Moment, which is a psychological tipping point in which borrowers become unwilling to buy debt because they realize that it will never be repaid. The issue becomes "return of money" rather than "return on money"'.

I am more worried about the fact that debt that is not invested profitably, that is, in a way that will result in the debt being paid off is simply consumption brought forward. Consumption brought forward means that it might be more difficult in the future to have demand for goods and services. This does not necessarily mean collapse. The worst result would be more like bankruptcy. However, because governments print money, what happens to money when a government goes bankrupt?

It is pretty clear that the world is in a deflationary cycle, so inflation will probably not lower the debt.  Inflation is not inevitable. this is why gold is just a hedge against a very low probability tail risk.

Another option is that the borrowers default. Since the government has purchased most of the debt, can the government just forgive the debt that the central banks have on their balance sheets? I am not knowledgeable enough to know if this type of default is possible, but it seems likely. However, if there are real external reasons like lack of water or climate change that will cause economic stagnation, then the debt forgiveness might not help.

The other possibility is that interest rates stay low for a long time, and the markets currently think that the long time is going to be very long because of the low interest rates on decades long debt. I would call this latter situation a "muddle through" economy where there is economic stagnation for a very long time. The debt will just be an extra aggravation to any stagnation.

So, is global debt bad? certainly failed public policies caused the central banks to have to take on this large amount of debt. The remedial action was probably good, but I have little faith that governments will stop making bad decisions. I hope the pain of having a large global debt will become a constraining factor that limits government mis-management.
Last updated April 21, 2015
HTML 4.01