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The Problem Of Exponential Debt

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  • The Problem Of Exponential Debt

    The Problem Of Exponential Debt

    A Chinese proverb known by Americans as the “Chinese curse” says: “may you live in interesting times”. Boy do we live in interesting times. This is a veritable golden age in economic evolution. New theories are being crafted as we speak and old theories that have stood the test of (our short) economic time are being torn down. No theory has come under fire in recent years like Keynesianism. After decades of success, Keynesianism doesn’t appear to be having the same magical effect. Economic theorists are confused. To their dismay (and with all apologies to Sir John Templeton, to whom I promised I would never utter these words) – it’s different this time. Literally.

    We are fighting a very rare and wretched economic beast. As Bernanke’s great reflation experiment has ripped higher I have maintained that the hyperinflationists are wrong. Though we appear to have slipped through the hands of the balance sheet depression Grim Reaper, the balance sheet recession continues to nip at our heels. At his side always is his good friend Deflation.

    A balance sheet recession is so rare that it has only occurred a handful of times in modern economic times. And thus far, he remains undefeated by all of the powerful economic minds who have stood in his path. In his path today is the great Sir John Maynard Keynes. The global economy has stood behind the theories of Lord Keynes as the economy has tumbled and Central Bankers have literally bet their printing presses on his theories. I fear they are not working and could be setting the table for an even greater catastrophe.

    Over the course of the last 75 years governments around the globe have implemented policies of print and spend in times of economic downturns with great success. The truth is – Keynesianism works – in the right environment. It works well when debt is fairly low and organic economic growth is relatively strong, but exponential debt growth becomes an increasing concern every time you print your way out of an economic downturn. The larger the downturn, the larger the response. So on and so forth. If you happen to enter a period of severe irrationality and spending the problems multiply. If the recovery period is not used to pay down debts the problems become exponentially worse. The tipping point comes when the debt burden hinders future economic growth and destroys your ability to spend your way out of any future recessions. It effectively turns into one great pyramid scheme if it you let it get out of hand. We approaching a level of extreme inefficiency and wasteful spending. Spending which is not having the beneficial long-term impact that Keynesians might expect.

    Marc Faber believes we are already there. He refers to the current period in U.S. history as “zero hour” – the point where we have indebted ourselves so deeply that we can’t be trusted to pay off our debts. Perhaps worse, however, is the inability to fend off future economic downturns. Not everyone agrees with this perspective, however.

    Paul Krugman argues that the deficit worrying is entirely political. He’s correct to a certain extent, but as someone who loathes politics and understands that money has no political party I can say, without bias, that Krugman is also wrong to a large extent. Krugman argues that the economic downturn caused much of the current budget deficit – as if that somehow justifies it. But therein lies the problem. The prior Keynesian responses became multiplied and directly contributed to the current downturn. 20 years of easy money and accommodative print and spend monetary and fiscal policies have finally boiled over. In essence, we have tried to print and spend our way out of one too many recessions while failing to use the recovery periods to pay down our debts. The issues in the private AND public sector speak for themselves.

    The problem is, as the United States economy has matured we have become increasingly confident of future growth and increasingly less fiscally prudent. The following chart shows the decade change in debt, GDP and debt/GDP. What was once a sustainable ratio in the 50’s, 60’s and 70’s has ballooned in the 80’s, 90’s and 00’s. The story in the private sector is largely the same as debt ratios have ballooned in the 90’s and 00’s.



    Now, as the recovery remains weak and worries of a double dip increase, Krugman and the other Keynesians are saying we’re not spending enough:
    “The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs.”
    Talk about doubling down on a losing bet….The truth of the matter is the U.S. economy is on an unsustainable path and our Keynesian economic responses have been large contributors. As the U.S. economy has matured and growth has slowed our inefficient spending has actually picked up pace. As we became more wealthy as a society we began to price-in increasing wealth expansion and with it came more debt – and more risk. That’s all well and good until the revenues begin to fall off a bit and then the debts become a substantial constraint. Real recovery relies not only on a strong public sector, but a strong private sector. Thus far, the private sector is not picking up the baton that the public sector is attempting to hand off.

    Reinhart and Rogoff recently published a paper titled “growth in a time of debt“. They found that debt at 90% of GDP begins to substantially impact future economic growth:
    “The relationship between government debt and real gross domestic product (GDP) growth has been weak for debt/GDP ratios below a threshold of 90% of GDP. Above 90%, median growth rates fell by one percentage point and average growth fell considerably more. The threshold for public debt was similar in advanced and emerging economies.”
    With the budget expected to reach 95% of GDP this year we are nearing the point of no return.
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  • #2
    Re: The Problem Of Exponential Debt

    I think the key reason why Keynesian theory is breaking down is b/c implied within it is equal & infinite access to cheap energy to all parties involved.

    Clearly, that is no longer the case - they can print all the money they want, but they can't print more oil.

    So, as Bernanke and Central Bankers run the Keynesian playbook that has worked so well for the last 90 years, the wall of money they are creating is flowing to the bottleneck, which this time around is energy.

    Ironically, & why this blows up Keynesian theory IMO, is that higher energy costs effectively serve as a tax on consumers, unlike other asset prices that have been inflated by Keynesian actions in the past 30 years (stocks, homes, etc.) that have then led to increased consumption. This time around, increasing stimulus dollars drives higher oil prices which then leads to lower consumption.

    So IMO, global central bankers are painted into a corner where the more they increase stimulus, the more they effectively raise taxes on the consumers of the world by virtue of driving up energy prices.

    The solution to the crisis IMO is ultimately not more stimulus, but finding a new, large, cheap energy source.

    I thought that Andy Lees' book "The Right Game" did a fantastic job highlighting the critical tie b/t increasing consumption of cheap energy & economic growth ...

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    • #3
      Re: The Problem Of Exponential Debt

      The problem is more than cheap peak oil. It is "peak everything", or having an unsustainable human population on a rather limited planet.

      Our socio-historical context takes some time and perspective to appreciate. Upon first encountering Peak Oil, most people tend to assume it is merely a single isolated problem to which there is a simple solution - whether of an eco-friendly nature (more renewable energy) or otherwise (more coal). But prolonged reflection and study tend to eat away at the viability of such "solutions"; meanwhile, as one contemplates how we humans have so quickly become so deeply dependent on the cheap, concentrated energy of oil and other fossil fuels, it is difficult to avoid the conclusion that we have caught ourselves on the horns of the Universal Ecological Dilemma, consisting of the interlinked elements of population pressure, resource depletion, and habitat destruction - and on a scale unprecedented in history

      Petroleum is not the only important resource quickly depleting. Readers already acquainted with the Peak Oil literature know that regional production peaks for natural gas have already occurred, and that, over the short term, the economic consequences of gas shortages are likely to be even worse for Europeans and North Americans than those for oil. And while coal is often referred to as being an abundant fossil fuel, with reserves capable of supplying the world at current rates of usage for two hundred years into the future, a recent study updating global reserves and production forecasts concludes that global coal production will peak and begin to decline in ten to twenty years.4 Because fossil fuels supply about 85 percent of the world's total energy, peaks in these fuels virtually ensure that the world's energy supply will begin to shrink within a few years regardless of any efforts that are made to develop other energy sources.

      Nor does the matter end with natural gas and coal. Once one lifts one's eyes from the narrow path of daily survival activities and starts scanning the horizon, a frightening array of peaks comes into view. In the course of the present century we will see an end to growth and a commencement of decline in all of these parameters:
      • Population
      • Grain production (total and per capita)
      • Uranium production
      • Climate stability
      • Fresh water availability per capita
      • Arable land in agricultural production
      • Wild fish harvests
      • Yearly extraction of some metals and minerals (including copper, platinum, silver, gold, and zinc)

      The point of this book is not systematically to go through these peak-and-decline scenarios one by one, offering evidence and pointing out the consequences - though that is a worthwhile exercise. Some of these peaks are more speculative than others: fish harvests are already in decline, so this one is hardly arguable; however, projecting extraction peaks and declines for some metals requires extrapolating current rising rates of usage many decades into the future.5 The problem of uranium supply beyond mid-century is well attested by studies, but has not received sufficient public attention.6

      Nevertheless, the general picture is inescapable; it is one of mutually interacting instances of over-consumption and emerging scarcity.
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      Last edited by Rajiv; February 11, 2010, 08:57 PM.

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      • #4
        Re: The Problem Of Exponential Debt

        Agreed...i suspect Heinberg's points are the reasons why Marc Faber suggest investing in farms & in firearms...

        If you went to the avg American financial planner & told him you wanted to deploy an allocation of your retirement funds into farms, timberlands & ammunition (probably good store of value made of brass & lead) instead of stocks & bonds, they would look at you like you had three eyes...

        i don't think the next crisis is CRE or sovereign debt - it's all paper & as such can & will be extended & pretended given the national security designation the financial system has received in the US...

        But the day the oil runs short, you can't extend & pretend...

        I think Richard Branson is onto something...

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        • #5
          Re: The Problem Of Exponential Debt

          Wasn't peak fish in the 1940s?

          my understanding is that all the seafood being caught now is lower quality, compared to what used to be out there.

          Some of the historical accounts of the fish population off Newfoundland are astounding. Cartier (early 1700s I think) reported you could stick your arms into the water & catch huge cod with zero effort.

          Originally posted by Rajiv View Post
          The problem is more than chep peak oil. It is "peak everything", or having an unsustainable human population on a rather limited planet.

          Comment


          • #6
            Re: The Problem Of Exponential Debt

            Originally posted by Rajiv View Post
            The problem is more than chep peak oil. It is "peak everything", or having an unsustainable human population on a rather limited planet.
            If you buy into this, and I do, than what most people have been taught about economics will break down. Most economics is based on more supply being created by demand, or a reasonable substitute will come forward. If we don't start thinking about an economic theory that treats declining physical supplies as reality, we're all in for a very rough time ahead.


            Q: How many conservative economists does it take to change a light bulb?

            A: None. The darkness will cause the light bulb to change by itself.

            Q: How many Keynesian economists does it takes to change a light bulb?

            A: All. Because then you will generate employment, more consumption, dislocating the aggregate demand to the right.

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            • #7
              Re: The Problem Of Exponential Debt

              There are no Keynesians. What there are rather, are folks who selectively quote Keynes to fit their ideology. Krugman is the worst.

              How can you get a Nobel prize and not realize that Keynesian stimulus assumes that you are spending money you have saved when times were good, or using deficits that must later be paid back? Keynes never would have argued for spending in the context we have today....nor in any context of the last 30 years.
              ScreamBucket.com

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              • #8
                Re: The Problem Of Exponential Debt

                The link between energy consumption and GDP has been known for some time. This data is from the 1960's

                Attached Files

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                • #9
                  Re: The Problem Of Exponential Debt

                  Well generally only one side of the supply demand paradigm is spoken of, but the other side deserves just as much attention.

                  The price/supply/demand tautology goes as follows

                  As the supply reduces, the price goes up resulting in either an increase in supply, a reduction in demand or both. Yes new alternative sources of stuff to use will come, but they will be at a real higher cost, so the demand will be reduced -- leading to a change in the lifestyle that we are used to. Generally at a higher real price, both the overall supply and demand would decline.

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                  • #10
                    Re: The Problem Of Exponential Debt

                    Keynesian ideas would also require a free market economy to work.

                    We do not have one, financial de-regulation changed the free market economy into a ponzi / pyramid scheme.

                    Since the crisis occured the pyramid is being held up by the Fed, Treasury, D.C., and other central banks.

                    If she blows, the fat lady really is going to sing.

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                    • #11
                      Re: The Problem Of Exponential Debt

                      Originally posted by Aetius Romulous View Post
                      There are no Keynesians. What there are rather, are folks who selectively quote Keynes to fit their ideology. Krugman is the worst.

                      How can you get a Nobel prize and not realize that Keynesian stimulus assumes that you are spending money you have saved when times were good, or using deficits that must later be paid back? Keynes never would have argued for spending in the context we have today....nor in any context of the last 30 years.
                      Exactly.

                      Lord Keynes would have been appalled at what Chancellor/P.M. Brown and New Labour have done to his native Britain during their custodianship of the economy and national balance sheet.

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                      • #12
                        Re: The Problem Of Exponential Debt

                        Originally posted by Aetius Romulous View Post
                        How can you get a Nobel prize and not realize that Keynesian stimulus assumes that you are spending money you have saved when times were good, or using deficits that must later be paid back?
                        We're playing the Texas Two Step Multi-Player Asset Enhancement Ponzi Game.

                        In traditional barter systems, people trade goods and services for other goods and services.

                        In traditional monetary systems, people trade goods and services for money.

                        In the Texas Two Step Multi-Player Asset Enhancement Game, we trade the discounted cash flows of increasingly enhanced assets (dot.com stock, liar loans, pension promises, corporate, local and national debt, corporate equity, spec built housing, shopping malls, office space and manufacturing plants, ...) for money, some of which money can then be used to purchase real goods in the parallel traditional monetary system.

                        In the Ponzi-fied version of this game, multiple players trade increasingly inflated asset classes back and forth until, one by one, each asset class bubble pops. Each time one pops, it takes out the players currently holding too much of that class, like losers in a game of musical chairs.

                        We've taken out so far some Wall Street investment banks, some real estate agents and mortgage brokers, many ordinary holders of mortgages, earlier investors in dot.com stocks, some weaker retail outlets, some redundant laborers, a couple of small nations (Iraq, Iceland) and a few banks. Many others are now marginalized, though perhaps not yet officially declared economic casualties.

                        Only a few players still hold major chips in this game. The treasuries, national and regional central banks, and national political and taxing authorities of a few major nations, the U.S. military, various central intelligence agencies, and a few major banks are still sitting at the central table. These remaining big players have been trading positions back and forth. There are various symbiotic dependencies between the players, creating multiple concurrent variations of the Prisoners Dilemma and complicating analysis and play for all.

                        Nota bene: this is not a single dominant player pure fiat monetary system. No major government just "prints" it. Only a few comic tragic side shows do that, such as Zimbabwe. For all the major players, "wealth" is expanded through valuation enhancing trades of assets and their monetized income streams. That is why central banks and governments can and must (to survive in the current game) trade major assets with key banks, in order to continue to inflate the asset classes (big bank equity, mortgage backed securities, credit default options, interest rate and foreign exchange swaps, national debt, national currencies, ...) that have not yet collapsed beyond hope of recovery.

                        One way to score this game is the way we monitor the elimination rounds of a sports championship playoff series. One by one, major players are sidelined beyond any hope of returning to play again for the main prize.

                        Unfortunately (for current, has been and would be players) this game must end. Power, income and wealth only come in this game from the essential act of exchanging assets with monetizable cash flows. If we play this out to its logical conclusion, eliminating all but one final victor, it's game over. Wealth and power in this game only come from increasing advantage in asset class trades. If only one player remains standing, there are no trades. If I personally held all the securities, debt, bonds, treasuries, mortgages, swaps, derivatives, futures, options, certificates, and cash in the entire planet in my personal warehouse, I'd be a poor man. The rest of the world would ignore me and my stash of paper that was once worth vast wealth could only be sold for scrap paper pulp (to a tragically downsized and economically collapsed civilization.)

                        Currently, it seems that some Eastern and Southern European countries are being marginalized. Behind them would appear to be some European banks too heavily invested in these now collapsing nations.

                        JPMorgan, Goldman, BIS, China, the Fed, the U.S. Treasury, Fannie/Freddie, some resource rich nations, Northern European countries, a few major oligarchies (Ag, Pharm, Insurance, Chem, Financials, Petro, Opiates, ...) the political power of most all governments, and the U.S. military and intelligence are still sitting at the main table (though each has taken on some major damage.)
                        Most folks are good; a few aren't.

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