Sunday, April 10, 2011

Debt Ceiling, Default And Teleporters

With all the budget talks lately, the fact that we are quickly approaching the debt ceiling is slipping under the radar.  But we'll hit our debt target in about a month, maybe 6 weeks, and then congress will be forced to raise that limit.  That the debt limit will get raised is a guarantee, the only question is how much it will get raised.

The pundits on TV will tell you that we need to raise the debt ceiling because failing to do so will destroy our bond market, raise interest rates and ultimately cause us to default on our debt.  The problem is that all of those things are going to happen anyway.  Guaranteed.  Sure, there are things that government can do (and they have been doing these things for years) to put off this inevitability into the future.  But the longer we delay these problems, the worse they will become.

Anybody who thinks we won't default on our debt is either a lunatic, drunk or both.  So if we will not pay back our debt, we must default on it.  There are two ways that governments can do this.  First, they can be honest about the situation and restructure the debt.  They can get their budget in order and then make deals with their lenders where they don't get paid 100% of their loans but at least they get paid in money that has some value.  The problem is that the budget need to be balanced for this to work.  We almost saw a government shutdown because politicians couldn't agree on whether to cut $30 billion or $60 billion. OUT OF A $1.6 TRILLION YEARLY DEFICIT! On my most optimistic day I can imagine a scenario where we try really hard and our politicians are willing to fight for a balanced budget and we'll maybe see one in 15 or 20 years.  Even if that would happen, it's not nearly soon enough.  I don't think we have 5 years before the system breaks down.  So option 1 is out the window.

The second way to default on the debt is to inflate it away.  That is, we simply print new money to pay our debts.  Our lenders will get their money, but they will be paid in money that is worth much less than the money they lent us.  This is the worst option, but it's becoming clear that it is the option we'll take.  As long as the debt ceiling continues to be raised, as long as interest rates stay extremely low, as long as the Fed is willing to print money to monetize our debt, and as long as someone is willing to lend us money at the low interest rates this is what we will do.

But that option can only work so long as all of those things stay true.  Once one of those factors goes away, the bubble will pop, interest rates will skyrocket, the dollar will plummet, we will default on our debt and hyperinflation becomes a real threat.  Notice that the end result of that scenario is nearly identical to the end result of not raising the debt ceiling right now.  Like I said, all of those things are going to happen sooner or later.  The only option we have is whether we want to face the problems today, take the medicine and deal with the pain (and trust me, it will be very painful), or keep delaying the problem until it's impossible to do so any longer and in the meantime pray for some new technology or invention (like a teleporter for example) that completely changes the nature of our economy.  Barring a new, revolutionary technology, the end result of this option is only a deeper and more painful recession/depression than what we would have to face right now.