Snowdrifts of Debt

How long can the world’s largest debtor hold its head above water? Not forever, argues Christopher Mayer – "These debts must be dealt with; they cannot grow indefinitely at their current rates…"

Debt is an institution in American government, long established and widespread. A cursory glance at debt statistics will quickly show that there has been a lull in the truth about debt, namely, that it cannot grow indefinitely at the rate at which it has been growing – at least, not without a serious revaluation of the dollar, something we are already in the midst of seeing.

We know that the U.S. government is the world’s largest debtor, with deficits feeding debts that pile on in increasingly larger numbers of numbing proportions. The current federal debt outstanding according to the Bureau of Public Debt stands at nearly $7.2 trillion. It was only in 1981 that the legal debt ceiling was $1 trillion. Then again, expecting debt ceilings to curb debt growth is sort of like trusting the fox with the henhouse.

Though it may be surprising to some, particularly those who believed in the supposed fiscal responsibility of the Clinton years, the public debt has risen without interruption since 1956. Incredibly, the $7.2 billion is conservative; if you add in all the off-balance-sheet contingencies and guarantees (implicit and otherwise), you probably triple that figure, at least. This also excludes debts incurred by states, municipalities, etc.

Legalized Counterfeiting: The Old Art of Repudiation

Given the large amount of debt outstanding, it is easy to see that creditors are not likely to win any votes in deciding the future monetary policy of the country. Democratic hopefuls are not likely to rail against the effects of inflationary monetary policy in transferring wealth from creditors to debtors. The Bush Administration is not likely to lead a charge for hard money. No, the more likely path will be to perform some sort of con, like legalized counterfeiting – the modern form of the old art of repudiation.

Statecraft learned the art of repudiation a long time ago, at least at early as Solon, the lawgiver of Athens in 7th-6th centuries BC. Thomas Cahill, in his latest book, "Sailing the Wine-Dark Sea," called Solon "a sort of Athenian Franklin D. Roosevelt." Indeed, both men led famous swindles on the citizens they governed.

It was Solon, according to the historian Plutarch, who lightened the debt burdens of Athenians by "raising the value of their money; for he made a pound, which before had passed for seventy-three drachmas, go for a hundred; so that, though the number of pieces in the payment was equal, the value was less; which proved a considerable benefit to those that were to discharge debts."

In fine Athenian fashion, and very much like our own modern age, treachery was given a pretty name. By "softening the badness of a thing," as Plutarch put it, harlots became mistresses, tributes were called customs and a jail became a chamber. The Greeks called Solon’s act a "seisacthea," meaning a relief or a disencumberance. Plutarch cites a poem, credited to Solon, where he "takes honor to himself that…The mortgage-stones that covered her [Athens], by me, removed, / the land that was a slave is free…"

Solon forced a revaluation, in effect transferring wealth from creditors to debtors. The mortgage stones would make their marks again and again through the ages. Solon’s financial alchemy would not be unique.

Legalized Counterfeiting: Breaking Contracts

It was probably not Cahill’s intent, but his linking Solon with FDR is most apropos in this respect, because FDR too pursued a similar policy of debt relief in the 1930s – by breaking contracts.

Faced with paying for the extravagance of the New Deal and also grappling with a severe crisis, Roosevelt chose the tried old hand of repudiation. (Note, we call it the "New Deal" when in fact it was basically "Old World Socialism," more "softening the badness of a thing.")

In 1933, the incoming Roosevelt administration assaulted the monetary order of the country, forcing it off the old gold standard, confiscating the gold of American citizens and putting it under the ownership of the Federal Reserve. They placed an embargo on the export of gold and devalued the dollar to $35 an ounce, where once an ounce of gold could be had for about $20.

The Roosevelt administration also brazenly stepped in and repudiated private and public contracts that required payment in gold. In other words, it had been customary for contracts to have gold clauses requiring payment in gold and thereby protecting the creditor. Roosevelt said that this was no longer legal and that if you had signed a contract stating that you promised to pay in gold, you no longer had to do so. A promise was not a promise anymore.

The anti-New Dealers, a spirited group still clinging to simple morals and personal liberty, fought the Roosevelt administration. History would later show they were part of a rearguard action. For the most part, they are written out of mainstream histories of the period. The victors do write history, after all.

This group was dealt a severe blow when the Supreme Court upheld the government’s repudiation of private and public contracts to pay in gold, by the slimmest of majorities, 5-4. The court reasoned that these contracts interfered with the government’s ability to control the supply of money – which they did, and which was precisely the point of such clauses.

These actions were largely consistent with the goals of the New Deal. As economist Benjamin M. Anderson noted in his financial history, "the New Deal tax policy from the beginning has been more concerned with the redistribution of wealth than with raising revenue." All of these schemes simply robbed creditors and handed the gains to debtors.

Legalized Counterfeiting: What Kind of Prosperity Is This?

With all the debt still saddled on the U.S., it is an irony that the rising stock market and happy GDP statistics have given most Americans the hope that things have turned and the boom is on. GDP is growing, we are told, among other things. The economy, many believe, has turned the proverbial corner and is now gingerly making its way forward once again. But what sort of prosperity is this?

Commenting in the 1930s, Albert Jay Nock noted the "the regular pre-election effort to start a boom in the stock market" and observed how optimistic Americans remained despite the large amount of debt and deficits. He wrote that "Americans have a strange notion that the ordinary laws of economics do not apply to them. So doubtless they will think they are prosperous if the boom starts, and that deficits and indebtedness are merely signs of how prosperous they are."

This false sense of prosperity has deceived many and has produced a fertile field for the institution of debt to grow – fertilized as it is by a fiat currency, a central bank, fractional reserve banking and other monetary interventions.

The laws of economics likewise never cease. These debts must be dealt with; they cannot grow indefinitely at their current rates. Furthermore, history tells us that these debts are not usually repaid as agreed.

In a world of fiat currency, debt relief takes a subtler path than the overt aggression of a Roosevelt. Inflation (an expansion of the money supply), or legalized counterfeiting, is the modern spin on an old idea. The forces that led to these earlier swindles are converging now on a debt-laden America. From Solon, to Roosevelt, to Nixon’s closing of the gold window, the tradition of fraud is evident.

In today’s world, all you need is a printing press. My guess is that Bernanke’s printing press will be busy.


Christopher Mayer,
for The Daily Reckoning
April 14, 2004

Editor’s note: Christopher W. Mayer is a veteran of the banking industry, specifically in the area of corporate lending. His essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is also the author of "Capital and Crisis," a recently launched investment advisory for contrarian-minded financial observers.

This article appeared in the April issue of The Free Market, a monthly newsletter available to members of the Mises Institute, and was featured as a Daily Article.

Too good to be good.

That was the problem with yesterday’s financial news. So many corporations, for example, reported earnings ‘greater than expected,’ it was almost as if they planned it that way.

We explained a day or two ago how consumer spending seemed to have topped out. Would you hold that item, dear reader? We will use it later.

But yesterday’s news brought more evidence that the consumer was still ruining himself – faster than ever. Retail sales rose 1.8% in March. The poor lumpen consumer had no more money to spend – his wages had not gone up, his costs had not gone down – but he spent it anyway.

Where did the money come from? Thank the feds. Like sneaking whiskey into a rehab center, the Fed keeps plying consumers with the one thing they cannot resist: free money.

The Fed’s key lending rate is 1% – well below the actual level of consumer price inflation. This is an "emergency" level, we’ve been told. But as for what the emergency is, the feds keep that to themselves.

Reading the news, we see no emergency at all. Life goes on as always. People borrow. People spend. People go further into debt.

It has to come to an end sometime. We don’t know when. What we do know is that it didn’t come to an end in March. Instead, the fantasy economy became even more fantastic.

In San Diego, house prices rose more than 16% over a year ago. In LA they were up an incredible 29%. Even in the Baltimore area, the median house sold for 20% more in March than it had a year ago.

This is great news, of course. It means your editor can borrow more money against his house. He is not sure how he will answer the "use of funds" question…or even if the question is still posed to prospective borrowers. But the lure of taking out equity – that is, spending money you never earned – is so strong, he is sure he can think of something.

Alas, good fortune is self-correcting. Yesterday’s news was so good, investors were spooked by it. "Now the Fed will have no choice," they said to themselves. "They’ll have to raise interest rates…before the election, not after."

The morbid specter of higher rates dropped upon Wall Street like an exhausted zombie. Stocks fell. Gold fell. Bonds fell. Only the dollar rose – in anticipation of higher yields from U.S. dollar holdings.

Isn’t it fascinating, dear reader? We mean, the way everything works. Things seem to get better…but only as long as people fear they are getting worse. Then, when the betterness is undeniable…they suddenly get worse. And then it looks as though they were right all along!

No, consumer spending didn’t head down in March as we thought it might. Nor did the dollar end its rally. But hold these thoughts, dear reader; we may need them soon.

And now, over to North America, where our U.S.-based colleagues bring you more news:


Addison Wiggin writing from the mean streets of Baltimore…

– The history of the U.S. credit bubble now stretches back over two decades. And yesterday gave rise to some wacky action in the markets…

– First, some background. As Michael Lewis details brilliantly in his 1988 classic, "Liar’s Poker," we owe much of our current dire fiscal situation to two men: Michael Milken of Drexel, and Lewie Ranieri of Salomon Brothers. In the early eighties, these two fellows were responsible for innovations that enabled Johnnie Q. Public to leverage himself with billions of dollars of debt. Using junk bonds (Milken) and mortgage bonds (Ranieri), Wall Street began siphoning off wealth "locked up" in America’s great pool of medium and small-cap corporations…and the neighborhoods that housed their employees.

– America never looked back. So doggedly ahead did she forge, that staggering debt loads on the family balance sheet now seem as American as apple pie. The monster these two men helped create has become so big – and so unpredictable – that good news now causes the market to tank.

– "U.S. stocks extended losses Tuesday in afternoon trading," says CBSMarketwatch, "on concern interest rates may rise sooner rather than later after earnings and better-than-expected retail sales suggested the U.S. economy is in robust form."

– We are skeptics, dear reader, and we rarely accept the conventional wisdom. But to suggest that that "stocks extended losses" as a result of the economy’s "robust form" sounds like somebody missed the point.

– The point is this: low rates are puffing up the stock market, lifting share prices over and above the true fair value of the assets they represent. When the artificial stimulus is removed…when rates rise, as they must eventually…stocks will fall. Bonds and house prices, too. Both of those markets are trading near all-time highs. And who owns these assets? Johnnie Q., our friendly indebted consumer…

– The precious metal markets were in absolute disarray yesterday. Gold was down over $15 at one point, then bounced back to close at $407. Overnight in London, the barbarous metal continued to sell off, falling an additional $7 to just below $400. Silver got whacked hard, too…dropping 57 cents, or 7.12%, to $7.45 an ounce. Gold stocks were murdered, receiving the double whammy: soft equities and soft metals (To illustrate: Silver Standard dropped 13%, Western Silver 9%, Vista Gold 8%, Goldcorp 6%).

– Conversely, the dollar rallied all the way to a buck eighteen against the euro. The last time the greenback saw this level, November 27, Americans everywhere were comfortably tucking into a steaming plate of turkey and stuffing.

– Our friend Chuck Butler, watching the currency markets on the Everbank Trading desk, summed up yesterday’s action nicely: "I’m very confused these days," writes Chuck, "by the rhetoric that comes across the screens and in the market place.

"For instance, this morning…I see a report that says the dollar is gaining VS all currencies on the basis that it is believed CPI will be higher in this morning’s report…

"What? Pardon me, but isn’t inflation the bane of all currencies? OK, I realize that the traders and investors that wear short-term glasses, are only looking at this as an indication that the Fed would be moving interest rates higher…

"Again though, this is where I get so confused, because with U.S. rates so low, how much higher are interest rates going to have to go to bring U.S. assets up to those offered in Australia, New Zealand, or even the U.K.? And even more important, who among us believes that the U.S.
recovery can withstand 200 to 300 BPS of rate hikes in less than a year?

"So, you can see my confusion with the dollar bulls holding the hammer right now…"

– Mainstream stocks fared better, but not well. Like a fainting woman needs a cool rag for her forehead, a glass of water and assistance sitting on a couch, the ailing Dow could use some investor TLC. Instead, it got hammered yesterday…losing 134 points to close at 10,381…and is off another 40 points as we write this morning. The S&P slid 16 points to 1,129, while the Nasdaq shed nearly 2% to close at 2,030.

– The market’s sell-offs came despite reports of a 1.8% rise in retail sales, released just moments before the opening bell. Interest-sensitive stocks – banks, utilities and financials – were hit hardest. Meanwhile, government bonds also sold off, predictably; the 10-year Treasury added 11 basis points to yield 4.34%.


Bill Bonner, back in London…

*** Why are houses rising in price so much? We don’t know. But the feds are doing some extraordinary things. The national debt is rising at the rate of $2 billion per day. And the Fed itself has not only left its key lending rate at an extraordinary 1% for almost a year – apparently fighting a battle with an enemy it says doesn’t exist – it has also goosed up the money supply to an extent the world has never before seen.

In the last 4 weeks, M-3 has shot up $100 billion. At this rate, a trillion dollars is added to the planet’s money supply in a single year. By our calculation, this equals about $10,000 new dollars for every family in America. Hmmm…

*** Colleague Dan Denning ventured the following reflection on M-3’s astonishing growth: "My conclusion: Sell bonds. Quickly. Look for the dollar to depreciate against nearly everything."

But the situation is not simple.

"In another scenario," wrote Marc Faber last June in the Gloom Boom & Doom report – as Dan graciously pointed out to us – "asset inflation would spill over into the commodities, goods, and service markets and would be, in my humble opinion, discounted by rising bond yields – and this well in advance of the price inflation showing up in the doctored inflation figures published by the government. The sudden rise in interest rates amid still-benign inflation figures, as published by the Wall Street Journal on its front page, would then prompt Mr. Greenspan, whose habits have changed little since he was a consulting economist for White Weld in the early 1970s, to erroneously believe that the Fed hasn’t eased sufficiently. Another tidal wave of liquidity would then be injected into the system in the hope of bringing down rates. But by then the bond and foreign exchange markets would no longer be fooled! A violent downward adjustment in the dollar exchange rate and in bond prices would immediately follow.

"The question, of course, is against what one should expect the U.S. dollar to depreciate, since the Fed can almost force other central banks to ease monetary conditions in concert through a massive dollar magnetization. Such a policy would lower the dollar value so much against other currencies as to create serious economic problems in Europe and Japan (competitive devaluation). In this event, foreign central banks would be compelled to pursue similar monetary policies as the Fed, which would lead to an unprecedented reflation on a global scale.

"However, such concerted global reflation wouldn’t necessarily lead to global growth. What it would do is to depreciate all currencies against any hard asset whose supply couldn’t be increased at the same rate as Bernanke’s ‘money printing presses’ would turn out additional banknotes and credit.

"In other words, prices of real estate, art, collectibles, coins, jewelry, stocks (but not bonds), and commodities, especially precious metals, would soar for some time…until a major financial reform in the world would lead to a stabilization crisis that would not only pale against the German stabilization crisis of 1923, which produced temporary unemployment of around 30%, but also the Great Depression of the 1930s. (Only in this stabilization crisis should we expect massive deflation.)

"The global reflation that I am talking about could last for several years and, given the way smart operators amassed large fortunes during the German hyperinflation, under this scenario there would be great, although very speculative, investment opportunities.

"Hard assets aside, and emerging market equities, I believe that Japanese stocks would be one of the prime beneficiaries of this (in the long term) financially suicidal central bank policy. In a global reflation, Japanese interest rates would likely rise in percentage terms more than other interest rates around the world, and such a rise would bring about a huge reallocation of financial assets from bonds into equities."

*** Since Dan was in the office, we posed another question: Is what’s going on in Iraq at all like the Tet offensive in 1968? And what was the effect of Tet on markets?

"The short answer," he replied: "Tet was a sell signal…even though in military terms, it was a U.S. victory. In that respect, today’s situation in Iraq bears looking at.

"The market is overbought. The economy gives conflicting signs of its fundamental health. America finds itself in the midst of another contentious election and another contentious war…just as during and after the Tet Offensive. Fallujah could be a similar sell signal…"

*** George W. Bush appeared on TV last night to reassure the nation. We did not see his address, but the news programs in London reported this morning that he believed he was "making the world a better place."

How the gods must have howled! Was not the world already the way they wanted it? How could a mere mortal improve upon it? Bush might push upon lever A or turn knob B…but how would he know that that would make the world better? Could he see into the future? Would he be able to recognize a better world – even if it came up and bit him on the derrière?

What surprise…what comeuppance…what irony are they preparing for him? Will they punish him now…or advance him just a little more rope, so they can hang him good and high later on? We wonder.