The Problems With "Printing Your Way out of Debt"

Governments are running breathtaking deficits…and accumulating alarming debts. Japan has a national debt of nearly 200% of its GDP. Where did that debt come from? It came from 20 years of trying to buy its way out of a slump with borrowed money. Of course, it didn’t work. But now, Britain and America are following the Japanese lead…and the Japanese are still at it! At the present rate, Japan’s government debt will grow to 300% of GDP in 10 years. America’s debt could grow to 100%…and then 200% of GDP…over the next decade (depending on whose projections you believe). And Britain, if we read the report in The Financial Times correctly, will have debt equal to 200% of GDP within 3 years.

Just what kind of crisis do these numbers portend? It’s hard to say. Probably a combination of confidence, followed by debt default and inflation.

Would the US actually default? We agree with Paul Samuelson; the answer is ‘maybe.’ Samuelson, writing in The Washington Post:

“The idea that the government of a major advanced country would default on its debt – that is, tell lenders that it won’t repay them all they’re owed – was, until recently, a preposterous proposition. Argentina and Russia have stiffed their creditors, but surely the likes of the United States, Japan or Britain wouldn’t. Well, it’s still a very, very long shot, but it’s no longer entirely unimaginable. Governments of rich countries are borrowing so much that it’s conceivable that one day the twin assumptions underlying their burgeoning debt (that lenders will continue to lend and that governments will continue to pay) might collapse. What happens then?

“…People have predicted such a crisis for decades. It hasn’t happened yet. The currency’s decline has been orderly, because the dollar retains a bedrock confidence based on America’s political stability, openness, wealth and low inflation. But something could shatter that confidence – tomorrow or 10 years from tomorrow.

“Despite huge deficits, interest rates on 10-year Treasury bonds have hovered around 3.5 percent. In time of financial crisis, investors have sought the apparent sanctuary of government bonds. But the correct conclusion to draw is not that major governments (such as Japan and the United States) can easily borrow as much as they want. It is that they can easily borrow as much as they want until confidence that they can do so evaporates – and we don’t know when, how or whether that may happen.”

Why wouldn’t the US just “print its way out of debt?”

Because it’s not that easy. In effect, the feds are trying to print their way out of debt now. They’ve added huge amounts to the monetary base. But that money is not getting into the real economy. Instead, it’s going into vaults and speculations.

“Jittery Companies Stash Cash,” says The Wall Street Journal.

And banks, too, borrow…but they don’t lend. They can borrow at negligible rates of interest…and buy US Treasury bonds on a leveraged basis…producing a 20% yield. That means, the US dollar has replaced the yen as the go-to currency for speculators.

Net effect? Lots of cash in what appears to the Mother of all Carry Trades. The Financial Times:

“The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualized – as the fall in the US dollar leads to massive capital gains on short dollar positions.”

But in the economy itself? As in Japan, very little economic progress comes from this kind of speculation.

Bankruptcies rose 7% last month. Unemployment gets worse.

The financial markets bubble up. The real economy shrivels up. And people with any sense are stocking up.

The Daily Reckoning