By John Mattingly
In previous articles the past couple months, “The Elephant in the Room,” and “Debt is a Four Letter Word,” I suggested:
A. The world economy is locked-in on a growth ethic. Though I believe there are good examples of the limits to growth, and although such limits make common sense, it must be acknowledged that over the last 50 years in particular, and perhaps the whole of human history in general, all predictions of such limits to growth have been swept away by innovation, substitution, and expanding (or manipulated) capital markets.
B. There is good debt and bad debt. Good debt has a positive gain over the cost of the capital and adds value to the economy; bad debt may or may not have a positive spread, but does not add value, and ultimately must be ledgered as a debit to the general economy. At least some of the growth in the last 50 years has been fueled by bad debt.
We now understand that much of the debt of the last decade resulted from unrealistic expectations of growth on the part of individuals, cities, states, and nations – some of whom now face either insolvency or outright bankruptcy.
So, how is all of this debt, from personal to sovereign, going to be paid back?
There are only four ways: default, revenue growth (aka increased taxes from economic growth), monetary inflation, or a Big Surprise.
1. Default. Anyone who’s ever lent money probably knows what it’s like to get stiffed by a borrower. With credit card debt, mortgages, and commercial paper, partial default and work-out agreements are common in today’s market. It isn’t clear how a U.S. state could go bankrupt, unless a special chapter is added to the bankruptcy code (which might happen), but municipalities can go broke because they’re corporations – the same as a person. New York and California, big states in big trouble, are now considering the elimination of inefficient municipal governments and consolidating them with their surrounding counties as a way of reducing duplicative services, and re-routing the sales tax that formerly went to the towns, directly to the state. On the sovereign level, it’s a true wild card what happens, though nations have defaulted throughout history. Russia did in it 1998. Greece almost did it a few months ago. The U.S. might do it someday.
If the debt is secured, default usually leads to liquidation of the underlying asset; if unsecured, there are legal processes by which a lender can reach the defaulting parties assets, if they exist. In this case, “No blood out of a turnip” applies. In the case of sovereign debt, it’s possible that governments, at all levels, will consider selling off public assets to pay off public debt.
For example, back in the early 1980s, Reagan’s Interior Secretary, James Watt, advocated selling off the National Parks to pay down the national debt at that time, a debt that today looks almost puny. The proposal died in a crunch of adverse public opinion. Today, public opinion might be less harsh. Assets are ruled by three basic functions: ownership, possession, and control. It may be prudent for governments to possess and control assets rather than own them.
Colorado, our favorite state, really isn’t far behind New York and California in its debt problems, needing mandatory 22% cuts across the board in 2011 to balance the state budget. But Colorado has attractive assets, such as our gold-domed state house. It need not be owned by the state, and could be sold to an investor or investors, then leased back at an annual cost far less than the current cost of ownership to the state, while the tax benefits of ownership in the form of depreciation and maintenance, unavailable to the state, would be captured by the investor(s). If the state failed to pay rent, legislators might have to meet on the sidewalk.
2. Revenue growth. There is ongoing disagreement among economists, politicians, and talking heads about whether the tax rate increases or decreases collected tax revenues. Some claim business expands in a low tax rate environment and thus higher gross revenues result. These folks claim that raising taxes to pay off government debt will cripple the economy. Those on the other side claim there is no correlation between tax rates and revenues. Statistics confirm both sides, depending on the time period selected.
There is also disagreement about who should get taxed at the highest rates: corporations, rich people, the middle class, or maybe everyone should simply cough up the same proportional amount.
I’ve always thought of this discussion as a calculated diversion from the more substantial question of what government can/should do for the public. Politicians always talk about cutting waste, reducing spending and so forth, but they seldom do because there is no real restraint on public spending. Government can borrow and/or raise taxes to fund spending excesses or meet politicians’ promises, a structure that inevitably leads to an expanded role for, and thus demand upon, government. It’s a symbiotic situation of a populace wanting more services from government; services which can only be paid for with money borrowed from guess who? Yes, the populace. Someone once said that government fails to function when the populace realizes they are being bribed with their own money.
This discussion circles back to the question of good debt versus bad debt. We may have finally reached a tipping point at which economic growth can no longer keep up with the bad debt created by government spending. Some people make a pretty good argument that governments at all levels have spent themselves into a hole and everybody wants somebody else to pay the cost of getting pulled out.
Whichever side one stands on the taxation issue, both sides agree that somebody has to be taxed, and economic growth is imperative. A recent cover of Time magazine suggested, a line on the bottom of a state license plate with the letters BNKRPT that reads, “More taxes, fewer services.”
3. Inflation. National treasuries worldwide can print money and pay off debt with paper of declining value. This strategy goes back to the 14th Century (or perhaps even longer ago) when kings would take all the gold coins they’d collected as taxes and melt them down. They would re-mint more gold coins that were slightly smaller in diameter and mixed with a percentage of nickel or tin, allowing them to pay off their sovereign debts with diluted gold. Thus the expression, “Giving good weight.” Today, the various processes of dilution are done by wise men with computers who claim that just a pinch of paper to the money supply has a multiplier effect.
This strategy violates one of the principal responsibilities of good government, which is to maintain integrity in the money supply. But there is no question that it works, short term. Long term, it destroys a nation’s sense of value, because monetary inflation actually masks value deflation. In the extreme, such as 1920s Germany when literally wheelbarrows full of money were needed to buy a loaf of bread, social upheaval, or even revolution, isn’t far behind.
If an individual suspects inflation is coming, the best strategy, of course, is to be in debt up to your eyebrows (collateralized by hard assets) because the debt can be paid off with cheaper dollars and the underlying assets increase in nominal dollar value. The downside risk is that interest on the borrowed money will accelerate faster than the revenue stream from the asset (unless the interest rate is locked in). This trap caught a lot of people back in the late ‘70s and early ‘80s.
At the moment, while inflation seems certain, and the gold bugs and silver pumpers are barking out warnings, in the near term it appears the surprise will be deflation, as massive blocks of various assets are liquidated to pay down debt, creating an “overstocked” situation in most markets. One must be nimble, aware, and perhaps most of all, lucky.
4. Big Surprise. Technology and innovation may yet provide new, real growth in human economies that we cannot see yet, making us victims of the same predictive blindness that blocked the Club and Rome and Paul Erhlich from seeing that the new millennium would get started with a boom rather than a bust.
To entertain this notion requires a little thinking outside the box. In his book The Singularity is Near, Ray Kurtzweil suggests that humans and machines will merge in the next twenty or so years, and humans will become silicon-based life forms who put much less demand on the planet for physical resources. Instead of needing more fuel, we will require less – so much less that our entire concept of what it means to be human will change. Kurtzweil’s book is long and builds a careful case for his prediction.
A little reasoning from analogy helps here:
1. We know that the rate of technological innovation is increasing at an exponential rate. It took humans millennia to get from the Stone Age to the Bronze Age, but less than a century to get from the Industrial Revolution to the Computer Revolution.
2. We know humans are surrendering more and more to machines. Just compare the new i-phone to the old rotary you used as a kid, or look under the hood of a 2011 automobile, or look at the way most services are rendered and products manufactured. Look at how most things, literally everything, seems to stop when, “The computers are down.”
3. We know that anyone magically transplanted from the 18th century to the present day would consider the most common aspects of modern life the stuff of wild science fiction. Stir all this together and Kurtzweil’s prediction makes ominous, or encouraging, sense depending on your technological disposition.
(Personally, I favor the Big Surprise because it has such a good track record.)
John Mattingly cultivates prose, among other things, and was most recently seen near Creede.
