Pick your poison


When you put yourself into the position that many of the western central banks have done with massive unsustainable national debt near, at, or well past 100% debt to GDP, you leave yourself vulnerable to any shocks that come along. And believe me, there are many shocks in the pipeline.

The main problem here is that central banks throughout the western world are dependent on private capital, via the bond market, to make up the difference between tax receipts and day to day spending. They have all been doing this for decades, so the annual deficit has each year added to the national debt which has grown relentlessly. This is why the debt levels are so high. The patience of the bond market has been sorely tested and will soon reach a breaking point. When this breaking point arrives, few will be prepared to buy any more treasury bonds and their prices will plummet. The interest rate, its corollary, will soar. The central banks will then find themselves in a bind.

There are three, and only three, ways out of this bind.

1/ An individual, who finds himself in debt, can do the responsible thing which is, try to reduce his spending, raise his earnings and accept the fact that he will have to grind through this for many years in order to repay his freely accepted debts. On a national level this means raising taxes, reducing entitlement spending and biting the bullet, accepting that things will be tight for years until the debt is down to a manageable level. All the while begging the forebearance of your creditors to allow you the few years breathing room needed to bring tax receipts and spending in line. This is the path that Ireland has chosen. The absence of demonstrations or riots in the streets of Dublin shows that the Irish people have accepted this grim burden.

2/ Another individual may say “There is no way I can pay this, I’m filing for bankruptcy”. On a national level this means defaulting on the debt, saying to your bond holders that they have to accept pennies on the dollar, or nothing at all. Take it or leave it. Along with shafting their bond holders, they are now in a position that they can no longer go to the bond market in order to finance their deficit (the difference between what the government spends each year and what it receives in tax revenues) which means they have to suddenly bring their spending and tax revenues in line so that they do not need to go to the bond market to make up the difference. This means that tax rates soar, entitlement spending plummets and no national consensus is there to accept this new reality. Hence, riots on the streets and stories of extreme hardship abound. This is what Greece has done.

3/ The final option is monetisation. This option is not available to individuals, only to sovereign governments with control of their own currency, so not Ireland or Greece, being tied to the Euro as they are. Monetisation is basically printing as much money as the government needs and ignoring the need to get spending in line with tax receipts. This is the most dangerous choice as it inevitably leads to hyperinflation as the market is swamped with currency with no actual value to back it up. I’m looking at you America.

So there are the three choices, pay the debt, repudiate the debt or inflate the debt away. There are no good choices, only varying degrees of bad.

Pick your poison.

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