Thursday, March 11, 2010

Forbes' Richard Lehmann: Dumping Debt on the Next Generation is Fine

I always like to think about who has the "other side of the trade" whether it comes to individual stocks, or an entire economic thesis.  So when I saw this headline on Forbes I did a double take... since I love to use the "throw the grandkids under the bus" analogy.  (ironically, I don't have kids, so I am not sure why I am worried about the country's future more than people who do)

I have never heard of Mr. Lehmann but since I always like to understand where the source of commentary is coming from, here is a description

Richard Lehmann is President and Founder of Income Securities Investor Inc. He has served on numerous creditors' committees, including the one set up by Chemical Bank for the municipal bonds of the Washington State Public Power Supply System. With over 30 years of bond investing experience, Richard Lehmann is a recognized expert on fixed income securities, high-yield bonds, bond defaults and investing in distressed securities. Richard is also a regular columnist for Forbes.

The basis of his argument is quite simple.  We can borrow to our hearts content because frankly, we will never pay it back.  (talk about the ultimate Ponzi scheme)  [Dec 30, 2009: Eric Sprott Wonders if US Debt Scheme is Simply the Biggest Ponzi Scheme Ever]  Rather than the potential of an outright default as a country without the inability to print currency faces (i.e. Greece), we can do partial "stealth defaults" using the oldest trick in the book - inflation.  Which is the end game many see - and the central banks of US, UK, and Japan have began with their QE programs. 

Now the only argument to that is why would countries continue to lend us money knowing we are going to short change them by partially destroying the value of what we hand them in return?  The US has a unique advantage as the world's reserve currency and "safe haven status".  But in a larger sense that is a question that needs no answering for now, since it hasn't reached the point where people doubt the US.  And since no one knows when that point will be reached, it doesn't seem particulary concerning to anyone.  Let us keep an eye on the UK over the next 5 years as they, unlike Japan, appear to be the real base test model (almost all of Japan's debt is held by its own citizens, who have high savings rate - UK is more like the US, relying much more on foreigners).  Without the reserve currency they will not be able to get away with the things the US can, and will continue to get away with.  If something goes dramatically wrong with the "hey, we'll just inflate our way out of it suckers!" theory in the UK, it might cause some rethinking of the thesis below by Mr. Lehmann. 


But for now, it's an interesting read, which should make you absolutely giddy if you are a debtor (everything you borrow can be repaid in increasingly worthless fiat money) and frightened if you are a saver (everything you save, will be devalued over time).  As for the grandchildren?  Well, I guess under this theory they are home free.
  • The current spending habits of our Congress has led to numerous gloom and doom statements by politicians and pundits that hint at imminent disaster. While I am as distressed as anyone at the long-term effects of this spending, I believe the consequences are nowhere near as dire as we are led to believe. Let's look at these one at a time and deflate the rhetoric.
  • A favorite line is to refer to the buildup of the national debt as "leaving trillions of dollars to be paid by our children and grand children." The fact is, the national debt will not be paid back by us or anyone else. It will be rolled over and added to by each generation with the rising interest bill also being financed by more debt.
  • The above reality raises the fear that we will run out of debt issuing capacity as we run out of investors willing to buy all this debt. There are two aspects to this fear. First of all, how much debt can the U.S. issue before it runs out of buyers. Well, Japan has already issued debt equal to more than twice the gross national product of its country and still pays only modest interest rates. We are only at one times GNP and our debt is way more popular so there is little cause to fear we will face a buyer shortage anytime soon.
  • The second fear often heard is that foreign buyers of U.S. debt will simply refuse to buy more treasuries, presumably because they fear more erosion of the dollar (more on this later). The fact is that there is no other market as large or liquid as the U.S. treasuries market. When you are a foreign government with hundreds of billions of dollars to invest, there simply is nowhere else to invest it without taking on currency, market and credit risk. Yes they threaten and complain, but that's mainly because they resent being trapped into a position they would rather not be in.
  • We even hear comments that the U.S. faces imminent bankruptcy ala Greece, currently. The theory is that if you cannot sell new debt to refinance the old debt, that debt renunciation and bankruptcy is the inevitable consequence. This scenario ignores the fact that a national government does not go into bankruptcy simply because it always has the power of the printing press to pay off its debts, assuming it was prudent enough to denominate that debt in their own currency. Greece is vulnerable because it has relinquished its money creating power to the EEC; which thereby, however, has assumed some responsibility and liability if it doesn't help a member state. (hard to argue with this point)

Hence... the "grand solution"
  • Politicians worldwide will come to recognize that there is only one solution they can apply that allows them to bring their nations finances under control while not jeopardizing their political futures and that solution is inflation. Of course, no politicians or bureaucrats can ever admit this is a goal, so don't expect to see a lot of commentary on this. Inflation is to economics what sin is to religion.
  • We have all been steeped in the destructive aspects of inflation, but let's recognize that the destruction is in accumulated wealth, which is mainly owned by a small percentage of the population. Once you have taxed the wealthy's income to where it produces no more revenues, you tax their accumulated wealth via inflation.
  • The good side of inflation is that it enhances government revenues automatically while giving the politicians the ability to control the growth of expenses that are mainly salaries, pensions and other entitlements.
  • It also diminishes the value of the trillions in accumulated debt and unfunded entitlements and is extremely helpful when you have a housing glut and foreclosure problem.
  • We have a government bureaucracy that is overpaid, overstaffed, politically powerful and often unaccountable. Sad to say, because of the wealth and resilience of this country, this situation will have to get much worse in order to get better. Meanwhile, expect more rhetorical hyperbole. Be patient and invest defensively to guard against the inevitable inflation.


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