This is the script for my Demographic Doom podcast episode (#39) released on 10 April 2020. It may differ slightly from the final broadcast. This episode is available on major podcast platforms, including Podbean, Apple Podcasts and a video version on YouTube. See the description on the YouTube version for annotations, links and corrections. You can also comment on this episode there. (If you leave comments on this blog post, I might not see them.) The main website for this project is DemographicDoom.com
I’m Glenn Campbell. I call myself a demographic philosopher. I’m looking at life and trying to predict the future through the lens of demography, or the study of human populations.
Today I'm going to talk about the timebomb of U.S. government debt and the terrible things that will happen as it becomes less and less sustainable. This isn't a new topic to this podcast. I've talked about it before the virus, but it was mostly academic back then. Federal debt has been unsustainable since at least 2009, and something bad was destined to happen, but it was hard to pin down a timeline. As of late 2019, unpayable Federal debt had been building up for a decade, and for all I knew it could have continued to build up for years more before there was a reckoning.
Now, thanks to the virus, the day of reckoning is close at hand, and I predict that by the end of 2020, we will see major cracks in both the viability of U.S. debt and the value of the U.S. dollar. So in today's podcast, I am going to revisit Federal debt in the light of a crisis happening this year as opposed to some vague time in the future.
The bottom line is this: I expect significant inflation by the end of 2020, spiced with a healthy dose of deflation. The price of all the things you need will rise, while the price of all the things you don't need will drop. This will be a fine time to buy a luxury car but not to go grocery shopping. Meanwhile, the US government will become more and more dysfunctional as it's financial underpinning erode. The next Presidential administration, be it Trump or Biden, could be America's last.
I know these are outrageous claims, which is why I need a whole episode to back them up.
This is April 9, 2020, and the world is still in the midst of Lockdown Mania in response to COVID-19. However, the biggest event on the planet right now is not the epidemic itself. The truly epic, world-changing event—the biggest since World War II—is the collapse of the world economy. The virus didn't cause this collapse; it was merely the trigger. It turned out to be a very efficient trigger, but even if coronavirus had never happened, the world economy had built up so much dynamite that something would have set it off.
The dynamite took the form of massive worldwide debt and absurdly elevated asset prices, powered by the desperate policies of central banks in response to the Global Financial Crisis of 2008. Yes, central banks and big government saved the world economy in 2008, but only at the cost of kicking the can down the road toward an even bigger crisis in 2020.
In a wider view, there is a demographic source of dynamite, a sort of super-cycle stretching back some 70 years. Following WWII, there was a Baby Boom, and those babies grew up to fuel a huge economic boom in the late 20th Century. In the 21st Century, the fuel started getting depleted. The Baby Boomers began retiring in 2011, moving from being assets to society to liabilities. No matter how you slice it, we can't reproduce the breakneck growth of the late 20th Century, because we don't have enough workers to power it, but the whole financial system is still geared on the assumption that past growth will continue.
The rise and fall of the Baby Boomers is sufficient in itself to cause a financial collapse, but there are many other kinds of financial dysfunction afoot. I can't hope to cover them all in this episode, so I'm going to focus on one key area: US government debt. Part of this debt crisis is demographic, and part of it is due to years of political stupidity, because there is no penalty to politicians in borrowing from the future.
Before the virus arrived, the world economy was already an interlocking series of Ponzi schemes, paying off present investors at the expense of future ones. Ponzi schemes can go on for years in apparent stability, as did Berni Madoff's famous one, but when they collapse, they do it catastrophically, and one Ponzi scheme tends to pull down all the others, and that's what's happening today. 2020 is the year all the Ponzi schemes collapse. In this episode I'm going to talk about only one of them, Federal Debt and monetary policy, because of all these harebrained schemes, this is probably the easiest to understand.
I got into demography because it is the only social science that can make hard and reliable predictions. There is one fundamental, unbreakable law of demography: there won't be more people in the future than are born today. In other words, if your country makes a million babies this year, than it can have no more than a million native-born citizens of that age group 20, 40 or 60 years from now. There can be less than a million in each age group, because people die, but there can never be more. This fact sounds obvious, but it is a very powerful tool when predicting what the world will look like in the future.
Likewise, in economics, there is one fundamental law: In the long run, you can't spend more money than you make. You can't do it as a private citizen, and you can't do it as a government. There is no free lunch. You can borrow money from banks, credit card companies, family and friends to support a more extravagant lifestyle than you can afford, but you can't do it forever, because sooner or later, people will stop loaning you money.
If you're a consumer, there's usually a hard limit when credit is cut off. On a certain date, you're credit cards get maxed out, and no bank will give you a new one. You can default on your credit cards by simply not paying them, but now you have no choice but to live within your means. At best you'll have to go back to living hand to mouth. At worse, you'll have all your creditors knocking at your door trying to confiscate everything you own.
With a government, the limits are much more elastic. There's no hard date when credit is cut off, because the government or its surrogates control the money supply. In a pinch, they can print new money to pay off their debts, which is essentially how the US government is funding itself now. The only downside to money printing is inflation, or the devaluing of the currency. Consumer inflation has been more-or-less absent from the US economy for some 30 years, but it will be back, because you can't flaunt the laws of nature forever.
You can't spend more money than you make. If you don't believe this axiom already, there's probably nothing I can say to change your mind. There's all sorts of economic slight-of-hand theories, like Modern Monetary Theory, that allows otherwise intelligent people to believe it isn't true, you can spend more money than you make. I'm not going to go down the rabbit hole of arguing with these theories, because there's no way I can win. It's like arguing with someone about their religion. No logical argument will work.
You can't spend more money they you make. Either you believe this, or you need to stop listening. If you do spend more money than you make, and do it consistently over time, there will eventually be a Day of Reckoning, a day when the credit cards max out. You may be able to extend the date by borrowing money, but it only makes the reckoning more brutal.
For almost 20 years, the US government has failed to balance its budget, consistently spending more money than it makes. It does this by issuing bonds to the public, promising to pay in the future, which is just like spending on your credit card except at a much lower interest rate. Spending greatly accelerated during the Global Financial Crisis in 2008. The deficit was gradually brought down over the course of the Obama Administration, but it exploded again under Trump.
In 2019, before the virus, the math was pretty simple: The government spent about $4 trillion a year and took in only $3 trillion. You don't have to know what a trillion is to understand the math. 25% of the money the government spent was added to its credit card bill. Before the virus, the total outstanding debt was $22 trillion, or more than seven times the annual tax income of the government. By some measures, it could have been several times higher, maybe even $100 trillion, when you consider the government's future obligations for things like Medicare and Social Security. The exact trillions don't matter as much as the qualitative fact that the government always spends more than it makes, with no realistic prospect of ever paying down its outstanding debt.
And that was before the virus, which is an unprecedented economic disaster the likes of which the world has never seen. People are losing their jobs in vast numbers, which ultimately means less tax revenue for the government in 2020. Meanwhile, virtually every national response to the virus involves massive government spending, well beyond the previous $4 trillion. It's unclear yet what the damage will be, but it is reasonable to guess that taxes revenues will fall to something like $2 trillion, while the total government budget rises to $5 trillion or higher. In other words, the government will be borrowing more than half the money it spends in 2020, and perhaps into the following years as well. The government is closing the shortfall by issuing bonds, which investors around the world are expected to buy.
So how are investors responding to this glut of bonds? You would think they'd be running for the hills, but no. They're running directly into the fire. As of today, investors are eagerly buying all the bonds the government can issue and paying a premium to do so. It's the craziest thing. You've got an insolvent debtor, obviously living off his credit cards with no hope of every paying them down, and investors are lining up to loan him even more money. Max out one credit card? No problem. Here's another at a low introductory interest rate.
The eagerness of investors to buy US government debt is reflected in the yield, or the effective interest rate on the bonds. Although the government issues the bonds with a nominal interest rate, the actual interest rate is determined by the open market, and right now investors are willing to accept an interest rate on 10-year bonds (or T-Notes) of between 1/2 percent and one percent per year. In other words, if you loan the government $10,000, you'll receive at most $100 in interest for the entire year.
Clearly, investors aren't buying these bonds for the income. They are buying them as a perceived safe haven. In periods of market chaos like we've seen over the past month, investors are bailing out of stocks and other investments, and when they do, they have to put their money somewhere, and US government bonds are seen as the safest investment there is. US government debt can never fail, the reasoning goes, because the government controls the printing presses and can always print more money to pay its bills.
Yes, but... there's a cost to money printing, which is inflation. In other words, you can loan $10,000 to the government for 10 years and feel reasonably confident the government will pay you back at the end of this period, but $10,000 may not buy you as much as $10,000 now.
Despite 30 years of apparent stability, $10,000 does not have a fixed value. It is worth only what the parties who exchange it think it is worth at the time of the transaction. In other words, you can walk into a store with $10,000 in your pocket, and maybe you can buy the whole store, or maybe you can buy only a single egg. This has really, truly happened in many a banana republic. If you flood the market with too much of your own currency, the value of each unit of the currency goes down, and the price of products and services in terms of your currency go up. This is a law of nature that for the time being the US government seems to have evaded, but it's still a law of nature.
The main risk people are taking when they buy a government bond is not so much that the government doesn't pay, but that inflation erodes the value of the capital. In the beginning, you can buy the whole store, and at the end you can only buy a single egg. Properly speaking, the government hasn't defaulted and has held up its side of the bargain, but you still get screwed in the end.
If you were born USA in the 1980s or later, you have almost no experience with inflation. You think a dollar is worth a dollar. I, on the other hand, came of age in the 1970s and had a personal relationship with inflation. At the beginning of the 1970s, I could go into a candy story with a dime or two and come out with a lot of candy. Back then, they had something called "penny candy." There were a whole range of candy items under a glass case, each for a penny. A small Tootsie Roll was a penny, or a Mary Jane taffy. A stick of licorice was a penny. Candy cigarettes were three for a penny, and they were good! You would pretend to smoke them like a grown up. When you went to the candy story, you'd point out the things you wanted, and the lady behind the counter would put them in a bag for you. If you walked in with a quarter, you came out feeling like a millionaire in candy.
Standard-sized candy bars—the same Snickers and Hershey bars we buy today—were 5 cents at the beginning of the 1970s, but they didn't stay that way. Over the course of the 70s and early 80s, I saw their price rise to 7 cents, then 10 cents, 15 cents and 25 cents. Eventually, it stabilized at something around 60 cents sometime in the late 1980s. Today a Snickers bar is about $1 at the supermarket checkout, but I regard that as opportunism, not inflation. If you go to the back of the store and buy a multi-pack, the 60 cent price still holds.
I don't really remember when penny candy ceased to exist, because I aged out of the market anyway, but I distinctly remember the price of a standard-size Snickers, identical to the ones today, going from 5 cents to 60 cents in what seemed like short period of time. It was almost to the point where you would buy an extra Snickers right now, knowing that the price could go up next week.
That's what you youngsters don't understand. A dollar is not a dollar. It is worth only the number of Snickers bars it will buy. We've had inflation before, and believe me, we're going to have it again.
When will it happen? Well, apparently not right now, in April 2020. In this era of national lockdowns, no one is raising their prices for anything, especially when it's hard to get people into stores. McDonalds still has its dollar menu—for take-out only—and you can still go to a Dollar Tree store and buy things for a dollar that are pretty much the same things you could have bought there 30 years ago.
If anything, we're in a period of deflation now, especially for things you don't really need. No one is in the market for a car right now, and dealers are hurting, so maybe they'll cut you a deal. The Great Depression was a period of rampant deflation, called a deflationary spiral. The price of an apple kept going down because there were too many apples and too few buyers who could even afford an apple. Luxury cars were being sold on the street for pennies on the dollar by investors who lost everything in the crash. Deflation is a self-fulfilling prophesy, because it encourages people to hold onto their cash. Why buy a washing machine now when you know its going to be even cheaper in six months?
But back in the Great Depression, the government wasn't printing money like there's no tomorrow. Back then, the US dollar was supposed to be based on gold. It got a little flaky, but essentially the dollar in your pocket represented gold stored at Fort Knox, so the government couldn't just print money at will. Inflation took off only after 1971, when Richard Nixon took the US dollar off the gold standard. The dollar became a "fiat currency", meaning that it's not inherently worth anything. It can't be converted into gold. It can only be sold to another sucker for however many apples he chooses to give you for it. Going off the gold standard untethered the dollar and set the stage for the inflation of the 1970s and 80s.
So what this means today is that the government, or its surrogate the Federal Reserve, can print money at will without any restrictions. And the current environment makes it mandatory that the Fed prints more money. It simply has no choice. You may think of the Fed as an independent entity, but it isn't. If the government spends more money than it makes, the Fed is obligated to print more money to make up the shortfall.
I want to explain how money is created in the American system. It's actually quite simple. There are all sorts of fancy debt bubbles out there, debt Ponzi schemes, but most of them are hard to understand, because they are so obscure and complicated. US government and the US currency are not complicated. The system is completely open, and all the numbers are available at your fingertips.
So let's start with that basic 2019 calculation. The government spent $4 trillion and and took in $3 trillion in taxes. It's actually $4.5 trillion and $3.5 trillion, but I like round numbers and the exact amounts don't matter. The extra trillion has to come from someplace, and that's government bonds, notes and bills. I'll just call them government bonds. Periodically, the government issues bonds and offers them to the market at auction. Investors buy the bonds, and then they pass them back and forth between each other in a secondary market. Bonds are seen as highly liquid, meaning you can buy them one day and sell them the next, unlike an fixed asset such as real estate where you might not find a buyer at all.
As I said, investors around the world love US bonds right now. In an era of crashing markets, US bonds seem like the prettiest house on an ugly street. If you've got cash, US bonds seem like the safest place to stash it. There's gold, but that's a quagmire I really don't understand and don't care to get into. The point is, investors perceive US bonds to be a safe haven, whether or not it truly is.
You've got what seems to be the perfect symbiotic relationship: The government needs to borrow money, and investors are eager to loan it money at ridiculously low interest rates. What could possibly go wrong?
What could go wrong is that the government eventually issues more debt than than the market can bear. As of the end of 2019, the government had $22 trillion in outstanding bonds. At what point has it issued to much? $40 trillion? $60 trillion? I have no idea. This isn't like the fixed credit limit on your credit card. There's not clear cut-off point, but there will be a point where things start falling apart. And once things disintegrate enough, there's usually a catastrophic failure.
US bonds are really no different than any other commodity, like watermelons. If they are relatively rare, each watermelon can command a high price. If you flood the market with watermelons, then eventually the price falls. If there's a glut of watermelons, to the point where every grocer has a ton of them, then the price can truly plummet, because they got to move these watermelons before they rot.
For a bond, the price is reflected in the "yield" or the interest rate that investors are willing to accept to hold the bond. If bonds are desirable, as they are today, the yield is low, between 1/2 and 1 percent. Those are wonderful watermelons! When bonds are more plentiful and less desirable, the yield goes up. Investors expect to receive more interest in exchange for loaning the government money. The yield also rises on anticipation of inflation. If you expect the $10,000 you give the government to be devalued to the buying power of $8,000 over the course of the bond, you're going to demand a higher interest rate to compensate.
I visited Ukraine about 5 years ago, and I saw a billboard for a Certificate of Deposit at an interest rate of some 40% per year. My jaw dropped at that, and I double-checked my translation. This implies that the inflation of the Ukrainian hryvnia was running at something like 35% per year. In an economy like this, you definitely don't want to keep your hryvnias in a mattress, because they will be devalued by 35% in a year, and in 10 years they'll hardly be worth more than the stuffing in the mattress. If you've got hryvnias in your pocket, you want to get rid of them as quickly as possible, because the coins and bills are losing value every day. Instead, you'll buy a CD or a foreign currency or some commodity like Snickers bars that you know you can resell later and retain your buying power.
This little diversion into hryvnias actually has some relevance to my thesis, because I want you to imagine if US inflation went that high. People would want to get rid of their dollars as quickly as possible, which actually accelerates inflation. People aren't keeping anything in their mattress or piggy bank. They are dumping every dollar they get back into the market, preferring commodities like Snickers bars instead. This is called the "velocity of money", or the number of times a unit of currency changes hands in a given period. As the velocity of money increases, so does inflation.
I'm not just playing mind games here. I truly believe that at some time in the future—I'm not saying when.—the US dollar will match Ukraine's inflation rate. You can call me a fool, because it certainly isn't true today. If investors are willing to commit now to loaning the government money for ten years at a yield of 1% per year, it implies not only that general interest rates will remain low for those ten years but that inflation will be virtually nonexistent for those ten years.
This is a truly insane proposition. Right now the official inflation rate is 2%. There all sorts of ways you can argue with that number, but it's not zero, and it is probably higher than the 1% yield on the bond. This means effectively that investors are loaning money to the government at a negative interest rate. They are getting less out of the deal than the money they put in. This is truly insane, and although markets can sustain their insanity for a long time, eventually reality crashes the party.
Reality will take the form of investors say, "I already have all the US bonds I want, I don't want anymore. I already have enough watermelons." At this point, the yield rises and the government has trouble selling all the bonds it issues. The market doesn't want them anymore unless they are a true money maker. I might still loan $10,000 to the government for 10 years, but I might expect a 10% interest rate to compensate for potential inflation and a potential government default.
Could the government really default? It wouldn't happen tomorrow, but over the course of 10 years of financial chaos, who knows? In any case, if I were to loan money to a dodgy debtor, I would expect a yield that is high enough to justify the risk.
So what happens when the government reaches the point where it has issued so many bonds that the market can't absorb them and yield rises? Is there any recourse? As a matter of fact, there is. There's the Federal Reserve, which is a supposedly independent bank that manages the money supply. If you look a dollar bill, you'll see that it isn't issued by the US government proper. It is issued by the Federal Reserve. It's a Federal Reserve Note. The government issues government bonds, but the Fed issues the currency and controls how much of it is in circulation. In theory, it can increase inflation by issuing new currency and decrease inflation by taking currency out of the system.
It is the Fed, not the government, that prints the money, although "printing" is a misnomer. The Fed creates money simply by adding digits to the account of a member bank, but "printing money" is still a pretty good analogy. The Fed can print money whenever it wants for whatever reason it wants, because it is nominally independent of the US government.
The way money printing works is the Fed buys something from the marketplace. In most cases, it is US government bonds, but in practice it could probably buy anything. The Fed could buy Snickers bars. I'm sure there are rules against the Fed buying Snickers bars, but there's no one to enforce the rules. When the Fed buys something, usually bonds, it creates new money out of thin air to give to the seller. It is increasing the money supply and risking inflation.
So how the process works is the government issues bonds to fund its deficit and sells the bonds to the public, then the Fed buys the bonds from the public and creates new money to gives to the seller. Money supply increases. So how is this different than the Fed just buying the bonds directly from the government? The truth is, it isn't. For all practical purposes, the Fed is buying the bonds directly from the government. The government is spending money and the Federal Reserve is printing the money to pay for it.
The amount of money printed is reflected in the Fed's "balance sheet" or the assets it technically holds. Right now, the balance sheet is roughly $5 trillion. This isn't all government bonds, but it's an artificial support. The Fed has printed $5 trillion in new money, quite recently for the most part, to prop up both the government and the financial sector, and at this point there's virtually no hope of the money printing ever stopping.
If government issues too many bonds, to the point where investors lose their taste for them and start demanding higher interest, the Fed is essentially obligated to step in and buy bonds. It has to buy watermelons to reduce the supply and prop up the watermelon market. It creates new money that in essence the government uses to pay its bills. It's a perfect system: The government spends more than it makes and the Fed prints the money to fund that spending.
It's a perfect system except for... inflation! If any government keeps printing money to pay its bills, eventually inflation rears its ugly head. It's true in any Latin American banana republic, and it's true in our banana republic. It's just that in our republic, there's been a delay. The Fed has been printing money with abandon, but there's been little apparent inflation. What gives? Where is the inflation gone?
The answer is, it's hiding. In two places that I am aware of. One hiding place is in plain sight. It's called "asset inflation." The price of a Snickers bar may not have changed, but housing prices have gone way up, especially in the desirable places where people most want to live. If you live in San Francisco, you've seen massive inflation in your housing costs. Before the virus, virtually all assets, from stocks to bonds to fine art, were vastly inflated. All of those assets are now in the process of deflating.
The second hiding place is mattresses in Ukraine. If you're a shady businessman in Kiev, dealing only in cash, you're not going to keep hryvnias in your mattress, because they'll lose value instantly, but you might keep US dollars in your mattress, because they are perceived to be stable. For decades, the US $100 bill has been the preferred store of value for drug lords everywhere. The US dollar is also a haven currency for legitimate investors. It's seen a safe haven at least compared to other currencies. So what might be happening here is the Fed is printing money, but if investors are stockpiling dollars at about the same rate, then there's no net excess of dollars and no inflation.
This just speculation on my part. I'm not sure that it's Ukrainian mattresses that are soaking up the extra dollars. All I know is that there's a certain market for dollars, just like watermelons, and once the watermelon market reaches saturation, the price is going to take a drive. What a price crash means for the dollar is inflation, where the dollar in your pocket doesn't buy what it used to. You can't buy a dollar cheeseburger at McDonalds anymore. It's now a 2-dollar cheeseburger.
Once you start to get substantial inflation in the US dollar, then a switch gets flipped, and everything changes very quickly. All those folks in Ukraine with dollars in their mattresses suddenly don't want to keep them anymore. They sell their dollars into the market to buy some other store of value, like Snickers bars. Suddenly the velocity of dollars increases dramatically. Dollars aren't just sitting in mattresses or dresser drawers. They are immediately returned to the market to buy something else. This in itself causes inflation, since there are so many dollars seeking too few buyers.
That's what is behind the hyperinflation of places like Venezuela and Zimbabwe. Not only is the government printing money to pay all its bills, but consumers don't want to hold onto their money for for more than two seconds. They immediately use their money to buy some tangible thing that will hold its value.
I got a sense of this mindset in the 1970s. There was always a pressure to buy something now, rather than later, because you didn't know when the prices was going to rise again. People got rid of their dollars, or at least put them into high-yielding bank accounts, because you didn't want to hold onto your cash for too long.
I predict that all will this will be coming back sooner or later, and I'm placing my bets on sooner. I'm thinking of 1970s-style inflation, like 10-20% by the end of 2020 and Ukrainian-style inflation, 30-40% sometime thereafter. Don't hold me to the timetable, because I don't know the saturation point where the world has absorbed all the dollars it can. I will only predict that inflation will not be a gradual process. It will happen very quickly, because once you reach a certain key threshhold, it starts triggering all sorts of feedback loops, like people emptying their mattresses of dollars.
So why is the Fed obligated to print dollars. It is supposed to be an independent agency, so why can't it just tell the government, "We're not going to fund your spending anymore." It could do that, but then we'd have a bond crisis instead, which is just as bad for the economy as inflation. So at some point the bonds issued by the government are going to run into market saturation where the supply exceeds the demand, and the price drops. The "price" is actually reflected in an increased yield. Investors expect a higher interest rate to loan money to the government.
Historically, the interest rate on long-term government bonds tends to hover around 5%, but following the Global Financial Crisis, the yield has been artificially low, bottoming out at the below-1% yields we see today. This is great for the government, at least on the surface, because it mean that for all the debt it has outstanding, it is paying relatively little total interest. This like getting a new credit card that offers you a "Low Introductory Rate" of 0%. This is great for as long as the low rate lasts, but it sucks as soon as the introductory period ends and you're paying 18%.
So an excess of bonds means a rising interest rate, and the government has to spend substantial tax revenue on interest alone. If the government has $22 trillion in debt, which it has to roll over at periodic intervals, and the interest rate rises to the normal level of 5%, the government now has to pay over $1 trillion in annual interest payments alone. If tax revenue is only $3 trillion a year, and even down to $2 trillion during 2020, the government is now spending something like half its tax revenue on interest payments alone. Of course, it doesn't have the money, so it will borrow the $1 trillion for interest payments, further adding to the supply of bonds and driving up the yields.
This is a vicious feedback loop that eventually ends in the collapse of the government, which the Fed can't allow. Instead, the Fed is going to buy the excess bonds to drive down the yield to a manageable interest rates. The money it prints to buy the bonds eventually results in inflation, which isn't good either, so the Fed is between a rock and hard place. It has no control over how much money the government spends or how many bonds it issues, but it is obligated to print money to fund it.
It's a doom loop, no matter how you look at it.
So that's about as far as I want to go right now. There are all sorts of questions like, what happens when inflation comes back, and what happens when the government can't borrow money anymore at ridiculously low interest rates? My only answer right now is "Bad things will happen" but it is hard to say exactly what will happen and when.
It's like the Titanic is sinking, taking in more water than it can pump out. You know it's going down and there aren't enough lifeboats, but you don't know who's going to be saved, who's gonna die, when the event will happen or how the ship is going to break apart as it sinks.
Once a doom loop has started, it's difficult to predict where it will end.
Written recorded and edited by Glenn Campbell. For annotations, links and corrections, see the description on the video version of this podcast. You can also leave comments there.
I’m Glenn Campbell. I call myself a demographic philosopher. I’m looking at life and trying to predict the future through the lens of demography, or the study of human populations.
Today I'm going to talk about the timebomb of U.S. government debt and the terrible things that will happen as it becomes less and less sustainable. This isn't a new topic to this podcast. I've talked about it before the virus, but it was mostly academic back then. Federal debt has been unsustainable since at least 2009, and something bad was destined to happen, but it was hard to pin down a timeline. As of late 2019, unpayable Federal debt had been building up for a decade, and for all I knew it could have continued to build up for years more before there was a reckoning.
Now, thanks to the virus, the day of reckoning is close at hand, and I predict that by the end of 2020, we will see major cracks in both the viability of U.S. debt and the value of the U.S. dollar. So in today's podcast, I am going to revisit Federal debt in the light of a crisis happening this year as opposed to some vague time in the future.
The bottom line is this: I expect significant inflation by the end of 2020, spiced with a healthy dose of deflation. The price of all the things you need will rise, while the price of all the things you don't need will drop. This will be a fine time to buy a luxury car but not to go grocery shopping. Meanwhile, the US government will become more and more dysfunctional as it's financial underpinning erode. The next Presidential administration, be it Trump or Biden, could be America's last.
I know these are outrageous claims, which is why I need a whole episode to back them up.
This is April 9, 2020, and the world is still in the midst of Lockdown Mania in response to COVID-19. However, the biggest event on the planet right now is not the epidemic itself. The truly epic, world-changing event—the biggest since World War II—is the collapse of the world economy. The virus didn't cause this collapse; it was merely the trigger. It turned out to be a very efficient trigger, but even if coronavirus had never happened, the world economy had built up so much dynamite that something would have set it off.
The dynamite took the form of massive worldwide debt and absurdly elevated asset prices, powered by the desperate policies of central banks in response to the Global Financial Crisis of 2008. Yes, central banks and big government saved the world economy in 2008, but only at the cost of kicking the can down the road toward an even bigger crisis in 2020.
In a wider view, there is a demographic source of dynamite, a sort of super-cycle stretching back some 70 years. Following WWII, there was a Baby Boom, and those babies grew up to fuel a huge economic boom in the late 20th Century. In the 21st Century, the fuel started getting depleted. The Baby Boomers began retiring in 2011, moving from being assets to society to liabilities. No matter how you slice it, we can't reproduce the breakneck growth of the late 20th Century, because we don't have enough workers to power it, but the whole financial system is still geared on the assumption that past growth will continue.
The rise and fall of the Baby Boomers is sufficient in itself to cause a financial collapse, but there are many other kinds of financial dysfunction afoot. I can't hope to cover them all in this episode, so I'm going to focus on one key area: US government debt. Part of this debt crisis is demographic, and part of it is due to years of political stupidity, because there is no penalty to politicians in borrowing from the future.
Before the virus arrived, the world economy was already an interlocking series of Ponzi schemes, paying off present investors at the expense of future ones. Ponzi schemes can go on for years in apparent stability, as did Berni Madoff's famous one, but when they collapse, they do it catastrophically, and one Ponzi scheme tends to pull down all the others, and that's what's happening today. 2020 is the year all the Ponzi schemes collapse. In this episode I'm going to talk about only one of them, Federal Debt and monetary policy, because of all these harebrained schemes, this is probably the easiest to understand.
I got into demography because it is the only social science that can make hard and reliable predictions. There is one fundamental, unbreakable law of demography: there won't be more people in the future than are born today. In other words, if your country makes a million babies this year, than it can have no more than a million native-born citizens of that age group 20, 40 or 60 years from now. There can be less than a million in each age group, because people die, but there can never be more. This fact sounds obvious, but it is a very powerful tool when predicting what the world will look like in the future.
Likewise, in economics, there is one fundamental law: In the long run, you can't spend more money than you make. You can't do it as a private citizen, and you can't do it as a government. There is no free lunch. You can borrow money from banks, credit card companies, family and friends to support a more extravagant lifestyle than you can afford, but you can't do it forever, because sooner or later, people will stop loaning you money.
If you're a consumer, there's usually a hard limit when credit is cut off. On a certain date, you're credit cards get maxed out, and no bank will give you a new one. You can default on your credit cards by simply not paying them, but now you have no choice but to live within your means. At best you'll have to go back to living hand to mouth. At worse, you'll have all your creditors knocking at your door trying to confiscate everything you own.
With a government, the limits are much more elastic. There's no hard date when credit is cut off, because the government or its surrogates control the money supply. In a pinch, they can print new money to pay off their debts, which is essentially how the US government is funding itself now. The only downside to money printing is inflation, or the devaluing of the currency. Consumer inflation has been more-or-less absent from the US economy for some 30 years, but it will be back, because you can't flaunt the laws of nature forever.
You can't spend more money than you make. If you don't believe this axiom already, there's probably nothing I can say to change your mind. There's all sorts of economic slight-of-hand theories, like Modern Monetary Theory, that allows otherwise intelligent people to believe it isn't true, you can spend more money than you make. I'm not going to go down the rabbit hole of arguing with these theories, because there's no way I can win. It's like arguing with someone about their religion. No logical argument will work.
You can't spend more money they you make. Either you believe this, or you need to stop listening. If you do spend more money than you make, and do it consistently over time, there will eventually be a Day of Reckoning, a day when the credit cards max out. You may be able to extend the date by borrowing money, but it only makes the reckoning more brutal.
For almost 20 years, the US government has failed to balance its budget, consistently spending more money than it makes. It does this by issuing bonds to the public, promising to pay in the future, which is just like spending on your credit card except at a much lower interest rate. Spending greatly accelerated during the Global Financial Crisis in 2008. The deficit was gradually brought down over the course of the Obama Administration, but it exploded again under Trump.
In 2019, before the virus, the math was pretty simple: The government spent about $4 trillion a year and took in only $3 trillion. You don't have to know what a trillion is to understand the math. 25% of the money the government spent was added to its credit card bill. Before the virus, the total outstanding debt was $22 trillion, or more than seven times the annual tax income of the government. By some measures, it could have been several times higher, maybe even $100 trillion, when you consider the government's future obligations for things like Medicare and Social Security. The exact trillions don't matter as much as the qualitative fact that the government always spends more than it makes, with no realistic prospect of ever paying down its outstanding debt.
And that was before the virus, which is an unprecedented economic disaster the likes of which the world has never seen. People are losing their jobs in vast numbers, which ultimately means less tax revenue for the government in 2020. Meanwhile, virtually every national response to the virus involves massive government spending, well beyond the previous $4 trillion. It's unclear yet what the damage will be, but it is reasonable to guess that taxes revenues will fall to something like $2 trillion, while the total government budget rises to $5 trillion or higher. In other words, the government will be borrowing more than half the money it spends in 2020, and perhaps into the following years as well. The government is closing the shortfall by issuing bonds, which investors around the world are expected to buy.
So how are investors responding to this glut of bonds? You would think they'd be running for the hills, but no. They're running directly into the fire. As of today, investors are eagerly buying all the bonds the government can issue and paying a premium to do so. It's the craziest thing. You've got an insolvent debtor, obviously living off his credit cards with no hope of every paying them down, and investors are lining up to loan him even more money. Max out one credit card? No problem. Here's another at a low introductory interest rate.
The eagerness of investors to buy US government debt is reflected in the yield, or the effective interest rate on the bonds. Although the government issues the bonds with a nominal interest rate, the actual interest rate is determined by the open market, and right now investors are willing to accept an interest rate on 10-year bonds (or T-Notes) of between 1/2 percent and one percent per year. In other words, if you loan the government $10,000, you'll receive at most $100 in interest for the entire year.
Clearly, investors aren't buying these bonds for the income. They are buying them as a perceived safe haven. In periods of market chaos like we've seen over the past month, investors are bailing out of stocks and other investments, and when they do, they have to put their money somewhere, and US government bonds are seen as the safest investment there is. US government debt can never fail, the reasoning goes, because the government controls the printing presses and can always print more money to pay its bills.
Yes, but... there's a cost to money printing, which is inflation. In other words, you can loan $10,000 to the government for 10 years and feel reasonably confident the government will pay you back at the end of this period, but $10,000 may not buy you as much as $10,000 now.
Despite 30 years of apparent stability, $10,000 does not have a fixed value. It is worth only what the parties who exchange it think it is worth at the time of the transaction. In other words, you can walk into a store with $10,000 in your pocket, and maybe you can buy the whole store, or maybe you can buy only a single egg. This has really, truly happened in many a banana republic. If you flood the market with too much of your own currency, the value of each unit of the currency goes down, and the price of products and services in terms of your currency go up. This is a law of nature that for the time being the US government seems to have evaded, but it's still a law of nature.
The main risk people are taking when they buy a government bond is not so much that the government doesn't pay, but that inflation erodes the value of the capital. In the beginning, you can buy the whole store, and at the end you can only buy a single egg. Properly speaking, the government hasn't defaulted and has held up its side of the bargain, but you still get screwed in the end.
If you were born USA in the 1980s or later, you have almost no experience with inflation. You think a dollar is worth a dollar. I, on the other hand, came of age in the 1970s and had a personal relationship with inflation. At the beginning of the 1970s, I could go into a candy story with a dime or two and come out with a lot of candy. Back then, they had something called "penny candy." There were a whole range of candy items under a glass case, each for a penny. A small Tootsie Roll was a penny, or a Mary Jane taffy. A stick of licorice was a penny. Candy cigarettes were three for a penny, and they were good! You would pretend to smoke them like a grown up. When you went to the candy story, you'd point out the things you wanted, and the lady behind the counter would put them in a bag for you. If you walked in with a quarter, you came out feeling like a millionaire in candy.
Standard-sized candy bars—the same Snickers and Hershey bars we buy today—were 5 cents at the beginning of the 1970s, but they didn't stay that way. Over the course of the 70s and early 80s, I saw their price rise to 7 cents, then 10 cents, 15 cents and 25 cents. Eventually, it stabilized at something around 60 cents sometime in the late 1980s. Today a Snickers bar is about $1 at the supermarket checkout, but I regard that as opportunism, not inflation. If you go to the back of the store and buy a multi-pack, the 60 cent price still holds.
I don't really remember when penny candy ceased to exist, because I aged out of the market anyway, but I distinctly remember the price of a standard-size Snickers, identical to the ones today, going from 5 cents to 60 cents in what seemed like short period of time. It was almost to the point where you would buy an extra Snickers right now, knowing that the price could go up next week.
That's what you youngsters don't understand. A dollar is not a dollar. It is worth only the number of Snickers bars it will buy. We've had inflation before, and believe me, we're going to have it again.
When will it happen? Well, apparently not right now, in April 2020. In this era of national lockdowns, no one is raising their prices for anything, especially when it's hard to get people into stores. McDonalds still has its dollar menu—for take-out only—and you can still go to a Dollar Tree store and buy things for a dollar that are pretty much the same things you could have bought there 30 years ago.
If anything, we're in a period of deflation now, especially for things you don't really need. No one is in the market for a car right now, and dealers are hurting, so maybe they'll cut you a deal. The Great Depression was a period of rampant deflation, called a deflationary spiral. The price of an apple kept going down because there were too many apples and too few buyers who could even afford an apple. Luxury cars were being sold on the street for pennies on the dollar by investors who lost everything in the crash. Deflation is a self-fulfilling prophesy, because it encourages people to hold onto their cash. Why buy a washing machine now when you know its going to be even cheaper in six months?
But back in the Great Depression, the government wasn't printing money like there's no tomorrow. Back then, the US dollar was supposed to be based on gold. It got a little flaky, but essentially the dollar in your pocket represented gold stored at Fort Knox, so the government couldn't just print money at will. Inflation took off only after 1971, when Richard Nixon took the US dollar off the gold standard. The dollar became a "fiat currency", meaning that it's not inherently worth anything. It can't be converted into gold. It can only be sold to another sucker for however many apples he chooses to give you for it. Going off the gold standard untethered the dollar and set the stage for the inflation of the 1970s and 80s.
So what this means today is that the government, or its surrogate the Federal Reserve, can print money at will without any restrictions. And the current environment makes it mandatory that the Fed prints more money. It simply has no choice. You may think of the Fed as an independent entity, but it isn't. If the government spends more money than it makes, the Fed is obligated to print more money to make up the shortfall.
I want to explain how money is created in the American system. It's actually quite simple. There are all sorts of fancy debt bubbles out there, debt Ponzi schemes, but most of them are hard to understand, because they are so obscure and complicated. US government and the US currency are not complicated. The system is completely open, and all the numbers are available at your fingertips.
So let's start with that basic 2019 calculation. The government spent $4 trillion and and took in $3 trillion in taxes. It's actually $4.5 trillion and $3.5 trillion, but I like round numbers and the exact amounts don't matter. The extra trillion has to come from someplace, and that's government bonds, notes and bills. I'll just call them government bonds. Periodically, the government issues bonds and offers them to the market at auction. Investors buy the bonds, and then they pass them back and forth between each other in a secondary market. Bonds are seen as highly liquid, meaning you can buy them one day and sell them the next, unlike an fixed asset such as real estate where you might not find a buyer at all.
As I said, investors around the world love US bonds right now. In an era of crashing markets, US bonds seem like the prettiest house on an ugly street. If you've got cash, US bonds seem like the safest place to stash it. There's gold, but that's a quagmire I really don't understand and don't care to get into. The point is, investors perceive US bonds to be a safe haven, whether or not it truly is.
You've got what seems to be the perfect symbiotic relationship: The government needs to borrow money, and investors are eager to loan it money at ridiculously low interest rates. What could possibly go wrong?
What could go wrong is that the government eventually issues more debt than than the market can bear. As of the end of 2019, the government had $22 trillion in outstanding bonds. At what point has it issued to much? $40 trillion? $60 trillion? I have no idea. This isn't like the fixed credit limit on your credit card. There's not clear cut-off point, but there will be a point where things start falling apart. And once things disintegrate enough, there's usually a catastrophic failure.
US bonds are really no different than any other commodity, like watermelons. If they are relatively rare, each watermelon can command a high price. If you flood the market with watermelons, then eventually the price falls. If there's a glut of watermelons, to the point where every grocer has a ton of them, then the price can truly plummet, because they got to move these watermelons before they rot.
For a bond, the price is reflected in the "yield" or the interest rate that investors are willing to accept to hold the bond. If bonds are desirable, as they are today, the yield is low, between 1/2 and 1 percent. Those are wonderful watermelons! When bonds are more plentiful and less desirable, the yield goes up. Investors expect to receive more interest in exchange for loaning the government money. The yield also rises on anticipation of inflation. If you expect the $10,000 you give the government to be devalued to the buying power of $8,000 over the course of the bond, you're going to demand a higher interest rate to compensate.
I visited Ukraine about 5 years ago, and I saw a billboard for a Certificate of Deposit at an interest rate of some 40% per year. My jaw dropped at that, and I double-checked my translation. This implies that the inflation of the Ukrainian hryvnia was running at something like 35% per year. In an economy like this, you definitely don't want to keep your hryvnias in a mattress, because they will be devalued by 35% in a year, and in 10 years they'll hardly be worth more than the stuffing in the mattress. If you've got hryvnias in your pocket, you want to get rid of them as quickly as possible, because the coins and bills are losing value every day. Instead, you'll buy a CD or a foreign currency or some commodity like Snickers bars that you know you can resell later and retain your buying power.
This little diversion into hryvnias actually has some relevance to my thesis, because I want you to imagine if US inflation went that high. People would want to get rid of their dollars as quickly as possible, which actually accelerates inflation. People aren't keeping anything in their mattress or piggy bank. They are dumping every dollar they get back into the market, preferring commodities like Snickers bars instead. This is called the "velocity of money", or the number of times a unit of currency changes hands in a given period. As the velocity of money increases, so does inflation.
I'm not just playing mind games here. I truly believe that at some time in the future—I'm not saying when.—the US dollar will match Ukraine's inflation rate. You can call me a fool, because it certainly isn't true today. If investors are willing to commit now to loaning the government money for ten years at a yield of 1% per year, it implies not only that general interest rates will remain low for those ten years but that inflation will be virtually nonexistent for those ten years.
This is a truly insane proposition. Right now the official inflation rate is 2%. There all sorts of ways you can argue with that number, but it's not zero, and it is probably higher than the 1% yield on the bond. This means effectively that investors are loaning money to the government at a negative interest rate. They are getting less out of the deal than the money they put in. This is truly insane, and although markets can sustain their insanity for a long time, eventually reality crashes the party.
Reality will take the form of investors say, "I already have all the US bonds I want, I don't want anymore. I already have enough watermelons." At this point, the yield rises and the government has trouble selling all the bonds it issues. The market doesn't want them anymore unless they are a true money maker. I might still loan $10,000 to the government for 10 years, but I might expect a 10% interest rate to compensate for potential inflation and a potential government default.
Could the government really default? It wouldn't happen tomorrow, but over the course of 10 years of financial chaos, who knows? In any case, if I were to loan money to a dodgy debtor, I would expect a yield that is high enough to justify the risk.
So what happens when the government reaches the point where it has issued so many bonds that the market can't absorb them and yield rises? Is there any recourse? As a matter of fact, there is. There's the Federal Reserve, which is a supposedly independent bank that manages the money supply. If you look a dollar bill, you'll see that it isn't issued by the US government proper. It is issued by the Federal Reserve. It's a Federal Reserve Note. The government issues government bonds, but the Fed issues the currency and controls how much of it is in circulation. In theory, it can increase inflation by issuing new currency and decrease inflation by taking currency out of the system.
It is the Fed, not the government, that prints the money, although "printing" is a misnomer. The Fed creates money simply by adding digits to the account of a member bank, but "printing money" is still a pretty good analogy. The Fed can print money whenever it wants for whatever reason it wants, because it is nominally independent of the US government.
The way money printing works is the Fed buys something from the marketplace. In most cases, it is US government bonds, but in practice it could probably buy anything. The Fed could buy Snickers bars. I'm sure there are rules against the Fed buying Snickers bars, but there's no one to enforce the rules. When the Fed buys something, usually bonds, it creates new money out of thin air to give to the seller. It is increasing the money supply and risking inflation.
So how the process works is the government issues bonds to fund its deficit and sells the bonds to the public, then the Fed buys the bonds from the public and creates new money to gives to the seller. Money supply increases. So how is this different than the Fed just buying the bonds directly from the government? The truth is, it isn't. For all practical purposes, the Fed is buying the bonds directly from the government. The government is spending money and the Federal Reserve is printing the money to pay for it.
The amount of money printed is reflected in the Fed's "balance sheet" or the assets it technically holds. Right now, the balance sheet is roughly $5 trillion. This isn't all government bonds, but it's an artificial support. The Fed has printed $5 trillion in new money, quite recently for the most part, to prop up both the government and the financial sector, and at this point there's virtually no hope of the money printing ever stopping.
If government issues too many bonds, to the point where investors lose their taste for them and start demanding higher interest, the Fed is essentially obligated to step in and buy bonds. It has to buy watermelons to reduce the supply and prop up the watermelon market. It creates new money that in essence the government uses to pay its bills. It's a perfect system: The government spends more than it makes and the Fed prints the money to fund that spending.
It's a perfect system except for... inflation! If any government keeps printing money to pay its bills, eventually inflation rears its ugly head. It's true in any Latin American banana republic, and it's true in our banana republic. It's just that in our republic, there's been a delay. The Fed has been printing money with abandon, but there's been little apparent inflation. What gives? Where is the inflation gone?
The answer is, it's hiding. In two places that I am aware of. One hiding place is in plain sight. It's called "asset inflation." The price of a Snickers bar may not have changed, but housing prices have gone way up, especially in the desirable places where people most want to live. If you live in San Francisco, you've seen massive inflation in your housing costs. Before the virus, virtually all assets, from stocks to bonds to fine art, were vastly inflated. All of those assets are now in the process of deflating.
The second hiding place is mattresses in Ukraine. If you're a shady businessman in Kiev, dealing only in cash, you're not going to keep hryvnias in your mattress, because they'll lose value instantly, but you might keep US dollars in your mattress, because they are perceived to be stable. For decades, the US $100 bill has been the preferred store of value for drug lords everywhere. The US dollar is also a haven currency for legitimate investors. It's seen a safe haven at least compared to other currencies. So what might be happening here is the Fed is printing money, but if investors are stockpiling dollars at about the same rate, then there's no net excess of dollars and no inflation.
This just speculation on my part. I'm not sure that it's Ukrainian mattresses that are soaking up the extra dollars. All I know is that there's a certain market for dollars, just like watermelons, and once the watermelon market reaches saturation, the price is going to take a drive. What a price crash means for the dollar is inflation, where the dollar in your pocket doesn't buy what it used to. You can't buy a dollar cheeseburger at McDonalds anymore. It's now a 2-dollar cheeseburger.
Once you start to get substantial inflation in the US dollar, then a switch gets flipped, and everything changes very quickly. All those folks in Ukraine with dollars in their mattresses suddenly don't want to keep them anymore. They sell their dollars into the market to buy some other store of value, like Snickers bars. Suddenly the velocity of dollars increases dramatically. Dollars aren't just sitting in mattresses or dresser drawers. They are immediately returned to the market to buy something else. This in itself causes inflation, since there are so many dollars seeking too few buyers.
That's what is behind the hyperinflation of places like Venezuela and Zimbabwe. Not only is the government printing money to pay all its bills, but consumers don't want to hold onto their money for for more than two seconds. They immediately use their money to buy some tangible thing that will hold its value.
I got a sense of this mindset in the 1970s. There was always a pressure to buy something now, rather than later, because you didn't know when the prices was going to rise again. People got rid of their dollars, or at least put them into high-yielding bank accounts, because you didn't want to hold onto your cash for too long.
I predict that all will this will be coming back sooner or later, and I'm placing my bets on sooner. I'm thinking of 1970s-style inflation, like 10-20% by the end of 2020 and Ukrainian-style inflation, 30-40% sometime thereafter. Don't hold me to the timetable, because I don't know the saturation point where the world has absorbed all the dollars it can. I will only predict that inflation will not be a gradual process. It will happen very quickly, because once you reach a certain key threshhold, it starts triggering all sorts of feedback loops, like people emptying their mattresses of dollars.
So why is the Fed obligated to print dollars. It is supposed to be an independent agency, so why can't it just tell the government, "We're not going to fund your spending anymore." It could do that, but then we'd have a bond crisis instead, which is just as bad for the economy as inflation. So at some point the bonds issued by the government are going to run into market saturation where the supply exceeds the demand, and the price drops. The "price" is actually reflected in an increased yield. Investors expect a higher interest rate to loan money to the government.
Historically, the interest rate on long-term government bonds tends to hover around 5%, but following the Global Financial Crisis, the yield has been artificially low, bottoming out at the below-1% yields we see today. This is great for the government, at least on the surface, because it mean that for all the debt it has outstanding, it is paying relatively little total interest. This like getting a new credit card that offers you a "Low Introductory Rate" of 0%. This is great for as long as the low rate lasts, but it sucks as soon as the introductory period ends and you're paying 18%.
So an excess of bonds means a rising interest rate, and the government has to spend substantial tax revenue on interest alone. If the government has $22 trillion in debt, which it has to roll over at periodic intervals, and the interest rate rises to the normal level of 5%, the government now has to pay over $1 trillion in annual interest payments alone. If tax revenue is only $3 trillion a year, and even down to $2 trillion during 2020, the government is now spending something like half its tax revenue on interest payments alone. Of course, it doesn't have the money, so it will borrow the $1 trillion for interest payments, further adding to the supply of bonds and driving up the yields.
This is a vicious feedback loop that eventually ends in the collapse of the government, which the Fed can't allow. Instead, the Fed is going to buy the excess bonds to drive down the yield to a manageable interest rates. The money it prints to buy the bonds eventually results in inflation, which isn't good either, so the Fed is between a rock and hard place. It has no control over how much money the government spends or how many bonds it issues, but it is obligated to print money to fund it.
It's a doom loop, no matter how you look at it.
So that's about as far as I want to go right now. There are all sorts of questions like, what happens when inflation comes back, and what happens when the government can't borrow money anymore at ridiculously low interest rates? My only answer right now is "Bad things will happen" but it is hard to say exactly what will happen and when.
It's like the Titanic is sinking, taking in more water than it can pump out. You know it's going down and there aren't enough lifeboats, but you don't know who's going to be saved, who's gonna die, when the event will happen or how the ship is going to break apart as it sinks.
Once a doom loop has started, it's difficult to predict where it will end.
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Written recorded and edited by Glenn Campbell. For annotations, links and corrections, see the description on the video version of this podcast. You can also leave comments there.
