Debtor's Prison

Greetings fellow inmates,

It’s an age-old adage that in order to know where we are going we must first understand where we came from.     In that spirit, today we will explore a good tract of history of US government debt in a variety of contexts in order to get a firm footing on where we are today.  “Worthless” is a strong word and one that we don’t use lightly.   Worth or value is something particularly tricky to define or ascertain, and one of the quintessential problems in economics.   In the next few days we will be doing a more thorough post on this matter, but for now, we will omit some of the details and simply utilize the notion that US Treasury securities (UST’s) are claims against US citizens, or more specifically, tax-payers.   As we often do, we will take a broad view of the relevant Numbers and use simple, rational arguments to make a point.    All the following data comes courtesy of Uncle Benny and Co. at the St. Louis Federal Reserve.  The FRED database is an excellent resource for all you inmates looking for some data.    We’ve aggregated all the following data and charts onto this XLS file for your convenience.

We begin by looking at the total outstanding amount of US public debt.    The following chart includes both debt held by the public and intra-governmental debt.    Bear in mind for the remainder of the post that we are looking simply at public debt securities, which exclude a wealth of other current and future US government liabilities like Medicare, Medicaid, Social Security, Fannie and Freddie debt, and the wealth of other government guarantees undertaken during the GCC, which in total add up to several tens of trillions of dollars.   We mention these only cursorily for now, but we’ll treat them in more detail in a later post.

As of 10.31.09, total public US debt was at $11.9tr.    The preceding chart shows data from 1966 onwards, which is as far back as the FRED database goes.   We also note that a significant ramp up in public debt began in the mid 1970s.    Presumably, a big factor in this was the Nixon Shock in 1971, in which the USD convertibility to gold was terminated, thus eliminating the last remaining semblance of a gold standard.   With gold finally out of the picture, governments and investors worldwide needed another “store of value”, and given Uncle Sam’s “impeccable” credit history, US Treasuries became the natural substitute.   This surge in demand allowed for the explosion in supply clearly evident in the multi-decade trend from the 70s to now.  

All else being equal, one would expect, as traditional economic theory postulates, that supply of a given debt security would be inversely correlated with its price.   In other words, the more a debtor borrows the higher interest rate they must pay.   Curiously, we notice the exact opposite in the case of US Treasuries.   In Count the Money v2.0, we estimated that the average maturity of outstanding US Gov debt would be around 7 years.    We actually looked at the Numbers published every month by the US Department of the Treasury and calculated the weighted average maturity of outstanding UST’s as of Oct 09, to be approximately 6.2 years: not bad for a shot in the dark!  In any case, for the sake of this exercise we will use this maturity as “characteristic” of the total outstanding public debt.   Though this is a non-trivial simplification, it still illustrates the point.  The following chart shows the yields on 7-year UST’s.

Immediately following Grandpa Volcker’s crack-down on rampant inflation, we notice a secular decrease in yields, from 14% at the beginning of 1982 to 3% near the end of 2009.    During that same time, Uncle Sam’s debt grew eleven-fold, from $1.06tr in early 1982 to the current $11.9tr.    In 2005, Alan Greenspan, a.k.a “Judy”, described low bond yields as a “conundrum” given the macroeconomic picture at the time.   Well Judy, we are equally puzzled by this enormous 27-year reduction in yields during a time when public debt exploded.   Very broadly, we could assert that the world’s perception during this time has been that Uncle Sam has become increasingly able to pay all his debts, thus affording him lower borrowing costs.   Alternatively, and more likely in our opinion, this was due to an acknowledgement that UST’s were so fundamental to the global economy and wealth that other people would always demand more of them, hence people felt safe buying them.   In other words, the US Gov had become too-big-to-fail (TBTF)   One thing that the GCC has illustrated in vivid color is the peril in the belief that anything is TBTF.   A student of history can easily see that patterns repeat at all scales:  no bank, no insurer, no market, no nation, no empire is TBTF.  

On this point we remain absolutely rationally befuddled.   While we are able to grasp the notion that the world at large has continued amassing enormous amount of UST’s for the past three decades based on the belief that the US Gov is TBTF, we struggle to understand why.  As we have stated before, and will demonstrate later, the outstanding debt will never be paid off through real economic growth.    The chart below shows the Consumer Price Index since 1913, coincidentally on the same year of the establishment of the Fed.    In the same 27-year period, the CPI increased by 150%, greatly eroding the value of US debt.   Yet we have kept buying. 

It seems like the only explanation is Faith that the USD/UST’s will remain supreme forever.   This is of course the nature of our fiat system.   We’ll return to this point shortly, but let’s re-examine our earlier definition of UST’s as claims against US tax-payers.    Well what exactly can the holders of UST’s claim?   Allegedly, these are claims on units of output, as measured by GDP.   The chart below shows US GDP and gross federal debt, which differs from total public debt in that it excludes state and local bonds.  

Call us crazy, but it would appear as though nominal GDP growth for the past three decades has been in large part fuelled by borrowed money.   Of course, this makes sense, as money has flowed into the US either from abroad or in an endogenous generation, which has resulted in increased output.   But what exactly is this output that UST holders can claim?   Well, there’s physical infrastructure, science, art and consumable commodities and necessities.   The rest is left over in the monetary system.   The following chart shows the M1 and M2 money aggregators, which measure the amount of money in the system.  

This amount of money in the system should represent a store of wealth, to be cashed in at a future date for assets with real value.   Though we would welcome some debate on this point, the parabolic growth in these money measures is one and the same as the parabolic growth in total debt.   Seen in a different light, this growth in money is a necessity of the Ponzi nature of this debt edifice, where each participant’s future claims get increased as payment for their participation in kicking the can today.   In other words, as debt matures, more debt gets issued to pay the beneficiaries (creditors) on a large-scale, simultaneously as more money gets created to credit the digital accounts of smaller claim-holders.   The monotonic nature of the CPI irrefutably shows this (the BLS’s statistical chicanery notwithstanding), as more money has been created than needed for the procurement of a “representative” unit of physical goods.   

This Ponzi process has been happening for decades, supported by nothing but Faith.    Ultimately, as this process continues, then the only rational conclusion is UST holders will only have claims on more debt.   That if of course, barring those lucky few that will get to cash in their claims in exchange for real assets in time.   Eventually, the world at large will realize this, Faith will evaporate and the mad rush that will lead to SuperInflation will begin.  Ricardian equivalence will finally be dealt the ignominious death it so rightfully deserves. This crumbling edifice will collapse, in a gruesome tsunami of financial destruction that will dwarf anything experienced in the modern world. 

In the interest of brevity, we have skipped many details (some of which we’ll treat in future posts); a thorough history of US debt would require tomes in and of itself.   Nevertheless, we believe that even this cursory glance should be enough to make you question the nature of the claims represented by USTs and shake your Faith in them.    Naturally, the question arises as to how best protect oneself from this impending catastrophe.  We advocate taking a good, long, hard look at your assets; defining what wealth means to you without contemplating the claims provided by the system; wasting no time in turning your current claims into a sustainable source of wealth.   Ultimately, the best time-tested protection against systemic collapse is placing your Faith in nothing but yourself.  On that note, we shall retire to The Chapel for some quiet contemplation.

May your capital be safe and your investments prosperous,

MAAA