Deadman's picture

    Government Debt: The Final Bubble

    Could this be the beginning of the end for our markets' last great bubble?

    An auction today of $34 billion in 5-year U.S. government bonds didn't go over so well, fetching prices well under what analysts were expecting.


    Oh I know, it may not seem like that big of a deal. The debt still got sold, unlike an unsuccessful auction for 40-year bonds in the UK. The fact that our auction resulted in yields (which move in the opposite direction of the price of bonds) of 1.849% versus the expected 1.801% seems like rather unimportant, inside-baseball type of stuff.

    And if it's just one bad auction, then it may not be important (Edit: Demand for an auction of $40 billion in two-year U.S. notes Tuesday was quite strong). But if this weak demand is a signal of things to come, then we are in for a world of hurt.

    In the past ten years, we have had a dot-com bubble, a housing bubble, a credit bubble and an oil bubble, but I have contended they will all pale in comparison to the government debt bubble we are now experiencing.

    Think about it: The U.S. government, despite owing $10 trillion in debt, despite incurring an additional $1.3 trillion deficit in 2008 (a number which will certainly be crushed this year and likely for years to come if the Obama plan even gets partly realized), has been up until now able to sell almost as much of the debt as it wishes to at extremely low interest rates.

    The Pollyannas will say that there's a good reason for the low cost of our debt, and why that situation won't change anytime soon. The big concern right now is deflation, not inflation. Other countries have at least as many problems as we do, and too much savings to boot. They need to put their money somewhere, and the U.S. markets are still the world's best, safest place to invest money. They own too much of our debt to start selling now - it would only lead to mutually assured destruction.

    "This time it's different." To me, there are no four more dangerous words. It defies the laws of economics and of logic to expect that a nation awash in debt with miles and miles of higher and higher deficits on the horizon will be able to lend more money at virtually zero interest for an extended period of time.

    The only question is when do the floodgates open? We've heard rumblings of complaints - notably, on the record and not anonymous - from Chinese officials about our country's economic situation and increasingly high levels of debt. We've seen budget deficit estimates from the CBO which far exceed the optimistic ones put together by the Obama team. And now we had a disappointing auction.

    Of course, to a certain extent, debasing our currency is what the government wants. If we could control the pace of the move, some inflation would be a good thing since we're so heavily in debt (as the value of the dollar falls, that means debtors owe less in 'real' terms). But it is highly likely that the transition would come too fast and too quick for our economy and our policies to adjust without experiencing significant dislocations and subsequent pain.

    I can almost guarantee you that if government debt is a bubble and it does pop, you won't see our foreign lenders gently exiting the market. It will be a stampede.

    And what will be the implications of such a scenario? Believe it or not, they are likely far worse than anything we have seen so far. Interest rates will soar, as will inflation. Savers will be crushed. Investment will grind to a halt. An already weak economy on its knees would get weaker. We will be forced to renegotiate our obligations with foreign lenders, most notably the Chinese.

    The end result could be no less than the end of U.S. hegemony.


    You speak of "the end of U.S. hegemony" as if that were a bad thing.

    Hey, pursuit of that illusion helped get us all into the fix we're in today. For all our sakes, the focus has to be on fixing the global economy. For that, we need a healthy U.S. But drop the idea of running the world; you don't own it -- never did!

    Watch out what you wish for. The next era may not by represented by the League of Happy Peaceful Mutually Respecting Democracies.

    I'm sorry I snapped at Deadman. I don't think he really meant "hegemony." But we're not exactly living in an era of world peace now.

    i took no offense to the original statement, but i did mean hegemony (tho perhaps the word is a bit too strong). i was just merely offering up a prediction, not trying to imply such an event would a good or a bad thing. i can understand the confusion, however, the word is a bit loaded with connotation, and most of my other predictions were clear negative events. for better or worse (and personally, i may be biased here, but i think it's been largely for the better), it's quite clear that for most of the past century, America has dictated and influenced world events more than any other nation.

    You've inspired me to write a post on the meaning, significance, and future of U.S. "hegemony." Maybe next week after my deadline. We can have a good smackdown then.

    Count me in. Whoo, this is like knowing the quiz questions in advance.

    D, this is one of the best posts you've written on this blog. Eloquent, clear, original, and thought-provoking. I just hope that your suspicions are wrong.

    A long, disturbing, necessary read. One I agree with almost entirely, and one that dovetails somewhat with the above post.

    It's a good article and certainly worrisome, but it's also telling that there was no talk of stimulus. The IMF has a bad reputation for ruining economies by demanding spending restrictions and strong currencies, very bad ideas during a recession. The organization's role in Argentina's economic collapse has been widely criticized, and the IMF itself admitted mistakes. Brazil faced similar pressures to Argentina's but succeeded in negotiating better terms with the IMF. Unlike Argentina, which kept its peso pegged to the dollar at the IMF's insistence, Brazil allowed its real to fall. Brazil quickly recovered. Argentina is still mired in recession. That said, I'm not sure what Johnson's position was during that crisis.

    i hear you, though i still question the premise the idea that a nation that's already mature and fully developed AND mired in debt can stimulate its way out of a recession without merely postponing the ultimate day of reckoning.

    btw, interesting that i read the piece today, the same day as when all the country's big bankers gathered in DC for a powwow with the president. certainly seems that perhaps we listen to these guys too much. especially given that many of them are partly responsible for the policies and practices that exacerbated the crisis if not largely created it.


    Yeah, Simon Johnson really lays it on the line. Grim.

    If you found the Atlantic piece enlightening, try Johnson's website:

    Read his Financial Crisis for Beginners. I don't know if he's 100% right, but he sure can explain stuff.

    It is really a fantastic article and it is superb article really wonderful excellent and mindblowing.




    Latest Comments