Can debt magically vanish?

Jul 3, 2015

- By Bill Bonner

Bill Bonner
Baltimore, Maryland

Dear Diary,

Stocks sat rather still yesterday in America. In China, they kept going down, with another 3% taken off stock prices on Thursday.

No resolution of the Greek situation, yet. No end in sight for the China situation. No 'macro obstacles' have been removed.

And now there's a 'macro obstacle' developing in Puerto Rico, too. Is the island really "America's Greece?" We'll look at the Puerto Rico story more on Monday. Today, we look neither forward nor backward, but at what the past left behind:

Debt.

We have been fascinated and puzzled by debt. What is it, exactly? It is clearly a liability...a negative...a bummer...no?

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But what if you can finance your whole life with debt, and then, when the curtain finally comes down on the last act, you and the debt both disappear?

That's the plan, by the way. The feds think they can run an economy fueled with debt...and then, magically, make the debt vanish.

Will it happen? What kind of thing is this - debt - that can go 'poof' at the end of the show?

We don't know. But McKinsey says the world added $57 trillion of it in that last 6 years --- with the biggest chunk of it in China. Yes, China raised the stakes by $21 trillion since 2008. That's more than 100% of its GDP.

China's debt to GDP ratio is now approaching 300% -- which McKinsey figures is more than Germany or the US (the numbers are a little fishy...we've seen some different calculations).

Most investors regard Chinese debt as a kind of 'mystery meat.' No one is sure what it is in it. And no one is sure how it will hold up under pressure.

Who owes what to whom? And what will happen if they don't get repaid?

"For every debt there's a credit," say the accountants. "Don't worry about it," say leading economists.

But the bookkeepers' truth is an economists' lie. If you net out the debts and credits, you only get zero on paper. In today's economy, you get a disaster...

Why? Because today's debt is not like the debt of the past.

Old Pharaoh saved up grain. 'When the famine comes, we will eat the surplus of the past,' he said, wisely.

New Pharaoh says, 'we don't need to save no stinkin' grain; we have a central bank. When famine comes, we'll print 'money' and lend it to you to buy grain.'

"A penny saved is a penny earned," is another old truth that has been turned into fib. Why bother to save a penny when you get a millions of pennies without breaking a sweat?

Total world debt is now over 3 times GDP. That is a 'macro obstacle' about as big as they get. And it is also an obstacle that is not going away anytime soon.

In the US, for example, debt totals about 3.3 times GDP. A 5% interest rate implies that more than 15% of GDP needs to be used just to service past spending. That, in itself, is not impossible. But at 5% interest the economy that depended on 2% interest becomes unstable. That's the trouble with New Pharaoh's system. Credit created by central banks is not the same as savings. It is more of a claim on the future, not the past. And when interest rates go up, the costs go up with it. Businesses, households, and governments that were perfectly happy to carry so much debt at 2% interest find themselves staggering under the increased load. Shops close. People are laid off. Sales decline. And marginal GDP melts away. That is what has happened in Greece. Its economy has shrunk by 1/3rd since the crisis of 2008.

As real rates rise, the gamblers and speculators begin to lose money. They withdraw from the market, causing asset prices to fall. This jeopardizes bank collateral, putting many lenders and borrowers underwater. The credits disappear; the debits are still there.

Take a third off US GDP, and you have a $12 trillion economy. Now, the debt is 5 times GDP. And 5% interest rates mean that a quarter of GDP is used to pay interest. The economy gets the shakes and the debt dies.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Can debt magically vanish?"

Dr G L Moondra

Jul 3, 2015

You are correct. Every debt has to be paid back some day. Some day greece will happen to many nations. And on that day people will suffer like never before. A time came in pre mao China when a bagful of currency could buy only a pocket full of grain. In Indnesia the value of dallar went up from 2000 to 20000 in few days. Russian rouble fell to negligible value against Dollar a few thears ago.
If that happens to many nations there can be a total chaos in the world and may be end of democratic system of Goverment which forces the politicians to resort to people appeasement. What will replace it is any body's guess.

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