49: Is Money Dying?

Is monetary collapse imminent as some pundits say? Plus another look at gold and how to tell if a government’s debt burden is unsustainable.

In this episode, you’ll learn:

1. What are the elements of a complex adaptive system.
2. What is reductionism.
3. What to do in the face of radical unpredictability.
4. What is financial warfare.
5. What is money.
6. What is a personal gold standard.
7. What factors contribute to the sustainability of nation’s government debt.

Show Notes

The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

The God Delusion by Richard Dawkins

Reinventing the Sacred: A New View of Science, Religion and Reason by Stuart Kauffman

Crunch Time: Fiscal Crisis and the Role of Monetary Policy

15: Stop Worrying About the Next Market Crash

42: All Countries Are Insolvent and That’s A Good Thing

Summary Article

Understanding the National Debt

Last month, I explained the U.S. government is insolvent because its debts greatly exceeds its assets.

The debt represents decades of annual budget deficits that are the result of the federal government spending more than it collects in taxes.

Total Income Equals Total Spending

In that article, I shared how the U.S. government only controls the spending side of its income statement.

While the government can set tax rates, the amount of tax revenue it receives is a function of the savings decisions made by households and businesses.

Every dollar spent by a household or business is a dollar received as income by some other household or business.

If households and businesses collectively decide to save more and spend less, than total household and business income will go down.Less private sector income means less income taxes paid to the federal government.

Even if the federal government sets a balanced budget, the nation could still run a budget deficit if tax revenues fall short of projections because households and businesses decided to curtail their spending and save more.

Why The National Debt Soared

Because the federal government only controls the spending side of the equation it is unrealistic to assume the national debt will ever be paid off. Instead, it will continue to grow.

What matters is the size of the national debt relative to the size of the economy.

Economic size is measured by gross domestic product (“GDP), the amount of goods and services produced by a nation during the year.

In 2014, U.S. nominal GDP was estimated to be $17.4 trillion. Total federal government debt outstanding was approximately $18.1 trillion or 104% of GDP. That includes debt held by the public as well as debt held by government entities such as the Social Security Trust Fund.

In 2007, just prior to the Great Recession, U.S. nominal GDP was $14.5 trillion and total federal debt outstanding was $9.2 trillion or 63% of GDP.

That significant debt-to-GDP increase shows how devastating the recession was on the U.S. fiscal situation as tax revenues plummeted and unemployment insurance and other social safety net expenditures jumped.

The federal debt balance ballooned because the budget deficit skyrocketed. A major reason the budget deficit soared was households doubled their savings rate from 3% of disposable income to over 6%. Higher private sector savings rates lead to higher federal budget deficits.

A Tipping Point

Still, the federal government needs to be more disciplined in its spending.

At some point, a nation can reach a tipping point when the debt-to-GDP ratio gets too high, investors lose confidence in the nation’s ability to service its debt and interest rates jump significantly. A debt crisis ensues.

Unfortunately, no one knows exactly where that tipping point is. It can vary by country even if debt-to-GDP levels are similar.

For example, Japan’s debt-to-GDP ratio is over 200%, yet the nation continues to have some of the lowest interest rates in the world with 10-year yields on government bonds of 0.3%.

Meanwhile, Greece’s debt-to-GDP ratio is lower than Japan’s at 175%, yet its 10-year government bond yields are over 11%.

What Determines Debt-to-GDP Trends

While we don’t know the exact debt-to-GDP level that triggers a debt crisis, we can monitor the mathematical relationships that determine whether a nation’s debt-to-GDP ratio is climbing, falling or holding steady.

Here are some of those relationships:

If a nation runs a balanced budget, its debt-to-GDP ratio will still grow if the interest rate it pays on its debt is greater than its nominal GDP growth rate.

Conversely, the debt-to-GDP ratio will shrink if a nation runs a balanced budget and its nominal GDP growth rate is greater than the average interest rate on its debt.

For example, Greece’s nominal GDP grew less than 1% in 2014, much lower than the interest rate on its debt. Consequently, even though Greece ran a small budget surplus in 2014, its debt-to-GDP ratio climbed.

In short, Greece is on an unsustainable path.

A nation’s debt-to-GDP ratio can still grow even if nominal GDP growth rates are greater than the debt interest rate if the country runs a primary budget deficit, which is its budget deficit after backing out the interest cost on its debt.

That is the situation the U.S. has been in since 2012.

The average interest rate the U.S. paid on its outstanding debt since 2012 is around 2%. That is less than its nominal annual GDP growth rate the last few years of approximately 3.8%.

Yet, U.S. debt-to-GDP ratio rose slightly each year since 2012 because its primary budget deficit as a percent of GDP was greater than the difference between its nominal growth rate in GDP and the average interest rate on its debt.

Granted, the numbers can get confusing, but the important thing is the U.S. has reigned in the accelerating trend in its debt-to-GDP ratio.

The key for the U.S national debt situation to remain stable and hopefully improve is disciplined budgets coming out of Washington, continued growth in the U.S. economy and low interest rates.