by FS
Both political parties and most economists have seemingly abandoned conservative principles of managing national debt. This situation is setting the U.S. up for serious consequences, Jim Rickards told Financial Sense Insider on a recent podcast. Rickards, a financial adviser and investment expert, spoke with Financial Sense about his new book, Aftermath: Seven Secrets of Wealth Preservation in the Coming Crisis, and where uncontrolled debt growth is taking the U.S.
Debt Is an Albatross
Traditionally U.S. national debt grew in times of war and was paid off in times of peace, Rickards explained. This cycle of growing and retiring debt followed a sine wave pattern: up and down, and then back up and down again. The change began in the early 2000s.
The debt burden of the U.S. now stands at $22.5 trillion. In 2000 George W. Bush doubled the debt from $5 trillion to $10 trillion. Then Barack Obama doubled the debt from $10 trillion to $20 trillion. Donald Trump has piled on a couple trillion more and we’re now closing in on $23 trillion. This rate of growth breaks the sine wave pattern, Rickards pointed out.
“Prior to 2000, we had bipartisan competence,” Rickards said. “Today, we seem to have bipartisan incompetence. No one’s concerned about the debt. … Our debt-to-GDP ratio is out of control. That debt overhang is the biggest single problem in the financial landscape. The question is, when does it matter?”
MMT to the Rescue?
Both parties have abandoned any pretense to fiscal discipline, Rickards stated. Modern Monetary Theory (MMT) is giving them fuel to ignore the debt. Traditionally, when someone proposed increasing the debt to fund something—whether it was for national defense or social programs—the standard reply was to note that we cannot afford to increase debt at that time. With the advent of MMT, advocates for increasing the debt endlessly say this isn’t true and that we can increase the debt forever.
To make their argument, they start by merging the balance sheets of the Treasury and the Federal reserve. Then, they argue we can spend money on anything we want, and run deficits as high as we want, because the Treasury can borrow the necessary funds.
If the bond market swells too much, the Fed can buy the bonds, monetize the debt and stash it away on its balance sheet for 10 years until collective maturity, the MMT advocates argue. They point to Japan’s debt-to-GDP over 250 percent and note that the U.S.’s current ratio is only 106 percent. This leaves us with plenty of headroom, according to MMT. They also note Ben Bernanke printed nearly $4 trillion and saw no significant inflation.
“When they put it that way, it has a kind of superficial appeal,” Rickards said. “What’s not to like? I certainly think there is a problem. There’s good evidence that says it is a problem. Look at the brilliant work of Carmen Reinhart and Ken Rogoff… they make it absolutely clear that when your debt-to-GDP ratio goes above 90 percent, you’re at a critical threshold.”
Limit to MMT
Above this 90 percent threshold, something happens, Rickards noted. Under normal conditions, if you borrow a dollar and spend a dollar, you should get a dollar of GDP in return. However, above 90 percent debt-to-GDP ratios, Rickards stated, debt itself becomes a headwind.
This is one of the reasons why growth has been so weak since the Great Recession. We’re in the eleventh year of an expansion that is now the longest in U.S. history, Rickards stated, but it’s also the weakest expansion in U.S. history.
Data discredits the idea that we can grow our way out of our debt burden, he added, and we cannot borrow our way out of it either. The only solution becomes inflation, but the Fed has been trying to produce significant inflation for the last 10 years and has failed.
“What the MMT people are ignoring is the psychological limit, not the legal limit,” Rickards said. “It is true that the Fed can borrow as much as it wants, but there’s a psychological limit. This is what physicists call a critical threshold or a phase transition. … I’m not saying inflation is an attractive option. I am saying it might be the only option and we can’t get the inflation, so we’re just heading for default with slow growth along the way to make it even worse.”