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Denninger You Can't Borrow Your Way Out Of This Mess

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http://market-ticker.denninger.net/archive...erings.....html

After a bit of prodding I decided to go back and expand a bit on the "Weekend Chart To Ponder" posting.

Be warned: this is a far more esoteric undertaking than the previous, and may make your eyes glaze over. Nonetheless I believe it is important, as it sets forth some "boundary conditions" that, when analyzed against current economic trends and behavior, are likely to lead you to inescapable (and perhaps ugly) conclusions.

Expanding this chart was particularly difficult to do because The Fed doesn't make it easy to find the data I was looking for - specifically, total outstanding borrowings on mortgages. Their "Flow of Funds" report shows changes, but that's not sufficient - I need total numbers outstanding. Fortunately The Census Bureau keeps track of that data - albeit with a bit of a lag (they don't have 2008 yet.)

Just to reiterate for those who didn't catch this up front - these numbers are expressed as percentage changes and are all per-capita.

The latter is important and often ignored - a rising population of course can support a larger (total) amount of credit outstanding, but at the same time it mutes GDP growth. That is, if you have 100 million people in the nation and double it (to 200 million) GDP doubling doesn't actually improve anyone's lot in life - the per-capita GDP is the same. Ditto for total incomes, and total debt - rising debt is bad, but only if it is rising per-capita.

Many people have asked why I didn't include inflation in these numbers. There are a number of reasons, the most-important of which is that it doesn't matter when one is comparing against incomes. There is also the problem of defining inflation - exactly what do you include and what do you not? Government statistics are notoriously inaccurate - for instance, they did not define the rise in house prices from 2003-2007 as "inflation", since they use a thing called "owner's equivalent rent" in the computations - a farcical measure for the majority of Americans, since the majority own their homes. Then there are what are called "hedonic" adjustments; the simplest explanation of "hedonics" is that when steak becomes too expensive the government substitutes hamburger, since both are meat and contain protein (yeah, really.)

We can fight over "inflation" numbers all day and all we'll generate is heat, not enlightenment. The easiest way to avoid doing that is to compare against what matters when it comes to debt - that is, income.

Why?

Because the servicing of debt requires income. The greater the outstanding debt (per-capita) in regards to income, the closer "the wall" gets to the consumer.

So with that, here's the chart (click on it for a bigger copy):

******UsCreditAndDebt.serendipityThumb.png

Now let's agree on a few things, shall we?

First, there is a "critical level" beyond which all debts will default - without exception. That point is where the carrying cost exceeds income. For example, if you have a $100,000 mortgage and $9,999 (or less) in income, if the interest rate is 10% every such mortgage will default since you can't pay $10,000 with $9,999.

A direct comparison of this sort is, however, a ridiculously optimistic scenario. "Money income", as defined by the Census Bureau, includes all money earnings before taxes (Census definition) and excludes non-cash benefits (that couldn't be used to pay debts) such as food stamps and housing subsidies. It also excludes capital gains and losses (we can argue over whether it should, but it does.)

Note, however, that taxes are not included, and for essentially all employed persons there is an explicit tax hit (even if you have zero federal income tax) for Social Security and Medicare, never mind state taxes, property taxes and other forms of tax, all of which reduce income available to service debt.

Second, before you can service debt you must have the basic necessities of life. Chief among these are of course food and shelter, the latter often being a big source of that debt too (mortgage debt in particular.) Therefore, we must subtract out of your income the cost (per-capita) of the basic necessities of life. We'll define this as the Federal Poverty Threshold; since the average household is 2.59 people (per the US Census again) this places the per-capita requirement for basic necessities of life at ($14,540 / 2.59) (arithmetic average of the 2 and 3 person poverty level divided by actual average household size) or $5,614 as of 2007. This must be subtracted from the per-capita income of $26,804 (for 2007) knocking the actual income available to service debt (in the best case) back to 1998 levels, when it first crested $20,000, or 500% of baseline.

Third, all forms of debt are additive. That is, you can't compute the percent interest necessary to force 100% default rates just for mortgages unless mortgages are the only form of debt out there, and clearly they're not. When you try to "blend" the numbers you again run into the need to make assumptions that make it impossible to set an accurate "must default" level.

Finally, we must add in the costs associated with the income and debt you are trying to service. This is often ignored and yet it can't be - the cost, for example, of a vehicle (including insurance, gasoline, repairs, etc) to get to work, if you live where mass transit is unavailable between your home and office, is an unavoidable expense that must come out of income before anything is available for debt service. The impact that this has on an individual varies greatly.

Does this particularly enlighten us on the promise (or peril) going forward for America?

Not really, but it does give us a framework to start thinking about whether what we've been doing to "address" the recession since 2007 can possibly work.

Now let's think for a moment about the actual "default function"; that is, how outstanding debt compared to income actually results in defaults (or not) in a real system. I would argue that it is most like the rational function f(x) = 1/x where x is a positive number representing the "displacement" from "zero hour", or the maximum debt possible to be sustained, and y is the default percentage with infinity representing 100%. The "zero point" is where debt service (if all debt) is impossible with current income (that is, interest due exceeds current after-tax and after-necessity income.)

That is, once we get a reasonable distance away from that "zero point" the change in default rate for a given displacement is rather small. This behavior is what leads to booms during loose lending periods - reasonably large changes in income and debt levels do not immediately lead to large changes in default rates - so long as we're a "safe" distance away from the "zero point."

But this behavior is deceiving, because the change in default behavior is in fact parabolic, not linear, as one approaches the "zero point." As debt continues to build in the system the ratio gets closer to the zero point for (x), and as that occurs the default rate starts to rise - first slowly, then much more rapidly for a given excursion toward zero. What's worse is that the act of default forces the equation the wrong way, since defaults tend to cause bankruptcies of both borrowers and lenders, and thus business failures - and the latter results in unemployment (thus driving per-capita income down.)

So, you say, this is all a nice bunch of arm-waving, but what does it mean? (Are your eyes glazing over yet?)

On that point we can reach some conclusions. We know, for instance, that unlike all previous recessions since the 1930s this one began with consumer defaults on subprime loans. That is, we began to approach the zero point through the dramatic increase in debt outstanding and the most-marginal borrowers were unable to make their payments.

This in turn caused the cessation of origination of these loans and the construction of homes that were enabled by them, which forced people out of work both in those lending and building enterprises (thus forcing per-capita income downward.)

That in turn drove us even closer to the zero point, and the damage began to move up the scale. Higher-quality borrowers began to default - first on ALT-A loans and then prime loans, and the defaults spread into other areas of finance including credit cards and commercial real estate.

The Fed and Government, in response to this trend, flooded the system with liquidity in an attempt to drive down borrowing costs (that is, to get the interest component down so "the wall" was further away.)

Did it work?

No - because the banks, rather than being forced to admit their losses and come clean, were instead permitted to hide them. They took this "cheap money" for themselves and instead of lowering interest costs for consumers, moving the default function in the desired direction, raised them on consumer debt, forcing the default function the wrong way!

The government in turn stepped up its borrowing and replacement of actual income with subsidy, since the interest rate for government borrowing did indeed go down. This prevented an all-on implosion at that instant in time.

But did it fix the problem?

NO!

Why not?

Because the debt is still out there and the ability of the government to continually borrow more money forever to use in these subsidies for the purpose of halting the shift to the left in the debt/income default function does not exist.

Oh sure, government can do this for a while - and it has. But not forever, and yet "forever" is what is required, until and unless those debt levels go down or income levels go up to get us back into the "safe" zone of the default function.

Yet the government's actions in fact move the curve the wrong way over time! That is because government borrowing is in fact debt that ultimately must be paid for out of individual income. While it is "cheap" borrowing it has not (and doesn't) replace the high-cost debt that is causing the problem - it is simply a means of attempting to subsidize the current payment required to keep the default from happening "right now" (as in this month.)

We are doing the wrong thing because government and The Fed have misdiagnosed (either intentionally or not) the cause of the recession and thus whether their tonic can be effective.

During an ordinary inventory-led recession where excessive credit is not the triggering cause (rather, it is over-capacity in the economy) the tonic applied is useful, because stimulating demand causes the slack to come out. It also causes debt:income ratios to expand, but remember the default function - so long as you are a good distance away from the "zero point" this has little cost in terms of increasing the actual number of defaults. It does, in each and every case, shave the safety margin. We've gone through multiple recessions (all the way back to the 1970s) where we had lots of safety margin, and as a consequence this "tonic" seemed the right medicine for the job.

The problem is that we never forced the contraction of borrowing and thus never, over more than 30 years time, caused the safety margin to be rebuilt!

When you are in a recession that is occasioned by getting "too close to the sun" - that is, too close to the zero point - such policies are a disaster, because there is no safety margin left - you have in fact entered the parabolic zone of defaults, where anything that ramps the debt/income ratio at best masks the problem for a period of time and at worst can drive you into the maw of what amounts to a singularity - the implosion of your economic and monetary system.

I believe the evidence is clear and in fact irrefutable - we are in this mess because we reached the parabolic portion of the default function - in fact, we just touched the edge of it.

As such what the government and The Fed have done is exactly backwards and is only going to make the inevitable pain that must be taken worse.

In 1933 Roosevelt devalued the dollar to get out of this death spiral. He was able to do so because the dollar was linked to gold, and thus he could simply sign a document and change the exchange rate, at the same time banning private ownership of the metal (and thus preventing the market from immediately counteracting his devaluation and rending it meaningless.) Today all currencies are fiat and this option is not available - should it be attempted via massive money printing (doing so would require The Fed to literally print the entire asset base underlying the credit system in the US - somewhere on the order of $20+ trillion dollars!) the outcome would be an instantaneous ramp in energy costs (and all other imports) by more than 1,000% and the immediate collapse of both our economy and all banks, including The Fed itself, since wages would not and cannot increase by that same 1,000% in a global economy.

We must force the outstanding credit levels down to sustainable levels. This will cause a huge number of bankruptcies, especially among the financial "heavy hitting firms" on Wall Street and the pension and insurance funds of Americans as the true "value" of their so-called assets are exposed.

The problem is that there is no alternative - we squandered the ability to rebuild our safety margins over the previous 30 years, and now we're into the maw of the parabola with no remaining margin available to exploit. The longer we wait to do the right thing the worse the outcome will be, and if we wait too long we will lose our nation - literally.

History has shown that the 2000-01 recession "avoidance tactic" of more than doubling outstanding consumer credit in mortgages and increasing it by 60% in other debt while income only rose 23% during the same period bought us seven years of delay and a collapse far worse when we hit the wall - unemployment only reached 6.3% during the 00-01 recession (in 2003) while we are now at 9.7% (officially) and climbing. Consumer spending and defaults were a non-factor in 00-01 - today they are the feature of our recession.

Today we simply have no more "forward debt capacity" in our economy.

This is not conjecture or belief - it is hard fact and has been proved by the structure of the current recession.

Attempting to use even more lending - that is, credit - to "pull us out" of this recession is not only doomed to fail it will drive the default equation closer to zero.

We must stop this madness and the accumulation of damage that must be taken in our economy before we find ourselves in a monetary and fiscal gravity well from which we are unable to escape.

Ludwig von Mises describes the endgame brought on by reckless expansion of credit: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

We have had a debt based expansion, the consequences are inevitable. We can't print away this mess without creating an even bigger mess.

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Perhaps one of the banksters of economists can help me with this:-

Denninger doesn't really address the other side of the equation which appears to be that for every default or bankruptcy that debt is partly or wholly written off. In the example he gave, if the $100,000 mortgage is defaulted upon because the borrower 'hits the wall' (or en masse, per capita), then that debt no longer exists, the asset is repo'd and sold (or written down) and the debt falls to $zero.

The creditor is forced to swallow it. In the case of securities backed by such debts, that creditor may be (and clearly was/is) outside of the system which Denninger is referring to. i.e. It may be a UK pension fund for instance.

So, as defaults rise, and assets are written down, is it not the case that the 'wall' shifts further away?

For instance, there is no particular reason why the US debtors must repay their debt. They could for instance just stick two fingers up at the Chinese. If transferring personal sector debt to the govt. means paying interest to the Chinese instead of the US banksters, why bother?

Edited by Red Karma

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snip

For instance, there is no particular reason why the US debtors must repay their debt. They could for instance just stick two fingers up at the Chinese. If transferring personal sector debt to the govt. means paying interest to the Chinese instead of the US banksters, why bother?

well the chinese could send their army over for reparations.

and as the US needs borrowing to support itself, default would mean the rest of the world would lose confidence and fail to buy new issues.

next the only thing left is pay down the debt that remains, by reducing spending, or, print....that is the short road to the end of the currency.

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"You Can't Borrow Your Way Out Of This Mess"

Yes you can -- Debt is Wealth, according to pretty much everyone in a position to do anything about it.

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well the chinese could send their army over for reparations.

and as the US needs borrowing to support itself, default would mean the rest of the world would lose confidence and fail to buy new issues.

next the only thing left is pay down the debt that remains, by reducing spending, or, print....that is the short road to the end of the currency.

China are buying US bonds to suppress their currency and stay in business.

When the Renminbi rises to where it perhaps should be, they'll be out of business.

The US will keep trading with the middle east, Canada, South America, Europe, Japan, the Commonwealth quite happily I'm sure.

China are just going to have to suck it up either in whole or in part. It's China who are f*cked, not the US.

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for every default or bankruptcy that debt is partly or wholly written off.

In the example he gave, if the $100,000 mortgage is defaulted upon because the lender 'hits the wall' (or en masse, per capita), then that debt no longer exists, the asset is repo'd and sold (or written down) and the debt falls to $zero.

So, as defaults rise, and assets are written down, is it not the case that the 'wall' shifts further away?

Yes but No.

Every debt that gets written off means the bank's assets decrease. Banks factor a small number of defaults into their models when lending but when enough people do it at the same time you get last years situation of banking collapse.

Then the government steps in and guarantees the debts, this means the debt still exists but instead of being owed by a reckless fool on his credit card it is now owed by the entire nation.

That is the horrific problem we face at the moment, the debt isn't being destroyed, it is shifting from private to public liability but at the end of the day the burden of paying it is still falling on exactly the same people that couldn't pay their debts in the first place...

The 'American consumer' and the 'American taxpayer' are in fact the same person, just different names.

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China are buying US bonds to suppress their currency and stay in business.

When the Renminbi rises to where it perhaps should be, they'll be out of business.

The US will keep trading with the middle east, Canada, South America, Europe, Japan, the Commonwealth quite happily I'm sure.

China are just going to have to suck it up either in whole or in part. It's China who are f*cked, not the US.

Us arent buying, their consumers are unemployed and overstretched.

this means mega blocks in china are empty.

maybe the Martians need some nik naks and Dells.

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Yes but No.

Every debt that gets written off means the bank's assets decrease. Banks factor a small number of defaults into their models when lending but when enough people do it at the same time you get last years situation of banking collapse.

Then the government steps in and guarantees the debts, this means the debt still exists but instead of being owed by a reckless fool on his credit card it is now owed by the entire nation.That is the horrific problem we face at the moment, the debt isn't being destroyed, it is shifting from private to public liability but at the end of the day the burden of paying it is still falling on exactly the same people that couldn't pay their debts in the first place...

The 'American consumer' and the 'American taxpayer' are in fact the same person, just different names.

Exactly my point.

The borrower that defaulted (business or individual) no longer owes the bank the money.

The reduction in the bank's assets have been either covered by fresh equity, write downs (largely insufficient so far) and government lending (or via the FED balance sheet).

That risk is thus being transferred from the lender within the 'system' that Denninger describes to a lender outside of the system, for the sake of argument, China. The borrower who defaulted is now debt free and can take on fresh borrowings inside the system. The US could choose not to honour its obligations to its external creditors, in part.

The problem is thus partly transferred out of the US. Sure, China could stop buying US treasuries, but then they have nobody to buy their cheap tat. That is their economy. The US could replace that lost production capacity internally albeit at a cost.

My point though is that the debt doesn't have to be repaid. It can be defaulted. Nobody is forcing China to buy treasuries to suppress their currency. They're grown ups. If they want to have their cake and eat it then they have to take the risk that goes with that. i.e. Being suckered into a US default.

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Exactly my point.

The borrower that defaulted (business or individual) no longer owes the bank the money.

The reduction in the bank's assets have been either covered by fresh equity, write downs (largely insufficient so far) and government lending (or via the FED balance sheet).

That risk is thus being transferred from the lender within the 'system' that Denninger describes to a lender outside of the system, for the sake of argument, China. The borrower who defaulted is now debt free and can take on fresh borrowings inside the system. The US could choose not to honour its obligations to its external creditors, in part.

The problem is thus partly transferred out of the US. Sure, China could stop buying US treasuries, but then they have nobody to buy their cheap tat. That is their economy. The US could replace that lost production capacity internally albeit at a cost.

My point though is that the debt doesn't have to be repaid. It can be defaulted. Nobody is forcing China to buy treasuries to suppress their currency. They're grown ups. If they want to have their cake and eat it then they have to take the risk that goes with that. i.e. Being suckered into a US default.

Not really.

His debt is now called 'national debt' instead of 'consumer debt' or 'mortgage debt'.

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Exactly my point.

The borrower that defaulted (business or individual) no longer owes the bank the money.

The reduction in the bank's assets have been either covered by fresh equity, write downs (largely insufficient so far) and government lending (or via the FED balance sheet).

That risk is thus being transferred from the lender within the 'system' that Denninger describes to a lender outside of the system, for the sake of argument, China. The borrower who defaulted is now debt free and can take on fresh borrowings inside the system. The US could choose not to honour its obligations to its external creditors, in part.

The problem is thus partly transferred out of the US. Sure, China could stop buying US treasuries, but then they have nobody to buy their cheap tat. That is their economy. The US could replace that lost production capacity internally albeit at a cost.

My point though is that the debt doesn't have to be repaid. It can be defaulted. Nobody is forcing China to buy treasuries to suppress their currency. They're grown ups. If they want to have their cake and eat it then they have to take the risk that goes with that. i.e. Being suckered into a US default.

China bought CDOs?

I thought they bought dollars.

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Exactly my point.

The borrower that defaulted (business or individual) no longer owes the bank the money.

The reduction in the bank's assets have been either covered by fresh equity, write downs (largely insufficient so far) and government lending (or via the FED balance sheet).

That risk is thus being transferred from the lender within the 'system' that Denninger describes to a lender outside of the system, for the sake of argument, China. The borrower who defaulted is now debt free and can take on fresh borrowings inside the system. The US could choose not to honour its obligations to its external creditors, in part.

The problem is thus partly transferred out of the US. Sure, China could stop buying US treasuries, but then they have nobody to buy their cheap tat. That is their economy. The US could replace that lost production capacity internally albeit at a cost.

My point though is that the debt doesn't have to be repaid. It can be defaulted. Nobody is forcing China to buy treasuries to suppress their currency. They're grown ups. If they want to have their cake and eat it then they have to take the risk that goes with that. i.e. Being suckered into a US default.

Surely it makes no differnece.

Before the default, bank owes China x amount, still owes same amount afterwards.

If anything it's made it worse. If the debt is now xferred to the govt which is less likely to default. If the banks had

been allowed to go bust then China would have lost money.

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Yes but No.

Every debt that gets written off means the bank's assets decrease. Banks factor a small number of defaults into their models when lending but when enough people do it at the same time you get last years situation of banking collapse.

Then the government steps in and guarantees the debts, this means the debt still exists but instead of being owed by a reckless fool on his credit card it is now owed by the entire nation.

That is the horrific problem we face at the moment, the debt isn't being destroyed, it is shifting from private to public liability but at the end of the day the burden of paying it is still falling on exactly the same people that couldn't pay their debts in the first place...

The 'American consumer' and the 'American taxpayer' are in fact the same person, just different names.

Good explanation, our children will end up paying the debt of their fathers. ;)

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I found this article a bit hard to get my head round as to how far the wall is away so to speak but it looks very close.

Regarding soverign defaults personal or business severe damage is caused.

Personal defaults is a personal problem but considering a soverign default the hurt will be massive on both parties assuming the US defaults which I dont think it will then nobody will deal with them unless paid upfront this will hurt the living standards of the US big time for a generation or so.

The main creditor to the US China will be hurt a lot more first they loose massive wealth in US treasuries but most important the hit to the Chinese export sector in China and the fall out from this on a global front I hope I dont see.

I read an article showing growing debt as no problem this being if GDP rose lets say 4% and the debt rose 2% than although the debts are increasing the higher incomes make it in burdon terms smaller.

This debt problem can be balanced by income growth above rising debts surly if the west cut out massive amounts of red tape from business could help and invest in things like the London underground in all main cities rather than bailing out bad loans the improved productivity in the long term would improve real incomes and create jobs while its being built to keep the wheels moving but to be honest I cant see real incomes increasing.

I agree with Mr Denninger deficit spending adding to the debt is making things worse since in my view I see it only papering over the damage to maintain things rather than increase real productivity gains and the future higher taxes and interest make things much worse clearly hard times are coming.

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That is the horrific problem we face at the moment, the debt isn't being destroyed, it is shifting from private to public liability but at the end of the day the burden of paying it is still falling on exactly the same people that couldn't pay their debts in the first place...

The 'American consumer' and the 'American taxpayer' are in fact the same person, just different names.

Very circular, perhaps collectively they might have a better chance in paying it off.

Currently that seems to be the plan.

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I have always wondered what would happen if their currency strengthened.

They would lose jobs and export strength, but then everything they owned would be worth more. Their property, savings.. anything denominated in local currency.

The problem is, what would they buy?

They make just about everything on the planet so a strong currency wouldn't lead to the Chinese consumer being able to buy more stuff.

The national savings are really just massive holdings of foreign currency, if their currency strengthens significantly those holdings effectively drop in value.

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I remember this idea of a debt limit was brought up several years ago by an HPC poster who did a graph showing how close we were getting to the maximum debt "ceiling", the level at which banks would like to keep us forever. The bank seems to have got carried away with themselves in practice though.

Some posters are expecting interest rates to rise. As soon as this happens, we crash into that debt ceiling in a similar way to Denningers parabola.

All this public debt has done is to move the debt around and flatten the repayment terms whilst hopefully getting the debt on better terms (gilt rates rather than credit card rates).

For those who have lived within their means through the boom, they are now lumbered with the costs unless they leave the country. I know a few 20-somethings that are doing just that, can't blame them. Default by departure.

VMR.

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Some posters are expecting interest rates to rise. As soon as this happens, we crash into that debt ceiling in a similar way to Denningers parabola.

It's amazing how many people don't see that, they appear to have fallen for the hype that interest rates can fix anything just like Mystic Merv said. It's a flexible tool dontcha know.

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All this public debt has done is to move the debt around and flatten the repayment terms whilst hopefully getting the debt on better terms (gilt rates rather than credit card rates).

VMR.

I think that is about the size of it.

To determine whether debt is affordable you need to know the

  1. The principal sum

  2. The interest being charged

  3. The earnings from which the principal and interest is to be repaid

.

If you cant meet at least the cost of the interest from earnings you are essentially screwed.

One of the aims of TARP, QE etc has been to drive down LIBOR, gilts and treasury prices in an attempt to keep interest rates low over the short to medium term. This makes it easier to support the existing debt mountain out of current earnings. The danger is that if deflation does seize hold as it has done in Japan and some other parts of the world then both corporate and personal earnings will also decline which essentially negates the benefits of lower interest rates (.ie although the cost of servicing the debt has been reduced the actual income from which it is being paid is also dropping). Worse the decline in earnings means that the total size of the principal of the debt in relation to income may actually greater than when the debt was first incurred .

Edited by up2nogood

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China are buying US bonds to suppress their currency and stay in business.

When the Renminbi rises to where it perhaps should be, they'll be out of business.

The US will keep trading with the middle east, Canada, South America, Europe, Japan, the Commonwealth quite happily I'm sure.

China are just going to have to suck it up either in whole or in part. It's China who are f*cked, not the US.

+1. The shonky analogy that I'd use, which is economically simplistic but still good material for these forums if you'll forgive me, is that the deficit nations (UK, US, Spain etc.) are drug addicts and the surplus nations (Germany, Japan, China) are the drug dealers. Drug dealers have more power and economic freedom than addicts, right? However, when the addict goes cold turkey and gives up the drug, who loses out the most? The dealer! He's lost his market, he can't sell. The addict, however, is getting clean, sorting his life out and getting on his feet.

If it really wanted to the West could retool its factories in a matter of years and start manufacturing sneakers and toasters and kettles and TVs and all that consumer tat that it buys of China at the moment. It doesn't need China. China makes things cheap, yeah, but that only worked when other (debt funded) industries like construction, real estate and public spending were keeping people in work in the West. All that's gone down the pan. The ability and appetite for consumers in the US and UK to take on increasing debt has gone, hopefully for good. The US and Europe could resurrect it's manufacturing base as quickly as China has built its own base (which they did in a few years). The problem China has is that it makes a lot of stuff but the very workers that make that stuff don't want to buy all of it. They want to save a chunk of their incomes because many of them remember real hardship, it was only a little over a generation ago that many hundreds of millions in China suffered tough, materially deprived lives that us in the West could hardly imagine. No wonder they are conservative with their cash. But that's the fundamental problem. They are trying to achieve, in a couple of decades, industrialisation and institutional sophistication that it took the West literally hundreds of years to do. But they are trying to do it by selling products to the west that we were already capable of making for ourselves and that we didn't need much anyway. Developing a huge supply of consumer goods without developing a demand for those goods is not a great plan and I think we'll all suffer because of it in the end, but the people that will come off worse could well be the Chinese. Don't get me wrong, I don't want this to be a rant against China. I'd take no satisfaction if this theory turned out to be correct. What I would take satisfaction in would be the improvement of economic lives in countries like China that wasn't to the detriment of the economic lives of people in wealthier countries. If this seems a bit over the top, whitness the debt penury that some unhappy posters on this website are suffering now (check the forum on the Titanic development in Belfast, for example) - it's all part of the same surplus/deficit, savings/debt imbalances in the global economy. For every pound saved, there's a pound that needs to be lent. That relationship can only continue in a productive way up to a point, beyond that point both parties get DPed.

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+1. The shonky analogy that I'd use, which is economically simplistic but still good material for these forums if you'll forgive me, is that the deficit nations (UK, US, Spain etc.) are drug addicts and the surplus nations (Germany, Japan, China) are the drug dealers. Drug dealers have more power and economic freedom than addicts, right? However, when the addict goes cold turkey and gives up the drug, who loses out the most? The dealer! He's lost his market, he can't sell. The addict, however, is getting clean, sorting his life out and getting on his feet.

Damn good post and I've never subscribed to the mantra that the West is screwed and that China will take over and that we should all learn mandarin. Had the Chinese made some massive technological leap by making stuff that we couldn't build, then maybe. But they haven't. They are several hundred years too late to the party. They may well catch up, but that will take decades and decades, and due to the way they are organised, may never happen.

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I read an article showing growing debt as no problem this being if GDP rose lets say 4% and the debt rose 2% than although the debts are increasing the higher incomes make it in burdon terms smaller.

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forget GDP growing beyond debt...part of its makeup is Government spending....ie DEBT.

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