Over the last three weeks, I have taken you into the liminal dimension of the economy as a blacksmith at work.
Imagine the blacksmith representing our activity (GDP), his arm as Congress shaping fiscal policies (we’ll begin to know shortly if rigor mortis has set in!), the anvil as our federal debt, and the red-hot piece of iron as the economy. The anvil appears solid. But is it?
Perhaps the anvil of debt–money owed–is like the universe: the visible universe represents only 5% of the sum; the other 95%–dark matter and dark energy–is what we neither see nor really comprehend.
With a “gold standard” mindset, do we fear the anvil will inevitably become a black hole for us? Could it tank us, our children, and our grandchildren?
The emotional reaction we have to the growing Federal debt—now approaching $17T—is that the debt could become that black hole. It would be so overwhelming that it not only creates a sinkhole beneath itself but also takes everything—blacksmith, iron, forge and community!—with it.
Alternatively, I can imagine a Modern Monetary Theory (MMT) perspective would say debt is more like 95% of the universe we cannot see: all that matters is the economy’s ability to service that debt—what we can see. So there is no final day of reckoning.
Over the long run—ignoring business cycle vagaries—as long as GDP grows faster than the interest rate on debt, the government will able to service that debt through taxes on GDP. If MMT is correct, neithert the size of U.S. debt nor paying back the principal is important. All that matters is our ability to pay the interest. MMT regards the reference to kicking the can down the road as an artifact of thinking from a gold-based economic perspective—one that accounts for only the 5% of the universe we can see. Nations with fiat currencies can always service debt denominated in their own currency. Debt is like the dark matter/dark energy of the universe that holds everything together.
Do you wonder, as I do, if that old worldview is correct: are we only kicking the problem down the road? Let’s not go through that liminal doorway. I have an alternative one for you to pass through instead.
I believe our personal experiences shape our perception and apprehension of MMT. Consider a common phenomenon in the early years of the 21st century. As a nation, we found a new drug in our addiction to debt. We began thinking of our home as an investment vehicle that doubled as a piggy bank. Homeowners rode the boom up with housing prices growing by double digits. All that mattered before 2008 was the ability to pay the mortgage—often an interest-only one—and literally bank on rising home values and dropping interest rates to allow us to get cash out and continue the cycle of refinancing. When we did refinance, we had more cash to access and feed the cycle of consumption. This worked as long as the value of a home continued to increase. As we know, most home prices collapsed post 2008.
As a result of those borrowing practices pre-Great Recession, many mortgages are now under water. During the trough of the Recession, many of us either walked away from those mortgages, leaving banks with that overhang of bad debt. It will take years for us to wind down those debts. Imagine the debt as the blacksmith whose strength is eviscerated by consuming desserts rather than vegetables, fruits and proteins.
We live with this memory the effects of the housing market crash. Even during this stage of recovery in 2013, I fear we are already forgetting that painful episode and chasing rising home prices in a low interest environment. I believe many of us still perceive economic questions with some of this emotional hangover.
While I am intrigued about this MMT view of the anvil of debt, I am skeptical. I appreciate being freed from my outmoded perceptions about money creation and a positive frame around deficit spending. But I am no prognosticator and hope the world’s citizens continue to accept, believe in and honor the notion that the “full faith and backing” of the U.S. government continues to merit its AAA rating (despite Moody’s negative outlook).
What do you think?
Vote below: Is the anvil of national debt more like a black hole that will ultimately destroy the economy much as wrong thinking and actions in the housing market did in the early 2000s? Is it more like an underwater mortgage?
Or is our national debt more like the dark matter/dark energy of the universe, held together by forces we do not see and are just beginning to understand? And all that matters is maintaining a view of debt as a tool to fight unemployment and grow GDP, trusting that GDP will continue to be fast enough to outrun debt servicing?
__ Yes: the anvil is like an underwater mortgage
__ No: the anvil is NOT like an underwater mortgage
I’ll share any results in future blogs.
Toolkit:
1. How does your perception of our national debt shape your investment assumptions/portfolio construction?
2. How does your belief about our national debt shape your personal financial decisions? your advice to clients? Consider just some of these areas:
- Solvency of banks, insurance companies impacted by debt markets
- Assumptions about health care costs, Social Security, or other pension benefits in retirement
- Assumptions about a safe asset drawdown rates in retirement.
