The debt crisis |

The debt crisis

I recently read a book that neatly laid out the world’s coming debt crisis and possible consequences. I won’t cite the book since it is not available to the general public, at least not yet.

The main premise of this book is that everything reverts to the mean. Normal exists because things tend to follow normal patterns and routines. Trees don’t grow to 1,000 feet. Horses don’t run at 100 mph. You don’t get something for nothing, at least not for long.

This reversion to the mean also applies to markets and economies. It has been thoroughly tested and studied in the investment world. It also applies to nations. Think of Rome. At one time it was a small agricultural town. Its society went on to produce some of the finest philosophical minds ever, invented the toilet, and created an empire. Yet in another 500 years it reverted to a small town.

One other premise was stated. That is that too much of a good thing leads to disaster. One drink might be good for you. Several can lead to disaster.

A good example of these premises is the real estate crash of 2007. Up until then housing prices could go nowhere but up. The uptrend was perpetrated by government interference and poor lending practices. When the housing market corrected it was painful because the trend was allowed to extend beyond its normal life. It was too much of a good thing and reverted to the mean.

So what is all this leading up to? Worldwide, debt of nations is reaching record highs and in many cases unsustainable levels. Something for nothing mentalities and governments are the root cause. The history, social influences, and poor decisions are too lengthy to discuss in detail here.

In the U.S. for example, national debt is $20.6 trillion today. In 1970, prior to going off the gold standard, $1 of debt created $1 of GDP (gross domestic product). Today, it takes $10 of debt to produce $1 of GDP.

The entire U.S. economy is credit driven. People do not save anymore. You can buy almost anything on credit, including groceries. Every major purchase, from a house to an appliance to a car, is typically purchased with credit. In fact, for many people the determining factor for a purchase is not total cost, credit term, or interest rate, but what the payment will be.

The national debt is fast approaching unsustainable levels. When you buy a bond you are lending to the issuer. If interest rates on U.S. Treasury Bonds rise to levels considered typical, 5 to 6 percent, it would take over three-fourths of annual tax revenues just to pay the interest.

The Federal Reserve has taken huge steps to “stimulate” the economy. As a result, they currently have 40 times their typical holdings in Treasuries. This will be a colossal mistake. As Milton Friedman once said, “The Fed never makes the same mistake twice. They just make a different mistake.” Central banks worldwide haven’t learned from the past that no one can control an economy for long.

Unfortunately, there are only two ways out of this mess. They can default on their bonds. Or they can inflate their way out of their debt. Both have huge consequences. The first is not likely as it would destroy the dollar as the main world currency. The U.S. would rather have its citizens suffer through inflation. In either case, the credit system will revert to the norm.

When prices are inflating, credit issuers tend to restrict credit and increase rates. If they don’t, they get repaid in currency that is worth less than when they advanced it. This in turn curtails commerce. At some point, credit becomes either so expensive as to become unreasonable or is simply unavailable. Some of you may remember the early 1980s when the prime rate was over 15 percent. You just couldn’t afford to borrow.

It can and probably will happen again. Only this time it will be worse, because so much more is dependent on credit. If credit is tight, the gas station requires cash (if you have it) because his supplier requires cash. And so on. The entire economic system breaks down due to everyone requiring cash that few have.

Make no mistake, a credit collapse is coming. The question is, when? I don’t know. But credit, as with everything else, will eventually revert to the mean. Hopefully you will be ready.

Tom Riggins’ column appears every other Friday. He may be reached at