Diary

Some things I don't know and one thing I do know

Politico has an interesting article on the possible economic collapse of China on their site today. I don’t know if China is headed for collapse, but assuming that this is a real possibility, there are two things that come to mind that are very bad for current US econonic policy:
1) If China can’t continue to buy our debt, the only way to continue to run massive deficits is to monetize the debt by having the Federal Reserve simply print money and buy the treasuries issued by the US gov’t. This will certainly lead to massive inflation. By certainly, I mean that every time a nation has tried to monetize debt to this degree it has always lead to massive inflation.

2) There is currently a push for a second stimulus being thrown around in Washington and on cable news networks. The theory is that the first bill was too small and not targeted towards job creation. China instituted a much larger stimulus bill (relative to the size of their economy) and it was specifically tailored to infrastructure programs and jobs. According to the article it now appears that it has not worked. This further proves the point that a nation cannot borrow and spend its way out of a recession and that the talk of a second stimulus will only put us further in debt (see the above).

Again, I have no idea if China’s economy is on the verge of a collapse, but the fact that we, as a nation, have put ourselves in a position to be this vulnerable to another country’s internal struggles is frightening. The massive consolidation of power at the federal level over the past 10 years has seen the federal budget over double and now we are staring at budget deficits near $1 trillion/year for the conceivable future.

What I do know is that the current US budget is unsustainable regardless of what happens in China. If the US budget was simplified to a household budget of say, 50K/year in revenue, this is what it would look like:

You make 50K/year a year at your job (no taxes deducted as the gov’t pays no tax). You currently spend 75K/year on outlays (bills, mortgage, etc), which is a net loss of 25K every year that you have to borrow from the bank. However, that mortgage you have is interest only with no money down and the current balance is 300K. Because you pay only interest on it and since you continue to add to your debt every year, the principle is actually increasing. If you assume a 5% interest rate, that’s 15K just in debt service that you are paying today. Using a simple interest formula (assuming 25K added every year to the principle and interest compounded annually), that debt has become 817K in 10 years. Now the debt service is over 40K and has likely become the largest part of your household budget. In 10 more years, the debt has doubled again and now you are paying 83K just in debt service. That means that you are working all year round to pay PART of the interest on your debt. No food, no health care, no LCD TV….just interest. 
 
If this scenario was actually the case with an individual…well…this is actually the case for many people today. All those that have lost their house and had to declared bankruptcy know this scenario. However, they were forced into bankruptcy in the “today” stage of the scenario. If the US continues on this path, that is where we will end up as well, but instead of bankruptcy court it will be runaway inflation and the destruction of the dollar.