The U.S. debt trap: the odds on seven solutions

August 28, 2009

How will America escape its debt trap? The indispensable Arnold Kling puts some odds on various scenarios. An excerpt:

1. Muddle through. No major change in policy, and no major change in economic growth, but somehow the ratio of debt to GDP remains stable. I give this a 10 percent chance, although it implies that I am miscalculating the path that we are on

2. Technology to the rescue. Some major technologies, probably either wet or dry nanotech, produce so much economic growth that the ratio of debt to GDP stays under control. I give this a 20 percent chance.

3. Policy changes. Congress increases taxes (but does not enact a wealth tax) and/or takes steps to rein in Medicare and Social Security spending.  I give this a 25 percent chance.

4. Inflate away the debt with moderate inflation (between 5 and 10 percent per year). I think this would be politically costly, and it might not be enough to really inflate away the debt (it depends on how quickly bond investors adjust expectations and raise the inflation premium in nominal interest rates). I gives this a 15 percent chance.

5. Wealth tax. The government takes, say, 5 percent of everyone’s personal assets above $100,000. It does this on a one-time basis (or so it says). I give this a 25 percent chance.

6. Hyperinflation. This would certainly expunge the debt, but it would be political suicide.

7. Default. The U.S. simply refuses to pay some or all of its debt.  I think that the combined chances of (6) and (7) are no more than 5 percent, with (7) even less likely than (6).

Me: I think #3 is mostly likely, though I hope #2 happens — and there is a greater chance of that happening than most policymakers realize.

5 comments

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[...] By Andy Newman wrote an interesting post today onHere’s a quick excerptNo major change in policy, and no major change in economic growth, but somehow the ratio of debt to GDP remains stable. I give this a 10 percent chance, although it implies that I am miscalculating the path that we are on … [...]

I think the government has already put plan 5 in effect.
I’m losing roughly $6000 a year due to Ben Bernanke’s artificially low interest rates.

Posted by Jim D | Report as abusive

Of course we will do #1 with a bit of #3 & #4. The odds on #2 are a lot closer to zero.
#5 would work better, and be politically possible, if the threshold was set at one or two million dollars.
A true progressive income tax, without loopholes written for the wealthy, is required, realistically. Taxing all corporations, and those with subsidiaries, doing any biz in the US, on all of their world wide income is also required, realistically.
Universal, single-payer health care, like medicare for all, is required.
#7 is the ultimate answer but the timing, as always, is the question. Every fiat currency has, and always will, eventually be over-inflated or basically renounced.
The dollar is only as strong now as the power of the propaganda machines ability to bamboozle the sheeple.
The U$Dollar is the “bubble” no one wants to contemplate, but the dollars “days” are drawing inexorably closer to the inevitable demise.

Posted by CLIFTON BUCK-KAUFFMAN | Report as abusive

What about another option? A deflationary cycle fueled by debt.

Dr. Lacy Hunt’s proposal is that we’re entering a 15-year period of debt deflation. Other historical instances include the U.S. during the 1870s/1880s, the Great Depression of the ’30s and Japan 1988 to the present. The U.S. escaped the deflationary cycle during the Depression thanks to World War II, otherwise these periods normally last about 20 years, according to her thesis. Stimulus helps create some cyclical growth but no economy has managed to simply stimulate itself out of a cycle like this, not even with the New Deal. At least, that’s her belief.

Backing her up is the news that Japan just experienced a record 2.2% year over year inflation in July.

Kling doesn’t factor in that possibility. Am I the only one who is starting to see opinion trend away from forecasting hyperinflation towards realizing that the deflation we’re facing could be deep and serious? I’m still an agnostic on the question, but I’m intrigued.

http://cbfe-econ.blogspot.com/2009/08/de bt-deflation-and-false-dawns.html

1929 – 2008: From GREAT DEPRESSION to GREAT DECEPTION

History tells us the bigger the financial crisis are, the deeper the political, social and cultural changes become.

80 years after the so called GREAT DEPRESSION, we are immersed into the GREAT DECEPTION.

Mankind has not learnt anything in 80 years of history. GREED continues being the global leader of the world.

Several and intense changes have occured during this time frame, but the basic stone of civilizations have not changed that much.

Severe economic crisis provoked wars, the big wars, nazismus, radicalism, … and obviously, populism movements.

Now, we have a black president in the WHITE HOUSE. Unbelievebable 2 years ago. Nevertheless, the worst modern financial downturn together with 8 years of erratic political decisions have made it possible.

Bill Clinton was the last president trying to implement an universal health care sytem. He did not get it. Barack might. In the middle of the current situation, everything is possible.

USA, the empire of capitalism, has now banks nationalised, insurance companies controlled, stimulus plans of more than 700 B dollars put in place, and now, maybe, a nationalised health system.

BIG CRISIS, BIG CHANGES. No doubt about it.

TAX HAVENS have been existing for ages. Even, 2 world wars have not been able to demolish them. Now, their pillars tumble. Bank secrecy may be over for these tax evaders paradises.

I published some time ago here in this blog, a post called THE RESTRUCTURATOR. I wanted to share with you the idea that there is nothing worst than someone come into power with the idea of making history.

MAKING HISTORY is not a wish, is a consequence of some actions taken without further planning. If a politician wants to make history… then praying is the only thing left to do.

DEFICITS seem not to matter. Public and external deficits of trillions do not matter at all.

” I have to stay here 4 years, maybe 8… so I want to be remembered forever as the president of change …”. Bad way, folks !!!

Fundamentals have worked properly during 80 years, these have made the US the most powerful country in the world. The american dreamt, the wild capitalism, the hard work, …

Very simple: FUNDAMENTALS have not failed, the greed of human kind failed.

This greed got feeded with a lack of regulation for new financial products, some kind of corruption inside the institutions, etc… but NOT the pure FUNDAMENTALS of american economy.

The GREAT DEPRESSION of 1929 takes now to the GREAT DECEPTION in year 2008-09.

Let´s take gain of this situation to revolution the world. NO !!!… Let´s take gain of this situation to save the fundamentals that work and have worked for ages … do not demolish them.

Jose Luis Revilla Escudero
Chairman & CEO
WWShares, Inc
-Global Wealth Management-
http://www.worldwideshares.blogspot.com

im betting on the gold price. ive taken on many long positions in gold stocks to hedge against the rest of my porfolio. i really beleive that the high level of debt will continue to erode the dollar well into 2020. from this outlook (and the nearly inverse correllation between the gold price and the usdx) i am quite confident. i use http://www.goldalert.com to check the spot gold price. i would definietly recommend gold investment to gain better leverage within the market.

Posted by john major | Report as abusive