The inflation time bomb

November 10, 2009

The public debt will likely pass $12 trillion this week, up another trillion since March. With Obama’s left flank calling for a second stimulus – which is really a third stimulus if you count George Bush’s tax rebates – there’s still no serious discussion about how to deal with debt. The bond market is telling us not to worry. But if history is any guide, the bond market is wrong.

(Click chart to enlarge in new window)


I’m referring to Treasury Inflation Protected Securities, TIPS for short, in particular those that reflect long-run inflation expectations. The current spread tells us to expect annual inflation averaging a bit over 2 percent for the next 30 years. That would be fairly benign. And fairly wrong.

Why? Because it assumes U.S. political leadership will put the country on a sustainable fiscal path. I highly doubt it will happen.

In a note to clients last month, Société Générale strategist Dylan Grice explained the connection between debt and inflation. Turning Milton Friedman on his head, Grice argued that “inflation is always and everywhere a fiscal phenomenon.” Money printing may be the vehicle, but the “root cause” of inflation tends to be “a government unable to pay its way.”

You see the real inflationary threat isn’t the $12 trillion public debt, which on its own is serviceable. The problem is $63 trillion worth of unfunded obligations for healthcare and social security. Putting these figures in context, the U.S. government’s total liabilities are 19 times current tax receipts. “Bear in mind that the U.S. consumer is widely seen as dead in the water with debt at 1.3 times income,” says Grice.

There are three ways to confront this mountain of debt.

Scenario 1: We essentially default, like Argentina, refusing to pay our debts once they’ve become too burdensome to service. The dollar would crash as the United States loses access to capital markets. The government would be forced to print money to pay expenses.

Unlike Argentina, however, we print the currency in which our debt is payable, so this scenario most likely won’t happen.

Scenario 2: We default through inflation. Policymakers are so desperate to avoid Japan-style deflation that the Fed will keep printing money to buy risky assets while Treasury pours on the stimulus to keep people employed. The Fed says it won’t run the printing press to pay the debt, but if the only alternative is default, they’ll have no choice.

Scenario 3: We put Medicare and Social Security on a sustainable path, cutting benefits or raising taxes dramatically. This would require a level of political will we’ve never demonstrated.

Right now, TIPS are betting on Scenario 3. I hope they’re right, but just in case, I’m planning for Scenario 2.


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Rolfe —

Logic says you must be right.

Scenario 3 requires about 20 Paul Volckers in the main positions of great influence. Currently, there are no Paul Volckers in positions of great influence.

Posted by Dan Hess | Report as abusive

Bit of an apples and oranges comparison going on here. The $63 trillion mark is for all unfunded obligations … forever … which you then compare to current tax receipts.

It’s also not helpful to lump in Social Security with Medicare. Social Security requires, at worst, a bit of tweaking. Medicare is truly unsustainable in its current form, which is something healthcare reform is meant to address.

Posted by Arthur | Report as abusive

The greatest economic story of our lifetimes involves the nexus of
(1) Aging demographics in the nations that are the source of most savings in the world: Japan, Western Europe, and also to a large extent our own boomers (social security trust fund, etc.)
(2) Massive fiscal deficits among nations (again Japan, Western Europe, United States) that should be running surpluses during these unrecognized metaphorical fat years.
(3) The coming reversal as aging first-worlders everywhere begin to not merely add to but actually start drawing down their retirement ‘savings’ in the form of government bonds issued by sovereigns worldwide. This drawdown is a literal certainty. Virtually all the developed world’s retirement ‘savings’ is sovereign bonds. Ten percent inflation for a dozen years and 2/3 of this ‘wealth’ is gone.

At some point, there is a shortage of savings, and it will probably be soon. Then the bond market, the biggest market in the world, will come under absolute duress.

America will get through without hyperinflation because of our healthy demographics and because we produce of a glut of the world’s most essential commodities, food. This at a time when China and other developing nations are paving over their prime farmland and still increasing in population and eating progressively more meat1.

Posted by Dan Hess | Report as abusive

Japan will lead the way. Their debt is worse than ours. Their fiscal mismatch is worse than ours. Their demographics are worse than ours. One worker cannot possibly support two parents and possibly multiple grandparents.

They have massive amounts of bonds and they will quickly become huge sellers of necessity, because will they need the money to pay their bills. That is why they saved, to pay the bills of their own old age (which is fast arriving) not to finance American deficits. From the beginning they’ve always wanted that money back.

(If that wasn’t enough to scare half to death reread the above, but insert Italy, Germany, Spain, Austria, Switzerland etc. where you see the word ‘Japan’).

We can expect that sovereigns in their own fiscal crises will let their US treasuries expire and just keep the principal rather than rolling it over, which they will desperately need. As the US treasury sends full principals back to Europe and Asia there will be new fiscal crisis and renewed pressure to print.

Posted by Dan Hess | Report as abusive

Why is the bond market registering none of this?

Simple: The biggest players in the bond market are not bond vigilantes. Quite the opposite, they are non-economic players.

The biggest bond market players are the social sec. trust fund, central banks and sovereign governments in asia and elsewhere. They are completely mechanical and non price-conscious in their purchases and they will be mechanical in their sales as well.

Posted by Dan | Report as abusive

[…] Source […]

Posted by The public debt will pass $12 trillion this week, up another trillion since March. With Obama’s left flank calling for a second stimulus – which is really a third stimulus if you count George Bush’s tax rebates – there’s still no serious discuss | Report as abusive

keep spending all americans, keep spending …and file the bankruptcy…and enjoy the life…
Let visa,mastercard,amex,…all go in debt…spend their money and enjoy man…

we all gonna die anyways…
either normal death or from muslim terrorist attack…
Its better to spend someones money and enjoy ! Right ?
I think i am 100 % Right.

Posted by Nilyo | Report as abusive

You make no mention of the role of the trade deficit. I realize that the trade deficit and the federal budget deficit are two different things, but it’s no mere coincidence that our cumulative trade deficit since 1975 (the year of our last surplus) is almost $10 trillion, closely matching the national debt. The government is forced into deficit spending to offset the negative consequences of the trade deficit – unemployment insurance being the most obvious example. Take away the deficit spending and our economy will collapse.

Posted by Pete Murphy | Report as abusive

I had seen a pie chart which did a good job depicting GDP, Debt as a percent of GDP and Interest on Debt as a percent of GDP. Several historical values were compared to today: approximately 1942, 1962, 1982,2002, and current data. When I looked at debt and interest on debt as a percent of GDP, I realized that historically, today’s values aren’t that elevated. Of course, that means that GROWING the GDP becomes the critical factor in our economy.

Posted by Sally Huntsberger | Report as abusive

“Right now, TIPS are betting on Scenario 3. I hope they’re right, but just in case, I’m planning for Scenario 2.”

What are you doing in your planning?

Posted by Mears | Report as abusive

You state ‘$63 trillion worth of unfunded obligations’.

According to Sprott Asset Management it is $118trl if you include other unfunded obligations. This is impossible to fund. Also the current deficit is $12trl but this according to Obamies fugures will rise to about $21.5trl in 2019 with a GDP of about $23trl. You are getting on to 95% of debt to GDP. How will this be funded when savings are so low and the US runs both a current and budget deficit? In addition Obamie has forecast GDP growth over the next 4 years at over 4% average:this will not happen.

US debt does not look too good. I go for option 2. No wonder commodities are rising in price.

Posted by D Rumsfeld | Report as abusive

[…] Rolfe Winkler The public debt will pass $12 trillion this week, up another trillion since March. With […]

Posted by The inflation time bomb – | Report as abusive

[…] The public debt will pass $12 trillion this week, up another trillion since March. With Obama’s left flank calling for a second stimulus – which is really a third stimulus if you count George Bush’s tax rebates – there’s still no serious discussion about how to deal with debt. The bond market is telling us not to worry. But if history is any guide, the bond market is wrong. full story […]

Posted by The inflation time bomb | World of Ulysses | Report as abusive

There is a fourth possibility. We get someone else to pay our debts.

Posted by Robert Foster | Report as abusive

Thank you for your interesting article.

I am personally for Scenario 2, considering also Obama´s style who already saved GM and others through cash incentives…

Posted by Philippe | Report as abusive

At the same time “Geithner seeks to reassure on dollar”, as I read at Reassuring the dollar assumes it is strong, and they are keeping it strong. This is the rethoric since 2000, and in the meantime the dollar has gone down almost 50% against the Euro.

It is very clear that the past already 10 years was spent with destruction of the strong US economy in favor of profits of large multinational corporations. The process eventually started during the early Clinton years by off shoring production and services. The same trend continues. The rest is empty talk, smoke and fire.

Posted by Arpad Szasz | Report as abusive

None of those are pleasant scenarios. Is there a number 4? Throw all the bums out and start with fiscal responsibility/smaller government/common sense?

Posted by Hal (GT) | Report as abusive

>But if history is any guide, the bond market is wrong.
I’m genuinely curious, but has there ever been a major debt crisis in a developed market that was not foreseen by the bond market? I don’t know of one.
The silly comparison of ALL future unfunded obligations with a single year of tax receipts doesn’t help your argument here either…

Posted by Kramer | Report as abusive

A few of the comments suggest it’s unfair to compare all future liabilities to present tax receipts. Here’s my thought, and I’d be curious to get reader comments: The $63 trillion figure works out to nearly $600k per household. That’s not a level of debt that households can feasibly pay off, no matter how long the time horizon.

Inflate it away? Not possible. Higher inflation means higher medical costs, which will increase the unfunded liability.

Posted by Rolfe Winkler | Report as abusive

I have no idea why Dan views US demographics as “healthy.”

The population is aging, and European-Americans are destined to become a minority by 2042 at the latest. The latter is something most people find difficult to bring up — unless, of course, they’re celebrating it.

Posted by Mike | Report as abusive

I can agree that there are serious problems with unfunded obligations, but these analyses almost NEVER address the other major expenditure after social welfare — that is the huge costs maintaining an empire.

The US has 5% of the world’s population and spends almost 50% of the world’s military budget. In addition to the actual year-to-year appropriation, there are huge legacy costs and sunken costs. Also there are huge opportunity costs — just look at all the intellectual resources used to build an ever-more high tech military instead of solving problems of the environment, infrastructure and food production.

I would suggest if we cut DoD and all empire-associated expenditures to 1% of GDP (like the rest of the world) many of the issues related to deficits and adequately funding social welfare would be much easier to solve.

I am not optimistic, however. The politicians are heading towards the cliff like Thelma & Louise, with the population as ignorant passengers.

Posted by Gregg | Report as abusive

they are all future predictions..

Posted by Michael | Report as abusive

Scenario #3 would be great. But for that to find acceptance the collective mindset has got shift enormously. Where I live, state governments go through rounds and rounds of layoffs and cut fundamental services because of tax income shortfalls. On the roads that are spruced up by stimulus money, brand new extended cab pick up trucks are all the rage. Nobody seems to accept that life has fundamentally changed.

In short, Scenario #2 is more likely to unfold and may result in great hardship. Remember the Weimar Republic! It is an experience no German would like to repeat.

Read more and see examples here: 2/reichsmark-fiscus-exuberance.html

Posted by Peter Melzer | Report as abusive

[…] Federal government is facing its own burn rate crisis, what Reuters calls an “inflation time bomb.” The article points out that real inflationary threat isn’t the $12 trillion public debt, which on […]

Posted by Governments, companies, and people all watching their burn rates « Aware Brain | Report as abusive

Revolution is coming…

“(Our) great industrial nation is controlled by it’s system of credit, our system of credit is privately concentrated, the growth of the nation, therefore, and all our activities are in the hands of a few men…. who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom.”

“We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world – not government by free opinion, no longer a government…. by conviction and the vote of the majority, but a government by the opinion and the duress of small groups of dominant men.”

Woodrow Wilson

Posted by LestWeForget | Report as abusive

[…] 009/11/10/the-inflation-time-bomb/ […]

Posted by The inflation time bomb – We are binding ourselves to slavery if we don’t stop the spending – The World of Aklaim | Report as abusive

Many of us have been saying this for over a year now…..It was very easy to spot if you understand economics at all.

By inflating the currency, the debt gets cut down in size. If we use an example of 100% inflation, the debt will be cut by a coresponding 50% making it much more managable.

Remember the slow down last Christmas season? Well wait until you witness the slow down this year. With U6 at 20% conservatively we are going to be in for it!

Saving our income is good, (for the people) but the nations money supply relies on debt and so if the public starts to pay back their loans, the money supply will start shrinking. With the “Jobless recovery” and a “shrinking” money supply that equals stagflation, even worse than inflation.

Posted by sideefx | Report as abusive

The Woodrow Wilson quote would make a lot more sense if Woodrow Wilson wasn’t the man who initiated our current central banking system. In fact, some might argue that he personifies our current governmental control issue.

Good article by the author. I respect those who criticize the author’s analysis of long term unfunded liabilities number versus one year of tax receipts, but feel that viewpoint is somewhat irrelevant. Extrapolate the one year tax receipts to whatever time frame you want and match it up against our liabilities and there will be a short fall. So, the authors theme of unfunded liabilities holds true.

We spend too much and can’t sustain it. We need MAJOR modifications in what we know as government and their spending. Plain and simple. If you make 100k per year and spend 110k per year, it’ll catch up with you sooner or later. It’s no different here. We spend too much. We have too many entitlement programs. We discourage innovation. And we tax too much. Corporate giants are in bed with politicians and vice versa. It’s the way of the world. It’s always been that way and it’s no different now. Eventually, the society will collapse (at least to some degree) because it’s inevitable. It’s happened since the beginning of time and there’s nothing to indicate that things are different now. Go look up why the Roman Empire failed. Remarkably similar to our current situation…politically and fiscally (as if the two can be separated).

Posted by tired | Report as abusive

Sideefx… problem: Debt has to be rolled over. Try to inflate away the existing stock of debt and interest rates on new borrowing will leap. I can think of no better way to hasten the day of default…

Posted by Rolfe Winkler | Report as abusive

I think it’s likely to be elements of (1), (2) and (3), with a lot of jawboning, hand-wringing, speechifying and excitement. Somebody (I think on Reuters) said we can’t inflate (without defaulting) because most of the debt is short term, and people won’t roll it over if they expect inflation.

Thought for the day: What if the Third Reich had had the Bomb, and won WWII?

Posted by Pete Cann | Report as abusive

Hello? Anyone home? Inflation has already began despite all the pretty graph and pie charts. Just ask the common folk.

Posted by dahc | Report as abusive

Typical wealthy view of how the fix the US debt problem:

(1) ignore the $12 Trillion in current public debt (this is the part of the total US debt directly attributable to the wealthy from their recent excesses (like tax cuts for themselves, the Iraq war, pork barrel spending on favorite projects, “outsourcing jobs” for cheap labor, etc.), and

(2) instead “put Medicare and Social Security on a sustainable path, cutting benefits or raising taxes dramatically” (they don’t mean raising taxes on themselves, of course, just the middle-class).

They want to pass the entire burden of fixing this economy onto the middle-class when, in reality, it is the wealthy who are the ones who created unfunded programs like Medicare and Medicaid, as well as looted the Social Security “trust fund,” which never really existed at all.

They are, in effect, blaming the poor and middle class for their greed and duplicity.

It is the ultimate rip-off by the US wealthy running the government. They created the illusion decades ago that they were actually doing something beneficial for the people (remember Johnson” “Great Society”?), instead of just lining their own pockets, but the American people should have looked this “gift horse” in the mouth more closely to see what we were getting from them. Remember, the old saying, “if it looks too good to be true, …”? Now, it looks like the whole thing was really nothing more than a massive Ponzy scheme by the wealthy.

Unfortunately, all Ponzi schemes have to come to an end eventually and we are now faced with the reality that we really don’t have any “safety net” at all. It was nothing but “smoke and mirrors” all along.

Along with the 3 solutions outlined in the article, I could add a 4th, which I don’t believe the wealthy would like very much.

Posted by Cassandra | Report as abusive

To fix this problem you must reduce the total cost of medical care. Step 1, provide health insurance to everyone. (a)The result will decrease the cost of the hospital bill, because it is no longer inflated to cover for the default risk among patients.(b) The result of lowered medical bills is lowered insurance cost because cheaper care is cheaper to insure.(c)If care is cheaper and access is universal, then people will go to the doctor instead of waiting and going to the emergency room as a problem gets worse.(d)Emergency care is more costly than primary care.(e)Reducing the total cost again, reducing insurance risk again, allowing the companies realize profit without bankrupting America. Ta da

Posted by Cheshire | Report as abusive

Rolfe —

You and sidefx are both right. But the wildcard card is quantitative easing. At rollover time, the Fed shows up with a bunch of new money (already 1.0 trillion in 2009) and holds interest rates much lower than they would otherwise be.

If interest rates on new borrowing leap, this will threat to throw the economy back into the pit at a time of double digit unemployment. The urge for a new round of Q.E. will be strong.

Assuming the QE is not ultimately mopped up (and I can’t see how it will be) each round of QE reduces the national debt by the amount of the easing.

QE should make our creditors nervous indeed.

Posted by Dan Hess | Report as abusive

Dan Hess, that’s interesting, but when you say quantitative easing should make our creditors nervous, isn’t it because the dollar is worth less, and isn’t that pretty much what inflation means? I guess we never know what will happen when when we increase the money supply, but QE seems to be the Fed printing money and giving to to the Treasury to spend, thus putting it in circulation. I don’t know much about this stuff. Yours is the rare post that should have been longer!

Posted by Pete Cann | Report as abusive

Okay, Pete, here’s more, now it’s too long!

The fed keeps telling us (again today) they plan to hold rates down for a considerable period and they can, by QE.

This extracts capital in the form of inflation (or foregone deflation) from our bondholders worldwide, ranging our own retirees and 401K holders to foreign sovereign holders, in terms of likelier inflation.

The result is an engineered dollar decline. It has already happened — all summer and fall, and risk assets have revived!

The global rebalancing solution needed would be for Asia and especially China (and Japan too) to quit their dollar pegs now and take the adjustment of rebalancing.

The longer they peg the more they hurt themselves. We can do this QE thing all day as long as they are buying our bonds (to maintain their pegs) and thereby sanitizing the inflation risk by getting the dollars off of our shores. Funny thing is, with our QE fun, all their bonds won’t be worth as much as they think.

As long as they keep buying our bonds to maintain wrong pegs rather than spending the dollars they earn on stuff we sell, this weird situation will continue. If I were them, I would much prefer to buy American physical goods rather than bonds. They (China) are comparatively young and poor. What are they waiting for? What cruel dictatorial oppression by China’s leaders, stopping their currency from appreciating and keeping the people poor and unable to afford things! The people should ask, if they produce all the goods for the world, why aren’t they rich yet?

Posted by Dan Hess | Report as abusive

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[…] The inflation time bomb – 009/11/10/the-inflation-time-bomb/ […]

Posted by Daily Wrap – 11/12/2009 « | Report as abusive

Dan Hess says:
“If I were them, I would much prefer to buy American physical goods rather than bonds. They (China) are comparatively young and poor. What are they waiting for?”

Well, China is right now spending like there is no tomorrow in buying or leasing land in Africa mainly but also in S.A. (mainly for food production), buying rights in mines, oil fields and ports and also buying property all over the world. Also, CHina sends millions of her citizens abroad subsidizing their immigration process, their businesses and them importing from China in order to sell to their new home countries.

China is taking over and we’re watching

Posted by Peripeton | Report as abusive


Posted by mICHAEL R STEINBERG | Report as abusive

How the Fed is inflating:

“Isn’t the Fed Monetizing Housing Debt? ”
Tim Iocono sn-t-the-fed-monetizing-housing-debt?sou rce=article_sb_picks

Posted by Dan Hess | Report as abusive

And if it fails you are going to see hyper-inflation occur that is prophesized in the bible. Revelation 6: 6Then I heard what sounded like a voice among the four living creatures, saying, “A quart[a] of wheat for a day’s wages,[b] and three quarts of barley for a day’s wages,[c] and do not damage the oil and the wine!”
Wow, a quart of wheat for a day’s wages? That’s like a loaf of bread for $150? Who can afford that? You will see the super rich become middle class and the middle class become poor. Jesus is coming soon take heed to His warnings!

Posted by CHRIS | Report as abusive

[…] to buy into this very strong bull market. Fundametals Review The US public debt is just about $12 trillion now having risen from $10.5 trillion early in 2009. Now that

Posted by One Step At A Time – Gold Speculator | Report as abusive

Arther, What have you been smoking? What kool-aid is in your refrigerator. Get a clue!

Posted by Brian | Report as abusive

When speaking of unfunded liabilities, why is there no mention of defense spending? Isn’t it better to care for our own people instead of paying for global empire?

Posted by Joe Sheperd | Report as abusive