Will Debt Ever Matter?

Share this article

Today is another landmark day in the ever-lengthening parade of government irresponsibility.  This morning’s news brought the message that Japan’s national debt has risen beyond one quadrillion yen.  That staggering figure is more than double the size of that nation’s GDP and exceeds the combined GDP of Germany, France and the United Kingdom.

Not many years ago, few had ever used “trillion” in financial reporting.  Now we’re talking about 1,000 trillion.  As is the case in a growing list of countries, Japan will never be able to pay all its obligations with money worth anything like today’s currency.  The United States is on that list.

In recent years, the U.S. Federal Reserve has led the way among major developed countries in “betting the ranch” to rescue financial institutions and to lift its economy out of a debilitating recession.  The Fed’s balance sheet was about $800 billion when it began to gun the monetary engines in 2008.  Today it reads about $3.5 trillion and climbing.  While the Fed’s largess has barely boosted the lethargic economy above recessionary levels, it has done marvelous things for the U.S. stock market.  Despite the obvious increase in future borrowing needs, the Fed’s direct intervention in the bond market has kept interest rates near historic lows until very recently.

The apparent success-to-date of the Bernanke model has emboldened monetary authorities throughout the world to abandon traditional propriety and similarly explode their balance sheets.  So far there has been no serious investor resistance.  Quite the contrary, until recently most world stock markets have soared, and interest rates–most notably in weak Southern European countries–have plummeted.  Perhaps the monetary alchemists have learned how to turn base metals into gold.

But what if these monetary wizards turn out to be no more legitimate than their medieval forebears?  Remember that the economic collapses of this century have all stemmed from excessive debt.  How likely is it that the solution to those problems will be a multiplication of the levels of debt?

That the Fed and other major central bankers have been able to bury the debt worry is compelling testimony to the power of unrelenting monetary steroid injections.  Investors have been mesmerized by soaring stock prices as though they constituted proof that debt can indeed be overcome by more debt.  Students of history, however, know that debt resolution is not that simple.  As laid out in copious detail in Reinhart and Rogoff’s, “This Time Is Different,” financial crises don’t die quickly and rarely without extended episodes of economic disruption.

The current recovery is fully dependent upon the retention of investor confidence.  Any number of things could disturb that confidence, not least among them a continuation of recent failures like Cyprus and Detroit.  At a point, investors will almost inevitably begin to wonder what lies beneath central bankers’ promises of endless support.  The day that investors come to see Bernanke’s successor, Draghi and Abe as wizards without portfolio, trillions in stock market gains could be immediately at risk.