“The Largest Legal Transfer of Wealth in U.S. History”

I’ve spoken on several occasions about debt and its crucial role in an economy, from the perspectives of individuals, families, companies and government entities.  It’s undeniable that our present economic malaise is profoundly affected by the unprecedented levels of debt that have built up in our economy.  They’re now so great that they overhang and outweigh almost every other factor.  In particular, many people don’t realize that so-called ‘quantitative easing‘, or the ‘printing’ of money by a central bank, is effectively identical to taking on greater levels of debt.  Its effect on the economy is at least the same, if not actually worse.

Karl Denninger recently explained the effect of debt on an economy, and on government spending, in admirably succinct fashion.  Here’s an excerpt.

Here’s the reality of money:

Money is only valuable because it is, in relative terms, scarce.  Money is really nothing more than a unit of accounting that’s convenient in the physical world.

We could (and perhaps should) account for production in the physical world, and its value, in some invariant physical unit.  I happen to like BTUs (or Joules) of energy required to produce a thing or contained within a thing, because it is an invariant and therefore not subject to tampering.  Accounting for it under production rather than the recoverable (e.g. “stored”) energy in a good or service means that improvements in productivity (e.g. discovery of a new, “cheaper” way to make gasoline, for example) makes the value of each unit (a gallon, for example) less and accessibility greater.  This is what productivity improvement is supposed to do — it advances the common benefit to everyone because it makes useful goods and services more accessible to everyone.

So let us assume that among everything in the economy there is 100,000 Joules of energy represented in a given period of time.  Yes, I know this is a ridiculously small number, but adding more zeros doesn’t change anything other than scale, and 100,000 is a nice convenient number.

We will also assume that there is $100,000 — that is, one hundred thousand dollars, in said economy.

It would be reasonable to assume that the average cost of transacting for one Joule of represented production of a good or service would be one dollar.  There would be items in the economy that are of relatively more value in terms of dollars-per-Joule, and some with less, but on average that would be the expected clearing price.

Now let’s remember that money is fungible (that is, exchangeable) with credit (which is just another word for “debt”); that is, a promise to make something tomorrow.  They both are accepted in the economy as exactly the same thing, even though they demonstrably are not.

Now here’s the problem: Bill and some others (e.g. the MMT charlatans) assert that the government can simply create money.

But that’s not true.  The “creation” he refers to is in fact credit because the government did not first produce anything.

Consider what happens if you double the amount of “money” in the system from $100,000 to $200,000, given that 100,000 Joules of production takes place.

The average clearing price of a good or service produced with those Joules will double from $1 to $2. It cannot be otherwise because equations always balance; this is what the laws of mathematics tell us.

Now does it matter whether you borrow or “create” in this regard?  Only in one respect: The prospect of having to repay (potentially with interest) is a check and balance on borrowing that is utterly absent if you “create.”

But in terms of the economic impact today, at the point in which you put the new “money” into the system the two acts are exactly identical.

Both do immediate violence to the purchasing power of every unit of currency or credit that exists in the system at that instant in time.

It cannot be otherwise because the laws of mathematics, which state that equations always balance, are not suggestions!

As a consequence there is no possible way for the government to spend more than it takes in via taxes without distorting the economy and destroying the purchasing power of the people.

There’s more at the link.  Essential reading to understand debt on an economy-wide level.

Not only governments have taken on astronomical levels of debt in recent years.  Companies and individuals have done likewise – and it looks like they’re about to pay the price.  Stansberry Research reviewed the situation in its September newsletter.  Here’s an excerpt.

We are in the early stages of a great debt default – the largest in U.S. history.

We know roughly the size and scope of the coming default wave because we know the history of the U.S. corporate debt market. As the sizes of corporate bond deals have grown over time, each wave of defaults has led to bigger and bigger defaults.

Here’s the pattern.

Default rates on “speculative” bonds are normally less than 5%. That means, less than 5% of noninvestment-grade, U.S. corporate debt defaults in a year. But when the rate breaks above that threshold, it goes through a three- to four-year period of rising, peaking, and then normalizing defaults. This is the normal credit cycle. It’s part of a healthy capitalistic economy, where entrepreneurs have access to capital and frequently go bankrupt.

. . .

The most recent cycle is the one you’re most familiar with – the mortgage crisis.

Six years after default rates normalized in 2003, they suddenly spiked up to almost 10% in 2009. But thanks to a massive and unprecedented government intervention, featuring trillions of dollars in credit protection, default rates immediately returned to normal in 2010. As a result, only about $1 trillion of corporate debt went into default during this cycle.

You should know, however, that the regular market-clearing process of rising, peaking, and normalizing default rates did not occur in the last cycle. A massive, unprecedented intervention in the markets by the Federal Reserve stopped the default cycle in its tracks. As a result, trillions of dollars in risky debt did not enter default and were not written off.

Over the last six years, this “victory” against bankruptcy and the credit cycle has led many government leaders and their economic apologists (like Paul Krugman) to declare victory. What they won’t admit is that the lack of a debt-clearing cycle has resulted in a weak recovery and an economy that’s still heavily burdened by unsustainable debts.

What happens next should be obvious to everyone: The big debt-clearing cycle that was “paused” in 2009 will make the next debt-clearing cycle much, much larger – by far the biggest we’ve ever seen. When will that happen? Six years after default rates last returned to normal. In other words… right now.

. . .

At the end of 2014, only 1.42% of speculative corporate debt had gone into default for the year – near a record low. The only better year for speculative corporate debt in recent history was the top of the mortgage-debt boom in 2006. As you know, two years later, disaster struck. A new low for defaults in 2014 points to 2016 as the year when corporate debt will begin a new default cycle.

Martin Fridson, the world’s foremost expert on the high-yield bond market, says his “base-case scenario” is for between $1.6 trillion and $2 trillion in defaults in high-yield bonds over the next three to four years. We believe default rates will be a lot worse, simply because the market has grown so much, thanks to things like CDS credit protection and the securitization of subprime consumer lending.

. . .

What’s coming is the greatest transfer of wealth in history. Over the next few years, trillions of dollars’ worth of businesses, land, resources, and intellectual property are going to exchange hands – legally, but unwillingly.

Again, more at the link, including a very useful analysis of sub-prime consumer debt and what that’s likely to mean for individuals and the companies who extended the debt to them.  Another excerpt:

… market participants in a credit boom always forget that underwriting standards heavily influence the nature of the market that is created.

When underwriting for mortgages was firm, when down payments were given, and when buyers had good credit, there was little risk that home prices would fall. They hadn’t been wildly inflated by loans given to people who couldn’t possibly repay.

But after a decade of loosening lending standards and several years of making loans that didn’t really have to be repaid on time… to people who didn’t really have any income… the exact opposite was inevitable. Housing prices had to fall because the owners of a significant number of houses couldn’t possibly afford them. Losses went from being impossible to inevitable.

As you’ll see, that’s exactly what has happened with subprime auto lending [today].

Go read the whole thing.  It’s worth your time, as are all Stansberry Research’s educational articles.  They’re a very informative resource indeed.  Recommended reading.



  1. Every boom is followed by a bust, although predictions about the timing differ.

    If there is any pundit who consistently gets the timing right, it must be purely by accident. Every new generation engages in "irrational exuberance" and fiscal foolishness in one way or another, we seem to be unable to learn from past experience.

    I am generally leery of "alternative" economic theories and proposals (e.g., return to the gold standard) because I suspect that whatever is wrong with the current economics mainstream, adopting any of the "cures" proposed by the alternatives would be worse than what we have presently, due to the law of unforeseen consequences.

    Simple rules of thumb (neither a borrower or a lender be, or both only in moderation; plan your career like you would a business, with periodic adjustments for reality; diversify savings and investments, avoid high-risk, high-yield ones; keep yourself in good shape physically; work on relations with family and friends; don't obsess too much over dangers, we all die) are quite effective. Too much time spent studying what the trained specialists (economists and central bankers) can do better takes away from earning a living, which is quite hard enough as it is.

    "Preppers" have a nice hobby, but their preparations will only be useful for the (quite narrow) interval between the situation today and the complete breakdown of social order (which will mean death for most of us regardless of our preparations, if it comes).

    Just my two cents.

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