When Debt Loads Become Too Large

Debt loads become unsustainable when people, businesses, and governments have to make choices…when they cannot just “have it all”.

A case in point comes from a story about the world famous philosopher Winnie-the-Pooh. In this particular story, Winnie-the-Pooh is presented with the choice: “What would you have, Bread or Honey?”

To this Winnie-the-Pooh replies, “Both!”

During the earlier periods of credit inflation, people, businesses, and governments are able to reply “Both” to all choices and are able to get away with it because the credit inflation “buys” them out of the implied limitation on resources.

Credit inflations are cumulative because choosing almost all alternatives and financing them with debt just builds and builds the expansion.

The problem with credit inflations is that they one day come to a halt…that is the cumulative build up of debt becomes unsustainable and choices have to be made. “Both” is not a viable answer any more.

The only possible means of extending the period of credit inflation once the debt loads become unsustainable and a “tipping point” is reached is for the monetary authorities to take the credit inflation to another level, a level that might be called “hyper-inflation.” Hyper-inflations, however, do not have happy endings

Many governments, as well as individuals and businesses, have reached the point where decisions have to be made. Budgets cannot just continue to be “wish lists” where all parties are satisfied. Governments cannot create across-the-board job programs because of the need to substantially reduce their budget deficits. In addition, raising taxes to cover these “wish lists” is just another effort to achieve a “both” outcome.

Keynesian stimulus plans are built on the presumption that the government can harmlessly attain “both” of the consequences of such policies: issuing unlimited amounts of debt and economic vitality. This type of credit inflation can only succeed for a period of time and then the accumulation of debt catches up with the government. In the case of the United States it seems as if the successful period of accumulation lasted for about 50 years.

And, we see that governmental hands can be tied in other ways. President Obama was not able to commit much in the way of resources to the situation in Libya. He dropped the ball to NATO. And, the Libyan battle drags on. And, President Obama cannot get caught up in the conflict in Syria. In fact, American foreign policy is finding itself short on resources in many cases, a situation not faced by this county in the post-World War II period.

In addition, many state and local governments have promised way beyond their capacities on pensions, water projects, and other large capital expenditures and now face the dire prospect of not being able to cover their commitments. We are seeing situations over and over again where debates about pension plans were put into arbitration in order to reach a settlement and those deciding the case had the sole objective of getting people back to work as soon as possible. Thus, generous pension plans were put into place and the governmental unit could justify the “largesse” of the plans by passing on the responsibility for the decision to the arbitration panel.
People in Europe and the United States are now experiencing the very difficult position of having to choose. And, as we see, having to choose is very painful. As we are observing every day, politicians and governments will do almost anything they can to avoid having to make a decision.

The consequence of such behavior? Decisions get postponed into the future.

The feeling: “Maybe if we postpone things long enough the problems will go away.”

The world, unfortunately, does not allow you to postpone the day when decisions have to be made indefinitely. In most cases, if decisions are not made, the time comes when the crisis becomes so bad that decisions “have” to be made.

And, the problem with this is that the burden of the adjustment becomes even greater on those that can least bear them at the “crisis” date than the burden would be had the decisions been made at an earlier time.

Politicians, however, are too concerned about their own re-electability to worry about this later time. But, this is true of executives and their teams and of individuals and families. People have a tendency to cling to the past and put off taking hard decisions.

So the battle becomes a “war” between those that want to preserve as much of the “wish list” as possible and those that claim that priorities have to be set and decisions have to be made.

All to often the decision-making is postponed and postponed and postponed…until it becomes necessary to choose.

The consequence of this in the financial markets…is volatility. The uncertainty created by the postponement of resolving the situation is the extreme movement of market prices as traders are moved this way and that way by the most recent information.

Value investing takes a back seat in such an environment for the achievement of long-term objectives requires extreme confidence and patience. The draw of short-term trading returns is heady…yet extremely risky.

Right now, there is very little hope for us to see a much better future. To see an improvement in the future would require some real leaders to emerge from the crowd and I don’t see anyone yet that fits that description.

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