The Debt Monster Will Destroy The World

Thursday, January 26, 2012
By Paul Martin
Jan 26 2012

There are still those who don’t believe the world is heading for massive debt defaults. But then there are also some who believe King Tut is not dead but merely sleeping.

Debt has grown exponentially in developed countries. This growth includes both consumer, corporate and government debt. Debt is supported by collateral assets. Assets grow linearly. To be sustainable, debt cannot grow long-term faster than assets. When there are fewer assets backing up debt, the riskiness of debt rises. Eventually lenders refuse to lend any more. This observation has little to do with economics. It is simple mathematics based on growth rates.

The gap between sustainable debt and actual debt is widening at a frightening pace. For corporations and consumers, there is an end point which markets impose. Markets constrain business and consumer debt expansion in line with collateral and perceived risk. When an entity becomes too risky in the eyes of the lender, lending ceases. At that point debt begins to be liquidated either by pay downs or by default (generally producing a bankruptcy condition).

For governments with printing presses there is no comparable constraint. Politicians could act prudently or central bankers could have the courage to end sovereign credit expansion, but modern political history belies either of these as likely. That does not mean that governments are entirely unconstrained. Markets provide constraints in terms of currency devaluation and inflation. To believe otherwise is to ignore the numerous damaging outbreaks of inflation that have scarred history.

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