We're Just Gonna Inflate Our Way Out Of It! (Or Are We...)

Tyler Durden's picture

From Contrary Investor

We're Just Gonna Inflate Our Way Out If It!...Oh really?  I don't think so, Scooter.  In a recent discussion we mentioned the fact that lately former Fed member Larry Lindsey has been talking up the idea of a potential fiscal trap for the US.  To be honest, we believe this idea has already played itself out in Japan and day by day is coming to a Euro theater near you in terms of individual country experience. The whole idea of a fiscal trap involves the combination of sovereign debt levels with manipulated domestic interest rate levels. Japan has been a poster child example of this simple concept.  By artificially holding its domestic interest rates at the theoretical zero bound, it has allowed the government to lever up in a magnitude that most likely never could have happened had free market forces set domestic interest rate levels.  Japan has enjoyed an artificial depressant on nominal dollar (in this case Yen) interest costs that has made incredible sovereign debt expansion feel relatively benign from an ongoing debt servicing cost perspective relative to what has been up to this point the magnitude of ongoing sovereign revenue collection.

Many moons ago we were involved with an investment idea for a time that was essentially a rollup of and specialized focus upon ventilator hospitals.  The company was called Vencor.  As a result of that investment we necessarily needed to get up to speed on the medical profession subspecialty that is pulmonology.  And what struck us at the time as being so critical in many patient cases was the "weaning period" or window of opportunity so necessary for a patient to get off a ventilator.  In the majority of cases involving a shorter term illness, the weaning period was simply a natural part of total patient recovery.  But as you would imagine in a smaller number of cases, patients were not so fortunate.  Although this is a very generic comment and completely dismisses patient and circumstance individuality, the fact is that the longer a patient remained on a ventilator, the greater the chances they would not be able to be weaned off of the machine.  The body “learns” not to breathe on its own after a period of time.  Essentially a patient would pass a critical window of recovery weaning period opportunity.

So, first, our personal apologies as we know this analogy is neither light hearted nor fun to discuss.  Somber may be the true characterization.  But we believe this analogy is incredibly apt in terms of describing the reality of the sovereign debt fiscal trap.  The longer Japan has been on the artificial zero interest rate "breathing machine" over the last decade plus, the harder it has become to wean itself off.  Although we could spend an entire discussion on Japan alone, we personally believe Japan has already passed the critical "weaning period" demarcation line for zero bound interest rate/monetary policy.  At this point, meaningfully rising rates in Japan would cause a rise in debt service payments that would crash directly into the current level of offsetting revenue collection by the government and leave little else in the way of excess funds in its aftermath.  Of course after so many years of zero bound for Japan , investors seem to believe rates will remain near zero indefinitely.  This is what complacency is all about.  Although this sure seems to be the real world reality that hovers over Japan, the Japanese fixed income markets have clearly not priced this in as of yet.  Somewhere down the road it appears an inevitability.  Again, a very big story that will be told another day.  But when that day comes, it may indeed be quite the eye opener and repricing event for sovereign debt globally.

It just so happens that a few weeks back, those thoroughly lovely folks at the US Treasury Department were kind enough to give us a current look at just where the structure of official US Federal debt stands as of January 2011 month end.  We pulled out our calculators and went to work to produce the chart you see below that breaks down the maturity structure of Federal debt by year looking out over the next decade.  Let's cut right to the bottom line.  A touch over 22% of US Federal debt matures in one year (2011).  A touch less than 50% of total Federal debt matures within three years.  And as you eyeball the debt maturities of 2011 through 2013, we believe it's fair to say that the average maturity of just shy of half of “official” US total Federal debt is roughly a year and one half.  Trying to be conservative, with one year Treasury paper near 30 basis points in cost and three year paper near 100 bp, we believe it's fair to say that a bit less than one half of total publicly traded (excluding intergovernmental transfers) Federal debt has an average cost of capital of about 55 basis points, again remembering that in weighting these numbers the bulk of maturities occurs w/in 1 year.  And without question this is a gift of Fed interest rate engineering at the theoretical zero bound.  The cost of servicing US Federal debt interest payments has been hooked up to a Fed sponsored ventilator, if you will, as it's certainly not breathing on its own.  So the much longer term thematic investment question becomes, just when will the eventual "weaning period" from the zero bound begin and what will be the character of the patient when this occurs?

For now, the US has in good part traveled down the path already trodden by Japan in the prior decade.  But as we see life, the US has not yet passed the critical "weaning period" stage where it can no longer "afford" to get off the ZIRP ventilator.  Time remains, but the clock is ticking ever louder with each passing day.

Here’s a fun fact you can use to thrill your friends at the next Wall Street cocktail party.  At year end 2006, “official” US Federal debt outstanding stood at $4.9 trillion.  The latest Fed Flow of Funds numbers tell us that by the third quarter of 2010, that number is now just over $9 trillion, an increase of $4.1 trillion.  Not quite a doubling in US Federal debt.  To find a similar increase of $4.1 trillion prior to the beginning of 2007, one has to travel back a quarter century and combine ALL Federal debt taken on.  We’ve now accomplished in three and three quarter years what took a quarter century to accomplish.


And of course what has happened to 1 year Treasury rates since the dawn of 2007?  They have fallen from literally 4.94% to under .3%.  You get the picture.  The government has been able to take on this magnitude of new debt as debt service costs are negligible under 30 basis points.  This is the birth place of the fiscal trap.

Remember, the numbers we are discussing do not include the impact of Fannie and Freddie, nor take into account the present value of SSI and Medicare liabilities.  But since Federal debt costs have been artificially lowered for now by the Fed sponsored breathing machine, debt service costs during this period of what truly is unprecedented US sovereign debt buildup have been totally benign.  Everyone and their brother know, or better know, that from a longer term standpoint this reality in current US Government funding circumstances is absolutely unsustainable.  Somewhere ahead, "something" will change.  It's how this set of circumstances is reconciled and what influences or effect this reconciliation has on financial asset classes and prices that will be important to investment decision making.

Sorry to have dragged you through the above, but it sets the stage for hopefully a thematic truism looking ahead.  Right to the bottom line.  The set of facts and circumstances we've dragged you through so far in this discussion argue incredibly strongly that the US is not going to be able to "inflate its way out" of its current leverage/entitlement obligation position.  Of course this thematic comment rests squarely upon the assumption that US interest rates would rise in an accelerating inflationary environment.  And yet wildly enough, does it not appear that Fed monetary actions seem absolutely hell bent on reflation at all costs?  It sure seems that way. 

You know that a few weeks back we received the new budget from the Administration.  Of course it came on the same day that the $1.5 trillion budget estimate for 2011 became $1.65 trillion.  (You may remember we entered the current year with an estimate of $1 trillion, but who's counting at this point, right?)  Of course the missing item from the current budget proposal was any type of an attempt at reconciling entitlement costs.  God forbid in a pre-election year, no?  C’mon, what’s more important, the long term economic health of the country, or near term election results?  Unfortunately and quite sadly, you already know the answer.  The key fact in this balance sheet and deficit funding drama is that the US is facing chronic short term budget deficit acceleration due to the now inevitable fact that here and now entitlement costs are accelerating as the baby boom generation has come to collect, so to speak.  Since there has never been any attempt by the Government to look at long term funding of these long term entitlement costs (match funding), it's a pay as you go set of programs.  And that means the Government long ago chose to fund these short term.  Hence the current structure of Government debt maturities.  The Government long ago chose to fund its entitlement obligations with an adjustable rate mortgage, if you will.  And for now, the chief pulmonologists at the Fed have chosen intubation and ventilator assistance in terms of current interest costs.  But the longer the patient (US Government debt acceleration) remains on the artificial interest rate ventilator, the tougher it's going to be to successfully move through and past the "weaning period".  Hence the description of the fiscal trap.  This is only amplified by the fact that this year SSI inflows will not meet outflow requirements, leaving the Government to make up the shortfall as part of the budget.  Just imagine what this will look like in a few years, let alone a decade.

For a minute, let's flip this set of circumstances on its proverbial head and ask under just what set of circumstances could the US Government potentially successfully inflate its leverage problems away.  It's a bit of compare and contrast with the reality of current factual circumstances.  The US could successfully "inflate away" its debt issues if 1) the structure of debt maturities was decidedly skewed to the long term, and 2) the US had not chosen to fund its longer term entitlement obligations on a pay as you go basis at the short end of the curve.  Small annual budget deficits with large long dated debt obligations could easily and absolutely be reduced in "real" terms vis-à-vis a process of accelerating inflation.  The problem, per se, could very much be inflated away.  But this set of circumstances stands in polar contrast to the current reality of the Federal Government debt structure and ongoing and accelerating short term funding needs.  Message being, the US will not be able to inflate its way out of what will be growing budget problems as we move ahead.  In fact, the Fed trying to force macro inflation short term is simply counterproductive to Government longer term budget and debt service interests.  Question:  How does the Fed creating another stock market ramp help to solve bigger picture US debt and ongoing funding cost issues?  We do not have an answer, not unless we are going to tax Wall Street and big bank record bonuses as well as stock related capital gains at a 100% marginal rate.

With a projected $1.65 trillion budget deficit for this year, the US will borrow about 11% of estimated GDP.  It has likewise been estimated that interest costs to service US Government debt singularly will total about $190 billion, or roughly 1.3% of GDP.  Due to the Fed manning the financial ventilator, borrowing costs are low, but borrowing needs are high.  With this type of a structural backdrop, inflation (assuming higher interest rates would be a result) is the last thing the US Government needs, but its the very thing the Fed seems intent on provoking.  The longer this set of circumstances not only exists, but continues to accelerate in trajectory, the tougher the "weaning process" will ultimately become for the Fed's zero interest rate policy.  Unlike Japan , we believe the US still has the time to address this key issue for longer term US economic outcomes.  Of course the most important question of all becomes, does it have the will?

The larger the US debt burden grows ahead as the Fed maintains the financial ventilator setting on zero bound, the greater the potential for a sovereign debt dislocation in the US to arise at some point.  We are already seeing these exact circumstances in the EU zone along with fallout consequences.  We personally believe it will not be long before the global capital markets "recognize" and price in the reality of fiscal and monetary circumstances in Japan .  The US given a bit of lead time has a key choice right now.  Either deal with this set of colliding circumstances proactively, or the global capital markets will do so somewhere ahead.  Unfortunately as sovereign debt issues continue as a critical theme ahead, the spotlights will shine on this problem ever more brightly from a global perspective.  We mentioned thematically many moons ago that the final provocateurs in generational credit cycle expansion would be sovereign entities.  Just as it was clear in the middle of the last decade that US households were heading toward a generational tipping point in terms of balance sheet leverage extension, so too is it clear now that many global sovereign entities are exhibiting similar character.  Unfortunately, our elected and appointed officials, as well as Wall Street and financial sector hangers on, told us "no one could have seen this coming" in 2008 and 2009.  We're telling you right now that from a sovereign sector balance sheet standpoint it's coming, okay?  We're just hoping we won't be calling ourselves "no one" in a few years.

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Long-John-Silver's picture

Reality is rapidly approaching.

Michael's picture

No one could have seen it coming.

Rainman's picture

" How could we have known ? " will be revised to " How could they have been so stupid ? "

Temporalist's picture

WTFK?  Whothefuckknew?

Based on the information we had at the time there were WMDs but upon further review...it was just opium...errr...I mean oil...

Clint Liquor's picture

Reality is the antidote for hope.

Bicycle Repairman's picture

"We personally believe it will not be long before the global capital markets "recognize" and price in the reality of fiscal and monetary circumstances in Japan".

Really?  The 'facts' have (seemingly) been in plain view for years.  Can the market really be that stupid or is there something else?

If history is any indicator, "Instant Karma" is not going to hit Japan or anyone else in the short run.  In the long run ............

RockyRacoon's picture

Last ditch effort to loot the country by the folks who don't need any more.

Not really hard to figger out.   Tragedy of the Commons.

Bicycle Repairman's picture

They need our military.  And will for some time.

Oh regional Indian's picture

A few observations and questions:

1) Whatever happened to the Yen carry trade. Did it unwind in an orderly fashion? It was going to blow the financial world apart a couple of years ago. As it should. No news of it at all for the past 18 or so months.

2) Repeated use of artifical inflation devices is said to cause terminal limpness. Is that the desired outcome of proposed inflation?

3) How do you inflate in a zero-bound environment? Is there other stealth ways, unknown to me/us?

4) Across the board inflation? How can that cure anything at all? Bi-flation I can see. BUt that is a twin-squeeze. A double whammy.

5) "We" will inflate "our" way....etc... Who is this we and our? Banks or peeps or Everyone, praise the Lord?




Oracle of Kypseli's picture

Governments are running out of other people's money, so they print their own. Why not then repeal taxation and spark consumerism? If that is what jump starts the economy.

The government can print its own money for spending. (As they now do anyway.)

Instead of giving it all to the banks, just share with the people.

Oh! yea. That's a bold experiment, they will say.

Yes! But it is more equitable experiment than the government's.

Bob's picture

That appears to be  the problem with anything that remotely resembles actual "socialism." 

cxl9's picture

Why not then repeal taxation and spark consumerism?

Because without taxation there is no fundamental demand for dollars. You'd also be giving people back 40-50% of their lives, and you know they would just spend that extra time getting into all sorts of mischief.

Long-John-Silver's picture

RE: How do you inflate in a zero-bound environment?

Simple; you add a zero to the price of everything just like Jimmy Carter.

Orly's picture

1) Whatever happened to the Yen carry trade.

It moved to Australia and is about to catch a major, major unwind.

3) How do you inflate in a zero-bound environment? Is there other stealth ways, unknown to me/us?

You simply allow unlimited speculation in the commodity markets.

How can that cure anything at all?

It allows deflation to be quenched in the hopes that consumers must pick up the ball, go back to work and gripe about paying higher prices.  Overall and in the grand scheme, it does nothing in the end.

Home prices in the US, which is the main deflationary asset, are still overvalued, in most places, by at least 20%.  When wages catch up with the ability to purchase these homes, or when home prices come down to the level of wages, then it will be set straight.  It will probably be a combination of both factors but the equilibrium will take years to achieve.

Bicycle Repairman's picture

"equilibrium will take years to achieve"

Yes.  Moderate inflation over as many years as it takes.  Wages will lag, living standards will drop slowly.  Negative interest rates.  Savers and J6P pay for all the sins.  No mad max.

History books will read: "Sir B. S. Bernanke Saved the World".  Brings a tear to my eye.

1984's picture

That's where you're wrong.  History books will say "The Bernank ...".

Tedster's picture

I hear that now and then - that housing "needs" to reset to some historical formula, e.g. three times avg. annual wage or somesuch. Years ago I read about an old sleepy mining town in Colo. - Telluride. Once the big money moved in for the then-new ski industry, the locals were displaced because they couldn't afford the property taxes, much less the land and housing. The analogy I see in our future is the public being un-assed from
the country. Everuthing seems to point that way - wages stagnant, inflation, loss of property and self defense rights, rule of law, crushing tax hikes in the pipeline, crumbling core infrastructure, etc.

Spalding_Smailes's picture

Hot money flowing into the emerging markets like water. The speculation in the commodity markets •  currency peg the real reason for run up in prices. Not uncle Ben.


Housing prices down 45% in Arizona. Many , many people questioning " why the fuck did I buy this " during the shadow banking credit orgy, stupid reigned ( keeping up with the joneses • fellow morons ). Many people thought credit was money.

akak's picture

Many people thought credit was money.

And there are still some deflationary flat-earthers who continue to believe so today, despite the ubiquitous evidence to the contrary in front of their closed eyes.

Spalding_Smailes's picture

Different argument.


Treasuries are not money, also. So don't look toward that growing pile of paper and thing it's money. But the deflation in a massive asset class like housing does trim some fat and drink down flowing digital bits. Bottomless pit of shadow obligations.

RockyRacoon's picture

Sure • is • interesting • to • read • your • comments.•••••••

akak's picture

Autism: It's not just for idiot savants any more!

(Or is it?)

Orly's picture

If you don't mind, my nine year old son is autistic.  Can we skip the retard jokes, please?

Thanks in advance.

akak's picture

Will do.

Henceforth, I will stick to mocking just niggers and cripples.

Orly's picture

I appreciate that.


Oh, and the Irish.

akak's picture

Oh, and the Irish.

The day that we can't mock pasty-white alcoholic Celts with hideous red hair and freckles is the day that all humor finally dies.

Orly's picture

All right, all right.  I'll lighten up.

Sorry to be a drag!

Of course, the Irish thing was a reference to Blazin' Saddles.

I'm now gonna occupy myself by singing Camptown Laties...

Spalding_Smailes's picture

What mac are you running .... Are you in the print industry also, or do you just like apple computers ?

Spitzer's picture

Treasuries back the dollar. As US debt defaults, the dollar sells off(inflation). Just like the Euro sold off when Greece was in trouble. Using your logic, the Euro should have went up.

equity_momo's picture

Greece , and the rest of the PIIGS , still in trouble Spitz. Euro , still doing nicely.

Guy Fawkes Mulder's picture


Many people thought credit was money.

And there are still some deflationary flat-earthers who continue to believe so today, despite the ubiquitous evidence to the contrary in front of their closed eyes.

I remember you. You like to talk about inflation or deflation purely as a change in money supply (which money supply do you mean, by the way? For that matter, what even is it that you mean by money? It seems like you call dollars, which are credit money, "money" too. Maybe I'm getting you wrong.)

It is meaningful to talk about price inflation, and to talk about inflation in terms of specific currencies or asset values.

The term "deflationary flat-earther" can only come from the mouth of a small mind.

I saw cjbosk make a good case that consumer prices won't be hyper-inflating any time soon, over on this thread:


What happens if Bernanke actually stops QE?

What happens if a US debt default is allowed to occur?

What happens if the market stops rising by Ponzi magic?

These things can happen; they are options on the table. These actions may benefit the infamous powers-that-be, and they may opt for them. I've heard it argued very well before that they have to continue QE, but at the end of the day I think they can still choose to let gravity have its say (to "pull the plug on the ventilator").

If you open your conception of "deflation" to include the loss of purchasing power (for example, Joe-65-Year-Old thinks he has "a million dollars" worth of investments today, but tomorrow the markets are allowed to crash and next week he has nowhere near the amount of purchasing power he had today), then you will realize that deflation is possible and it is serious threat. It's the knife that's at people's back as they Ponzi their way forward.

edit: TLDR = For consumer goods: "money" is fiat paper credit money, and "credit" is credit, and no one could possibly mix up "credit" with "money". The credit money we have now is paper Kool Aid. The bankers are planning to hyperinflate over the longest period possible and set themselves up in the ensuing new monetary order. But if the central bank juice stops flowing... deflation, bitchez.

Nathan Muir's picture

"currency peg the real reason for run up in prices. Not uncle Ben."


Are you really that ignorant?  You do realize uncle Ben controls the currency these countries are pegged to, right? 


"Many people thought credit was money"


Do you understand credit is money in a fractional reserve banking system?  I always assumed a blind bull like yourself not only understood debt as money, but was all for it.  Whereas the intelligent bears on this sight understood debt as money can never work in the long-run due to laws of exponential math.  Clearly, I gave you undeserved credit.  Here's some advice: critically think before you comment here...your nonsense is getting old.

Spalding_Smailes's picture

And they can move the peg. Ben can't move the peg. If they did not peg at suppressed rates they would not be drinking inflation.


Credit is not money until it is spent. Please read a book or something before you post. Just like treasuries are not money.


So who's the ignorant one ?

Orly's picture

It seems he may be correct, Mr. Smailes.  Credit is money (created from thin air or not...).  It has no velocity unless it is spent.

In a sense, you're both correct.  It is just a matter of semantics.

Spalding_Smailes's picture


Credit is not money. Credit can stay credit until infinity. Credit becomes money when you purchase an asset and then velocity is affected in the existing money supply..

Point being, existing money supply not effected by new credit on the banks books.

Orly's picture

So if I have a credit limit on my card that is ten grand, that is not money?  Of course it is money.  It may be potential money but it is still money, nonetheless.

When I go to Best Buy and plunk down two grand on a new LCDHDTV (!) and put it on my card, then the "money" takes on velocity.

I do understand your point, though. Which is why the talk of Zimbawaism in the American economy is just silly to me.  As long as the banks hold on to potential money and the velocity of said money (credit...) is not realised, then there can be no hyperinflation from it.  Eventually, the Fed can drain this credit out and it will be no harm, no foul.


Spalding_Smailes's picture

Yes your credit is not money until its spent on an asset. You can call it money if you want.


Maybe he will stop tossing out insults and turn off the t.v. and read 20 books on finance.


Correcting • educating people like him is very,very tiresome. Lol


Wish the junker would step up. I'll link to volumes of information supporting my thesis.

Orly's picture

Perhaps but you have posted more times than I have today, Mr. Smailes.  Seems to me you love it more than I!


Spalding_Smailes's picture

Hey, I hate seeing guys like ( Nathan Muir  )maybe telling friends and family the wrong information. Notice the dead silence on his part after tossing out all the insults in his first post.


Clearly, I gave you undeserved credit.  Here's some advice: critically think before you comment here...your nonsense is getting old.


Fucking Lol' .... Got financial books ??? The Macro View - Roger Miller or Handbook of Financial Markets and Institutions Sixth Edition or The Wealth of Nations - Adam Smith Books I-III Lol

Spitzer's picture

The peg is just the act of printing that same amount of local currency as what is coming out of the US.

Credit is money.

Spalding_Smailes's picture

Once again your dead wrong ...

They must print much more than 1 to 1 to suppress.

China M2 over the last 2 years going up at a 25% clip. Construction 70% of GDP trying to print 10% GDP, USA M2 with QE and POMO up 2% last 2 years.

Credit is not money until it is spent • velocity. Economics 101.

cxl9's picture

Home prices in the US, which is the main deflationary asset, are still overvalued, in most places, by at least 20%.

Just outlaw mortgages entirely. If you can't save up and pay cash for a house, then you shouldn't buy one. Better still, do it Viet Nam style. All real estate purchases must be settled in physical gold. That'll eliminate the whole fraudulent real-estate industry and restore some semblance of sanity to house prices.

Orly's picture

That may be a bit extreme.

Instead, how about having the homeowner put 20% of the cost of the property down on the loan up front.  That way, they have skin in the game.  Only allow HELOCswhen the value is 20% above the market value and then, only for the amount in excess of the 20%.

Banks get paid, young families can save to purchase a dream home and there is no incentive to rip anyone off.


Works for me!

Oh regional Indian's picture

Orly, thanks for the responese waaaay up thread. :-) It got busy thereafter.


equity_momo's picture

The whole idea of being able to "inflate away the debt" is a banker-perpetuated falsehood :it only works if the level of debt isnt growing by an order of magnitude greater than the means to repay it.

the article falls down in the last paragraph - it still paints the US in a position being able to chose. We are no different to Japan. The choice is simple - hyperinflate and then default or just default.


It doesnt matter how proactive the US , it is past the point of no return.  We have no lead time. Japan was able to live through its liquidity trap thus far due to global growth (what was the average price of oil from 1989 to now?)

Globalization is over , and with it comes widescale defaults.



Oracle of Kypseli's picture

Very true. The threshold has been crossed. US hands are tied. The saying used to be "inflate or die" but I guess there is a way out. Default before you die.

The government's conundrum is how do you know when death is near? And if you default, how can you survive from your creditors?

Is it therefore, the current uprisings US's attempt to create world wide revolutions to destroy its creditors before the US defaults?

Please weigh on this discussion as it appears to me that this may be the only way out.




LawsofPhysics's picture

"Is it therefore, the current uprisings US's attempt to create world wide revolutions to destroy its creditors before US defaults?"

Quite possible, or at least cause enough damage that U.S. companies can make money rebuilding our creditors countryside.  The debt, and "growth economics" are both fraudulent, either way, now things get interesting.  Possession will go from 9/10 ths of the law, to the law itself, hedge accordingly.