Default Is Inevitable

 | Aug 12, 2011 | 9:15 AM EDT  | Comments
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mcd

The debt, the debt, the debt.

On a daily basis, we hear the analysis. We are overleveraged, we owe too much, we have mortgaged our children's future for current consumption. We are consuming instead of saving, we are wasteful instead of thrifty.

The problem is not limited to the United States, either. The Europeans are being dragged down by their debt. A real estate bubble formed in China and perhaps half their banking system is secretly insolvent. Latin America? Well, it happened there once too.

The analysis is completely sincere, but for me something seems to be lacking. The concern about over-indebtedness addresses one side of the world's balance sheet, but who do we owe the debt to? Yes, individual nations can be debtors, but can the world economy possibly be brought down by debt? Every debt is counterbalanced by a creditor. We, meaning the human race, cannot owe money to anyone but ourselves.

What if this article began: "The loans, the loans, the loans ... we are over-committed, we have too many assets, our children's future is secure with the income our lending will bring them ... we are saving instead of consuming, we are thrifty instead of wasteful." Those sentences would hardly engender fear, yet are true as the commentary about debt.

If the US federal debt were paid off tomorrow, would we as a country be better off? What about the lenders and the income they receive, as paltry as it may be now? Where would they invest? I will partially concede that money flowing into private-sector debt rather than government debt would probably be a net positive. But money flowing into investment debt rather than consumption debt is the best of all.

If those who chose not to consume redirect their resources into productive assets, the economy can ultimately be better off. If resources are redirected into other people's consumption, whether via government redistribution or private sector consumption via credit cards, there can be no net gain. It just means a different person ate the hamburger that McDonald's (MCD) produced today.

Being overleveraged and in too much debt is code for saying our system of transferring consumption is broken, and those who have been over-consuming can do so no more. The battle is being drawn between the consumers and those enabling it, as the enablers decided "they want their money back." Unfortunately for the lenders, the answers are simple. Debtors -- European nations, Nevada homeowners, or the college kid with a maxed the credit card -- will never pay back the loans outstanding, because the funds were used for consumption, not investment. To pay them back, the debtors must produce and not consume, go to McDonalds every day and send the hamburger to the mansion in the Hamptons. Starving people will only give up their food for so long.

Default is inevitable. The debt problem will resolve the old-fashioned way, as lenders will simply have to give up. The economy might then actually be facing the opposite problem, an asset problem rather than debt problem.

Here is where I rank the probabilities of default in sovereign debt:

  • Greece 100%
  • Portugal 100%
  • Ireland 100%
  • Italy 75%
  • Spain 75%
  • United States 100% via inflation, not classic default

My investment position is simple. Neither a borrower, nor a lender be.

 

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