Terra Incognita: Hic Svnt Dracones



By George Noga 

The headline translated from Latin is: “Unknown Land: Here Be Dragons.” Early cartographers depicting unknown regions often would draw a dragon along with the words Hic Svnt Dracones. Today the phrase is used metaphorically to describe any unknown phenomenon. I invoke the phrase herein with reference to the crisis of spending debt and deficits. Sadly, America is sailing full speed ahead for terra incognita and, most assuredly, we all have dragons in our future.

“Even tea party folks don’t get it. They favor generic spending cuts, but when they are polled about specific programs, they say they do not want them cut.”

No public official (Paul Ryan and Ron Paul excepted) gets it; the good guys don’t get it. Even the tea party folks don’t get it; they are for spending cuts generically but, when asked about specific programs (Social Security – Medicare), they do not want them cut.

The Republican House leadership wants to cut an underwhelming $100 billion from the FY 2011 budget; but the fine print shows it really is only $50 billion. Even the most aggressive cost cutters want to cut only $2.5 trillion ovcr 10 years; that is chump change, i.e. only ≈$150 billion, or less than an average of 3% per year, in nominal (inflation-adjusted) dollars. All this does is cut the annual deficit on average from a putative $1.30 trillion to $1.15 trillion.

The ship of state is headed for terra incognita; consider the following developments:

  1. The marketplace stripped the US of its AAA credit rating. Based on current prices for credit default swaps, the US is the same as AA-rated countries. The price for default insurance on US sovereign debt is ≈$50,000 per year for $10 million – up 30% in a recent quarter. Why for crying out loud is insurance necessary on US debt?
  2. California, New York, Illinois, Connecticut and several cities are on the brink of default.
  3. If and when serious cuts are made to entitlements, you can expect public unrest of the kind that gripped France and England – and those were relatively minor cuts.
  4. Inflation expectations are rising. Ultimately this leads to higher interest rates and increases the portion of the federal budget that goes to debt service.
  5. The US dollar is depreciating and the yield curve is steepening – both bad signs. The yield curve has 10-year Treasuries 320 basis points above overnight rates, a danger zone.

What Actually Will Happen When the US Can’t Borrow?

The US will reach a point within 3-5 years when it no longer can borrow under acceptable terms; what will happen then? An explicit, legal default is extremely unlikely. The Treasury simply will print more dollars and the Federal Reserve will buy them. The government will pay its bills just as Zimbabwe does today. However, it will be a default nonetheless – only it will be a default via inflation.

“Other than war, inflation is the worst fate to befall a country.”

There will be serious collateral damage. The dollar will plummet making imports ultra expensive; inflation will skyrocket making everyone nostalgic for the Jimmy Carter era. People will be devastated. As always there will be winners and losers. The social cohesion of America will be tested; it will leave an indelible impression on everyone – comparable to or worse than the Great Depression.

Default via inflation and destruction of the currency is worse than outright repudiation. Inflation wipes out the virtuous class, those who are prudent and save money; it rewards the profligate and debtors. Other than war, inflation is the worst fate that can befall a country.

Default May Be a Good Thing

Ron Paul, Doug Casey and others, your humble correspondent included, have reached a stage in their thinking and analysis where a default on US sovereign debt no longer is to be feared. It seems inevitable so we may as well get on with it. This may be the only way to save our republic and at least there will be ancillary benefits including:

“Loaning money to the government is comparable to giving a teenager a bottle of whiskey and keys to a new Corvette. However, this is unfair to teenagers.”

  1. People who imprudently loaned money to the government will be punished; they will quit loaning. Casey described loaning the government money as “giving a teenager a bottle of whiskey and keys to a Corvette”. I believe Casey was unfair to teenagers.
  2. It will remove the albatross from around the necks of our children and grandchildren, although they will have to endure intense and prolonged pain in the process.
  3. It will return the government’s share of GDP back to about 15% to 20%; this is where it was during Eisenhower’s time.
  4. There will be more liberty and less government.
  5. Americans will remember this lesson and will be determined not to let it happen again. Everything will be fine for a few generations until memories fade and once again we are seduced by the siren song of big government and getting something for nothing.

In light of my previous reporting about spending, debt and deficits, I feel a responsibility to keep readers up to date. The lessons to take away from this update are: (1) nothing has changed following the election. Republicans and even the tea party movement talk the talk but they don’t walk the walk; (2) the coming default will not be explicit; it will be via inflation; and (3) a default is no longer dreaded to the extent is was before, although the consequences will be no less severe.

Unless there is something that absolutely demands attention, I do not anticipate further comment about the debt crisis until summer or fall. I will provide a more detailed update once the government’s FY 2011 budget is passed, the president’s FY 2012 budget is released and the OMB and CBO update their 10-year budget projections.

Post Script: Since the time this email was written, the CBO released a new 10-year baseline federal budget. It is even worse than the projections I prepared in my original paper entitled The Crisis of Spending, Debt and Deficits published in September 2010.


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