European government debt has been sold at negative interest rates recently. The United States Treasury has now come as close to that as possible with 0% 3 month T-bills in the latest auction.

The incredible policies that have created such loose credit has the world so flooded with money searching for somewhere to go that 0% is seen as attractive. This excess cash is dangerous. It is a condition that makes bubbles inflate.

Low interest rates are good for businesses seeking capital to invest. These super low rates for so long are almost certainly creating much more debt for no good purpose. And likely even very bad purposes since cash is so cheap.

One thing I didn’t realize until last month was that while the USA Federal Reserve stopped pouring additional capital into the markets by buying billions of dollars in government every month they are not taking the interest and maturing securities and reducing the massive balance sheet they have. They are actually reinvesting the interest (so in fact increasing the debt load they carry) and buying more debt anytime debt instruments they hold come due.

The Fed should stop buying even more debt than they already hold. They should not reinvest income they receive. They should reduce their balance sheet by at least $1,500,000,000,000 before they consider buying new debt.

Unless the failure to address too-big-to-fail actions (and systems that allow such action) results in another great depression threat. And if that happens again they should not take action until people responsible are sitting in jail without the possibly of bail. The last bailout just resulted in transferring billions of dollars from retires and other savers to the pockets of those creating the crisis. Doing that again when we knew that was fairly likely without changing the practices of the too-big-to-fail banks. But I would guess we will just bail them out while they sit in one of the many castles their actions at the too-big-to-fail banks bought them and big showered with more cash in the bailout from the next crisis.

How to invest in these difficult times is not an easy question to answer. I would put more money in stocks for yield (real estate investment trusts, drug companies, dividend aristocrats), I would also keep cash even if it yields 0% and actually a new category for me – peer to peer lending (which I will write about soon). Recently many dividend stocks have been sold off quite a bit (and then on top of that drug stocks sold off) so they are a much better buy today than 4 months ago. Still nothing is easy in what I see as a market with much more risk than normal.

I am almost never a fan of long term debt. I would avoid it nearly completely today (if not completely). For people that are retired and living off their dividends and interest I may have some long term debt but I would have much more in cash and short term assets (even with the very low yields). Peer to peer lending has risks but given what the fed has done to savers I would take that risk to get the larger yields. The main risk I worry about is the underwriting risk – the economic risks are fairly well known, but it is very hard to tell if the lender starts doing a poor job of underwriting.

Related: The Fed Should Raise the Fed Funds Rate – Too-Big-to-Fail Bank Created Great Recession Cost Average USA Households $50,000 to $120,000 – Buffett Calls on Bank CEOs and Boards to be Held Responsible – Historical Stock Returns

A reasonable amount of government debt is not a problem in a strong economy. If countries take on debt wisely and grow their economy paying the interest on that debt isn’t a problem. But as that debt grows as a portion of GDP risks grow.

Debt borrowed in other currencies is extremely risky, for substantial amounts. When things go bad they snowball. So if your economy suffers, your currency often suffers and then the repayment terms drastically become more difficult (you have to pay back the debt with your lower valued currency). And the economy was already suffering which is why the currency decreased and this makes it worse and they feed on each other and defaults have resulted in small economies over and over from this pattern.

If a government borrows in their currency they can always pay it back as the government can just print money. They may pay back money not worth very much but they can pay it back. Of course investors see this risk and depending on your economy and history demand high interest to compensate for this risk (of being paid back worthless currency). And so countries are tempted to borrow in another currency where rates are often much lower.

If you owe debts to other countries you have to pay that money outside the system. So it takes a certain percentage of production (GDP) and pays the benefit of that production to people in other countries. This is what has been going on in the USA for a long time (paying benefits to those holding our debt). Ironically the economic mess created by central banks and too-big-to-fail banks has resulted in a super low interest rate environment which is lousy for lenders and great for debtors (of which the USA and Japanese government are likely the 2 largest in the world).

The benefits to the USA and Japan government of super low interest rates is huge. It makes tolerating huge debt loads much easier. When interest rates rise it is going to create great problems for their economies if they haven’t grown their economies enough to reduce the debt to GDP levels (the USA is doing much better in this regard than Japan).

Japan has a much bigger debt problem than the USA in percentage terms. Nearly all their debt is owed to those in Japan so when it is paid it merely redistributes wealth (rather than losing it to those overseas). It is much better to redistribute wealth within your country than lose it to others (you can always change the laws to redistribute it again, if needed, as long as it is within your economy).

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The data, from IMF, does not include China or India.

The chart shows data for net debt (gross debt reduced by certain assets: gold, currency deposits, debt securities etc.).

Bloomberg converted [broken link was removed] the data to look at debt load per person (looking at gross debt – estimated for 2014). Japan has ill-fortune to lead in this statistic with $99,725 in debt per person (242% of GDP), Ireland is in second with $60, 356 (121% of GDP). USA 3rd $58,604 (107%). Singapore 4th $56,980 (106%). Italy 6th $46,757 (133%). UK 9th $38,939 (95%). Greece 12th $38,444 (174%). Germany 14th $35,881 (78%). Malaysia 32nd $6,106 (57%). China 48th $1,489 (21%). India 53rd $946 (68%). Indonesia 54th $919 (27%).

I think the gross debt numbers can be more misleading than net debt figures. I believe Singapore has very large assets so that the “net” debt is very small (or non-existent). Japan is 242% in gross debt to GDP but 142% of net debt (which is still huge but obviously much lower). The USA in contrast has gross debt at 107% with a net debt of 88%.

Related: Government Debt as Percent of GDP 1998-2010 for OECD – Gross Government Debt as Percentage of GDP 1990-2009: USA, Japan, Germany, China – Chart of Largest Petroleum Consuming Countries from 1980 to 2010 – Top Countries For Renewable Energy Capacity

I am glad we have a “fiscal cliff” to finally get some reduction in the future taxes both parties have been piling on with abandon the last few decades. When you have enormous spending beyond your income, as the USA has had the last few decades, cutting current taxes is just raising taxes on your grandchildren to pay for your spending. Shifting taxes to your grand children is not cutting taxes it is shifting them to future generations.

If you want to really cut taxes you must cut taxes and not pass on paying for your cuts to your kids. It seems pretty obvious those that advocating cutting current taxes the last few decades were only interested in living beyond their means today and foisting the responsibility to pay to their grandchildren. That is despicable behavior.

The fiscal cliff is an opportunity to return to a budget that has the generation doing the spending paying the taxes (last seen in the Clinton administration). The fiscal cliff outcome is going to be far from perfect. But the result will be a much more honorable outcome than foisting ever increasing taxes on future generations to pay for our current spending.

Obviously, if you reducing how much you are adding to your credit card balance each month and start paying your bills that means you don’t get to live off your future earnings today. So you will suffer today compared to continuing to tax the future to pay for your spending.

I hope the compromise results in spending cuts and an elimination of the Bush generation shifting taxes (cutting taxes on the the current wealthy without spending cuts – so just taxing the future to pay for tax cuts today). It is unlikely the fiscal cliff results in us actually paying for our spending (the best possible result is not an elimination of adding to the taxes future generations must pay but just a reduction in the level of tax increases we are imposing on the future every year).

Lots of little things should be done to save a few billion (maybe it could add up to $50 billion a year if we are very lucky). But the serious spending cuts have to come from reductions in military spending, reducing waste in the health care system and making social security more actuarially sensible (social security is not part of the fiscal cliff discussions though). Reducing tax breaks also has to happen, unless absolutely huge spending cuts can be found which is not at all likely.

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This chart shows government debt as a percent of GDP based on OECD data. The chart is limited to central government debt issuance and excludes therefore state and local government debt and social security funds.

Economic data is always a bit tricky to understand. It makes some sense that excluding social security would reduce the USA debt percentage a bit. But these debt as a percentage of GDP are lower than other sources show. There are obviously many tricks that can be used to hide debt and my guess is the main thing going on with this data is OECD intentionally trying to make things look as good as possible.

Still looking at historical trends in data is useful. And I believe looking at data from various sources is wise. There has been a dramatic increase from 2008-2010. The USA is up from 41% of GDP to 61%. Spain is up from 34% to 52% (but given all the concern with Spain this doesn’t seem to indicate the real debt problems they have.

Japan and France don’t have 2010 data, so I used a rough estimate of my own based on 2009 data. Greece has been over 100% since 1998 and now stands at 148%, 2nd worst (to Japan) for any OECD country (Europe, North America, Japan and Korea), Italy is 3rd. Ireland is at 61% (up from 28% in 2008). The UK is at 86%, up from 61%.

Related: Government Debt as Percentage of GDP 1990-2009: USA, Japan, Germany, China… (based on IMF data) – Government Debt as Percentage of GDP 1990-2008 – Government Debt Compared to GDP 1990-2007 – Top 15 Manufacturing Countries in 2009

The world today has a much different economic landscape than just 20 years ago. China’s amazing economic growth is likely the biggest story. But the overwhelming success of many other countries is also a huge story. Today it is not the developing world that has governments spending taxes they promise their grandchildren will pay, but instead the richest countries on earth that choose to spend today and pay tomorrow. While “developing” countries have well balanced government budgets overall.

The chart shows gross government debt as percentage GDP from 1990-2009. By Curious Cat Investing and Economics Blog, Creative Commons Attribution. Data source: IMF

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There are plenty of reasons to question this data but I think it gives a decent overall picture of where things stand. It may seem like government debt should be an easy figure to know but even just agreeing what would be the most reasonable figure for one country is very difficult, comparing between countries gets even more difficult and the political pressures to reduces how bad the data looks encourages countries to try and make the figures look as good as they can.

The poster child for irresponsible spending is Japan which has gross government debt of 218% of GDP (Japan’s 2009 figure is an IMF estimate). Greece is at 115%. Gross debt is not the only important figure. Government debt held within the country is much less damaging than debt held by those outside the country. Japan holds a large portion of its own debt. If foreigners own your debt then debt payments you make each year are paid outside your country and it is in essence a tax of a portion of your economic production that must be paid. If the debt is internal it mean taxpayers have to support bond holders each year (but at least when those bondholders spend the money it stays within your economy).
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Alan Greenspan made several huge errors while chairman of the Federal Reserve. Failing to deal with the massive risk taking and fraud by the member banks of the Federal Reserve was one. And supporting tax cuts for a country that was hugely in debt (while current deficits were still huge was another. Yes anyone can claim (and he did) future surpluses, but there had yet to be a single year of surplus, and obviously we would have been in deficit even before the tax cuts put us much much further in debt, history has shown .

That is either amazingly bad economic forecasting or a lie. My guess is he knew this wasn’t true. Which would make it a lie. If he really was that out of touch with economic reality, we have to question why we ever thought he had insight into the economy.

Greenspan Says Congress Should Let Tax Cuts Expire

Related: Estate Tax Repeal (2006) – Charge My Government to My Kids (2007) – USA Federal Debt Now $516,348 Per Household

Accepting that, I don’t agree with those that vilify his performance. He was Fed chairman from 1987-2006. He made some very bad decisions that cost people dearly. But it isn’t very surprising someone in such power for so long would make some very bad and costly decisions. My guess is he caved to pressure from political allies that reminded him how the current President Bush’s father blamed Greenspan’s decisions for his losing the Presidency. And so Greenspan was trying to do what he could to do what the then President Bush wanted. Not a very honorable explanation but people often do not make the most honorable choices.

In 2003 he publicly disagreed with the wisdom of additional cuts:

Politicians, eager to give favors, at the expense of the future, went ahead and passed more tax cuts – weakening the country for their (and their political allies) short term benefit.

Related: Estate Tax Repeal (2006) – Charge My Government to My Kids (2007) – USA Federal Debt Now $516,348 Per Household

Greenspan’s thoughts on the economy, from his July 16th 2010 interview:
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Roubini Says Rising Sovereign Debt Leads to Inflation, Defaults

I agree that the damage done by those (which is nearly all of them) countries living beyond their means is significant. The USA and many countries in Europe and Asia (South Korea and China are two exceptions) have raised taxes on the future (by default – spending more than you have necessarily increases taxes later) to consume today. The strong emerging markets are another exception, many having learned their lessons and stopped spending money they didn’t have in the 1990’s.

However the richest countries have been spending money they don’t have for decades and the increase in government debt as a portion of GDP is an increasingly serious problem. It would be nice if the government of the rich countries could behave responsibly but it does not look like many of them have citizens who will elect honest and competent leaders. As long as they elect leaders that insist on raising taxes on the future (and lying to the populace by claiming they cut taxes – because they eliminate taxes today) those countries will pay severely for the irresponsible spending.

Saying you cut taxes when you just delay them is equivalent to saying I paid off my credit card bill when all I did was get 2 new credit cards, borrow all the money I owed on my original card, pay that one off, and then borrow more to increase my debt even more. Yes it is true I did pay off my original credit card, but that is hardly the salient point. My credit card debt increase. All that has happened in the USA since the Clinton administration had a balanced budget is politicians used a credit card thinking to lower taxes while necessarily increasing them in the future. You don’t reduce debt by spending money you don’t have.
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With the dollar declining sharply, many are focused on the issue now. And the most common culprit for blame seems to be the federal debt. While I agree the dollar is likely to fall, the deficit doesn’t seem like the main reason, to me. The federal debt is large and growing quickly, which is a problem. But still the USA federal debt to GDP is lower than the OECD average. Even with a few more years of crazy federal debt growth the USA will still be below that average.

Japan has by far the highest level of government debt in the OECD. The Yen is not collapsing. The debt is a factor but the lack of saving (USA consuming more than it produces) seems the biggest problem to me. China not only does not have large government debt it has large amounts of personal savings. People have been living far within their means in Japan and China (only by government intervention, due to desires to not have the currency appreciate has that appreciation been slowed).

Thankfully we have been increasing savings a bit recently but it is a drop in the bucket so far (Consumer Debt Down Over $100 Billion So Far in 2009). It will have to increase in size and continue for years to begin to address the problems in a significant way.

Related: The USA Economy Needs to Reduce Personal and Government Debt (March 2009) – The Truth Behind China’s Currency Peg – Who Will Buy All the USA’s Debt?

The Greenback Effect by Warren Buffett

Related: Warren Buffett Webcast on the Credit Crisis – The Long-Term USA Federal Budget Outlook – Berkshire Hathaway Annual Meeting 2008 – Federal Reserve to Buy $1.2 Trillion in Bonds, Mortgage-Backed Securities

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