Sunday, October 05, 2008

Time to face Realty

Now that 700B has entered the consciousness in a single congressional bill, people no longer think that Bill Gates or Warren Buffett are particularly rich.

700B is an almost inconceivable amount of money, but it gives us handle on thinking about the 11T national debt. Eleven trillion dollars could buy HALF of all publicly traded companies in the world. Eleven trillion dollars could buy ALL the real estate in the united states (at current prices). Eleven trillion dollars could feed, clothe and shelter EVERY PERSON ON EARTH for five years.

If interest rates are nearly zero, the debt is not a large problem. However, every point increase in rates will cost 110B per year -- so if the cost of money returns to its late seventies level, we would be looking at an extra trillion dollars a year of interest expense.

In short, the system might be subject to the same instability that hit LEH -- or Argentina. After a threshold, every increase in interest rates decreases the creditworthyness of the debtor, forcing them to pay more to borrow money (which is another increase in interest rates) which further decreases the debtor's credit rating, driven from AAA to zero in a few days.

The good news about this gloomy scenario is that -- because there are gloomy scenarios all over the world -- the cost of money might well remain cheap, and we will never spiral into hyper-inflation.


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