Dealing With the Government’s Deranged Debt Addiction

Any eighth grade economics text book will tell you there are three ways to deal with an overspending problem by the government:

  1. Increase taxes. (aka Career suicide for politicians.
  2. Cut spending. (Also career suicide for politicians.)
  3. Borrow money. (The irresponsible yet painless solution.)

Our government has been taking the irresponsible yet painless way out for DECADES… I’ve written about it in the past.

Of course, excessive borrowing causes problems of its own. (Congress approves a debt limit and about three weeks ago, Treasury Secretary Janet Yellen sent a warning that we’d be bumping into it by Dec 15.)

There’s no question that overspending is a problem.

But there is another way governments can reduce their debt that’s not explained in your average econ 101 book. They do it without raising taxes, cutting spending or borrowing to oblivion.

This particular method has been described as having a “…pervasive lack of transparency.” In other words it’s a sleazy, underhanded, conniving solution. (Right up permanent Washington’s alley.)

They just steal it all back from you

The Real Debt Problem

What’s known as the “public debt” is somewhere in the neighborhood of $28.4 trillion dollars — the most recent debt ceiling approved by Congress. 

Public debt refers to the face or principal amount of marketable and non-marketable securities outstanding. In other words how much the government has borrowed.

But it doesn’t really represent “the debt” in the sense of what the government owes

Say you take out a 30-year $300,000 mortgage at 4%. You may say you owe the bank $300,000. But what you’ll end up paying back will be far greater. Roughly $215,000 greater

Sure, the government has borrowed $28.4 trillion dollars, but what they OWE is actually a lot more than that. 

To minimize the amount they owe, it’s been in the government’s interest to keep rates as low as possible. Hence the Fed’s soon-to-be-ending QE program. But while keeping rates near zero cheapens the debt load some, it does nothing to decrease the total of what they owe.

So what’s a spending-addicted government to do?

Use a little-known strategy called “Financial Repression.”

It was first introduced back in 1973 by Stanford economists Edward Shaw and Ronald McKinnon. Nearly 50 years later, an IMF paper was written about it as well. (If you’re inclined, you can read it for yourself here.)

Financial repression has been secretly used by countries around the world to pay down massive debts (like war debts) including the U.S. who used it from 1945 to about 1980.

It could be making a big comeback.

The Sleazy Way to Attack the Debt Problem

This can be a bit of a challenge to get your head around because it’s SO underhanded, but stay with me.

Negative nominal interest rates would be a “miracle cure” for reducing any debtor’s debt. Here’s the premise…  

Say you invest $1000 in a bond. But that bond pays a negative interest rate so at maturity you only get back $950. 

How easy would it be for a debtor to reduce however much they owe by issuing more debt at negative rates? It might take a while, but you would basically be the one who ends up paying off their bills. 

Of course no one in their right mind would make an investment like that. (Negative bond yields are a different conversation.) 

But the concept of financial repression effectively does the exact same thing, except without most people realizing it.

Here’s how it works:

First it requires artificially low nominal interest rates. This keeps borrowing costs from getting out of hand.

Low rates… Check.

Then it requires some moderate inflation. What’s moderate? A level higher than the interest rates being paid. The higher the level of inflation, the more quickly the debt in question is liquidated. Like I mentioned before, the U.S. applied for nearly 35 years post-WWII.

Today’s headline CPI just printed the highest inflation rate since 1982 — 6.8%!



Combined, these two factors create an environment of NEGATIVE REAL interest rates.

This means that while investors are, in fact, getting paid a positive nominal return (let’s say 1.4% on your 10-year bond) your overall wealth is actually shrinking by the excess rate of inflation (in this case roughly 5.4%). 

OK, we’re halfway home.

Inflation can also impact the government’s revenue stream. If tax brackets don’t change to adjust for losses of purchasing power, you get something called “bracket creep” which means you end up paying more in taxes. explains it nicely (my emphasis):

“…where rates rise based on nominal income, increases in incomes due to inflation push taxpayers into higher tax brackets, even without an increase in real income.”

Create enough inflation and government revenue rises (while the debt theoretically stays the same) and investors get paid back with dollars that are worth less than the dollars they originally invested. 

In other words they don’t really “pay back” the debt. What they actually do is destroy the value of those debts — your investments — through inflation!

Finally all they need is a captive audience for some involuntary funding. 

To accomplish this, the government will usually establish some sort of “quality” requirements for financial investment firms like pension funds, banks or insurance companies that basically require them to hold some form of government debt in the name of financial safety. 

They basically shove these below market returns down these firms’ throats (which is why most individuals are generally oblivious to this strategy). Of course these financial institutions don’t really care. They collect their fees and pass the losses along to you. 

Is This the Government’s Plan?

If you’ve followed me this far, you might be thinking to yourself, “But how successful could this strategy be in an environment that consistently runs $1 trillion deficits year after year?”

Excellent question! 

The answer is, it really can’t. Historically, this strategy has been successful only when it’s been accompanied by some reduction in spending or fiscal austerity. And we know our government’s position on cutting spending…

But as a tool to rein in the growth of the overall debt, the powers that be may be thinking this is just what the doctor ordered.

Last week, Fed Chair Powell admitted in front of the Senate Banking Committee that inflation likely wasn’t “transitory” and that they were considering accelerating the pace of the “taper” — a point that’ll be on the agenda at the December FOMC meeting next week.

This puts the Fed in a difficult situation. 

Speeding up the taper would imply a quicker path to hiking interest rates. In general, the market’s been taking the Fed’s warnings relatively well. But if and when they actually do start raising rates, it’ll only be a matter of time before stocks really do collapse.

So how could Fed maintain this balancing act? Pull the reins on inflation without tanking the stock market?

One conceivable option would be for the Fed to adjust their inflation target. They’ve already done it to some degree. 

In August of 2020 the Wall Street Journal reported the Fed, “…would seek periods of above-target inflation if inflation runs below 2% following economic downturns to prevent expectations of future prices from sliding lower. The Fed didn’t specify exactly how high or how long it would allow inflation to rise above 2%.”

It wouldn’t surprise me if, at some point in 2022, the Fed came out and said for the sake of promoting economic growth post-pandemic, they’re realigning their inflation target to 3% or even 3.5%.

This is, of course, conjecture on my part. They may just ratchet rates higher and watch the market freefall. 

But whatever the case, remember, as long as your real returns on government debt aren’t keeping pace with inflation, you’re footing the bill. 

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential