Stanley Druckenmiller, the great money manager who made a fortune trading with George Soros and running his own firm thereafter, is on a media blitz regarding the trajectory and sustainability of US government debt. He claims that a crisis far larger than 2008 is on the horizon. I wasn’t going to comment on this piece in the Wall Street Journal from a few weeks back, but I can’t seem to turn on the TV or pick-up a newspaper without seeing similar pieces or interviews by Mr. Druckenmiller.
I should start by saying that it’s clear that Mr. Druckenmiller is a great macro investor. But I am fairly confident that he’s misinterpreting a few things here. First of all, his WSJ piece sends up a few red flags. For instance, the piece says:
“First, the country’s existing entitlement programs are not just unaffordable, they are also profoundly unfair to those who are taking their first steps in search of opportunity.”
Unaffordable is an unfortunate way to describe this. Let’s remember how the US monetary system is designed. In this country, government spending is ALWAYS a redistribution of existing money. Our money system is designed around banks who create almost every dollar in the economy. If you want to call something “money printing” you should call the loan process “money printing”. The government is what Monetary Realism refers to as a “strategic currency issuer” in this system. That is, it is a self determined user of bank money, but never has a problem procuring funds. When the government taxes you they take Peter’s bank money (inside money because it’s created by banks INSIDE the private sector) and redistributes it to Paul. When the government deficit spends (spends in excess of tax receipts) it gives a t-bond to Peter who gives the government inside money and the government redistributes the inside money to Paul. The private sector has a net financial asset in the form of the t-bond (that is, there is no corresponding private sector liability), but the amount of actual inside money is exactly the same after deficit spending as it was before. It just got redistributed.
Is this process of taxation and deficit spending “unaffordable”? It’s only unaffordable if you believe that the government will run out of its ability to tax or deficit spend. Of course, the tax system could collapse, but that’s only likely in a hyperinflation, which is a highly unlikely scenario in the USA due to huge amounts of output and continually weak aggregate demand (in addition to a lack of real money printing by banks, ie, we’re in a balance sheet recession still). The US government’s ability to sell bonds is also not at risk for several reasons. First, the Primary Dealers are required to make markets in US government debt. If they want to be in the Primary Dealer system and reap the rewards of the system, they have to abide by the rules. The only situation in which they might revolt against the US government is in a hyperinflation, which is unlikely. The Dealers are always able to sell these bonds because of the attractiveness of US government paper. That is, in an environment where asset risks and economic growth remain high, anyone with a 0% interest bearing savings account is clamoring to find any interest at all. Long bonds, which yield just over 3% and provide a risk-free return (aside from loss of purchasing power) look pretty good in comparison. So, the ability to procure funds is never an issue except maybe in a worst case hyperinflation scenario.
In addition, the US government always has a rescue valve if it should ever need money. As a strategic currency issuer the US government can always call on its central bank to create the money it needs. Some foreign governments (such as Canada) already have central banks buying bonds in the primary market (as opposed to the secondary market as the Fed does). So a debt that is denominated in a money you can theoretically create, does not create a solvency risk. But of course, there’s no free lunch here. The US monetary system could certainly fall victim to inflation risk and credit disequilibrium. But these are very different problems than not being able to “afford” something in the sense that I cannot afford to buy 10 Ferraris today.
He goes on to mention the national debt clock, which is a fearmongering tool of epic proportion:
Second, while many in Washington pay lip service to the long term, few act on it. The nation’s debt clock garners far less attention than the “fiscal cliff” clock.
But what about the national wealth clock? The US private sector has amassed a net worth of over 65 trillion dollars. Why does no one ever point that out? We are a phenomenally wealthy country. The national debt is a piece of the private sector’s overall net worth (those savings bonds represent a big piece of grandma’s saving). So we have to keep this conversation in perspective. The national wealth substantially dwarfs the national debt.
Could government spending “water down” the private sector’s ability to produce growth, possibly increase inflation and cause disequilibriums in the US economy? Yes. I am not saying that there is no potential ill-effects of government spending. But the question of “affordability” and debt needs to be kept in the proper perspective. The USA has an inflation constraint. Not a solvency constraint. And if you’re worried about high inflation in a world where the real money printers aren’t printing because their clients are recovering from a debt crisis, then you’ve probably misunderstood the operational realities of the US money system.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.