The first thing is fairly obvious: debt is a problem. And creative ways of financing that debt increases the problem. Debt was the cause of, and derivatives trading largely contributed to, both the American and the Greek fiscal meltdowns. What is happening in Greece should be a warning for us in America (and other countries across the globe) about the ramifications of public debt. It took us 235 years here in America to rack up $10 trillion in public debt. Under the Obama administration’s own budget estimates, we will add at least another $10 trillion to that (doubling it) by 2020 (some estimates have it doubling as early as 2016). We’ve already added well over two trillion just since Obama became President.
Our public debt is currently around 55% of our GDP. But when you add in America’s intra-government debt obligations (debt we owe ourselves, such as to the Social Security trust fund, Medicare, and Medicaid), our debt extends above 90% of our GDP. It’s not difficult to see investors getting skittish about financing our debt if that number, like Greece’s, rises above the 100% barrier — something that is projected to happen sometime before 2020 without including intra-governmental obligations. There has even been talk by Moody’s and S&P’s that they may downgrade the American debt rating as well (although a downgrade to junk status is still highly unlikely).
Additionally, derivatives trading is simply out of control and is threatening to explode in a manner that will make both the subprime mortgage and the Greek crises look like someone who defaulted on a pack of gum on layaway. The whole of the global derivatives market in 2002 was worth about $100 trillion — an enormous market even then, to be sure. But that market exploded and rode a massive bubble up to more than $500 trillion in 2007. Current estimates put the valuation of the derivatives market well over $700 trillion. (Consider for comparison sake: our entire GDP is under $15 trillion. A recent valuation of the entire world’s stock and bond markets was just over $100 trillion.)
As a general rule in finance, every bubble has to eventually pop, and when the derivatives bubble finally does it will be a disaster. The subprime mortgage crisis and subsequent housing bubble pop was just the tip of the iceberg that showed the potential power of failed derivatives trading.
So then, the danger we face is the potential alignment of several factors — any one of which would create an economic downturn in itself, but if all of them occur in close proximity to one another could spell disaster. First, as Americans grow older we will find ourselves unable to make good on our intra-governmental obligations such as Social Security and Medicare. Secondly, outside those obligations, because of incredibly loose fiscal policy in Washington right now our public debt will continue to soar and approach or pass the 100% of GDP mark, with the potential of being downgraded like Greece’s debt was. And thirdly, the derivatives market bubble is eventually going to pop and when it does hundreds of trillions of dollars of bad debt will come crashing down on the global financial economy.
So what can be done to avoid this convergence of financial ruin? First and foremost, the biggest lesson we need to take away from the situation in Greece is that debt matters. Dick Cheney infamously told Bush’s Treasury Secretary Paul O’Neill that “deficits don’t matter” and he couldn’t have been more incorrect. Perhaps they don’t matter a lot in the short term, but in the long term debt causes financial ruin. Ordinary Americans and world citizens, of course, already know this. Governments are apparently just starting to wake up to that common sense realization. We must necessarily get our debt under control. We must find a way to fund or eliminate social welfare programs. We must stop enacting expensive new social programs such as health care and pay for what we already have in place. And we have got to stop hiring new federal public employee positions, sweetening their pay and their benefit packages and expanding the federal government at a time when our debt is spiraling downward out of control. And finally, we must find some way of limiting or regulating derivatives trading — but this must be done in an intelligent way, not in a political way designed to score points with an uninformed electorate. The derivatives bubble can either pop violently and calamitously, or it can be brought back down to earth safely and carefully. It’s going to take politicians with steel wills and steeled nerves to take on any of these solutions, however.
Only time will tell if the world learns anything from the crisis in Greece. My guess is that we will not, just as we never learned the most important lessons from the subprime mortgage crisis and housing market meltdown. After all, our own President was one of the voices urging European leaders to bail Greece out just as he had bailed out the companies in America that made poor investment decisions with their debt. He encouraged an additional $1 trillion in European debt to save Europe, as he adds trillions of dollars to our debt in order to save America. At some point, this Ponzi scheme is going to come crashing down and we will finally understand the words of the prophet Habakkuk: “Will not your debtors suddenly arise? Will they not wake up and make you tremble? Then you will become their victim.”
UPDATE: Apparently, the White House budget director agrees with this assessment:
WASHINGTON (Reuters) – White House budget director Peter Orszag told Reuters Insider in an interview on Wednesday that the United States must tackle its deficits quickly to avoid the kind of debt crisis that hit Greece.
Now, let’s see if they’re actually going to do anything about it, or just talk about it.