George Noga; The Endgame

By George Noga

This is the second of a three-part series about the coming default by the US government on its sovereign debt. The first part, dealing with the interest bomb, is available on our website:

This second episode addresses the endgame, specifically what happens between now and the arrival of the Minsky Moment, the unknown and unknowable instant the debt crisis goes thermonuclear. The third and final installment describes what happens after the Minsky Moment. Hint: default on US debt is only one of the horrors we will face.

“When we break economic rules, markets punish us;
at some point they won’t buy our currency or bonds.”

I would be remiss if I failed to acknowledge the contributions of Endgame by John Mauldin and Jonathan Tepper. I heartily recommend you read their book; if you own significant assets it is a must read. I have written extensively over the past several years about the debt crisis and the ideas and conclusions in Endgame are inseparable from my own work. If I were to write a book about the debt crisis, I could not do any better than Endgame. Again, it is a must read!

We are in Trouble Because We Broke the Rules

As a lifelong golfer, I know the rules of golf often are esoteric; nevertheless, there are rules. There also are rules in economics, albeit not codified in a formal rule book. If I break rules in golf there are penalties; if the violations are egregious enough, no one will play with me any more.

When sovereign nations break economic rules, there also are penalties; markets punish them by devaluing their currency and/or charging more interest on their debt. If the violations are egregious enough, ultimately no one will play with them any more, i.e. they wont buy their currency or purchase their debt at any realistic price.

“We not only are borrowing against the goose’s entire future
production of golden eggs, we are eating the goose.”

Countries have borrowed money throughout human history. The Athenian Republic went bankrupt under Pericles because of excessive debt. For the past 600 years, history is clear about the rules and what happens to violators.

George Noga

When a nation’s debt exceeds 90% of its economy, bad things begin to happen. If this ratio goes high enough, default or bankruptcy is inevitable; the precise point varies with a nation’s circumstances; however, escape from a ratio of 120% is problematic; escape from 150% requires Houdini.

The rules are not arbitrary; they evolved over six centuries of experience and they can’t be revoked; there are no mulligans. The USA already is past 90%, will hit 120% in 2014-15 and reaches 150% long before 2020.

Stability Breeds Instability (Current US Position)

Economist Hyman Minsky first posited the counter intuitive maxim that stability leads to instability. From Endgame: “The longer a given condition persists and the more comfortable we get with it, the more dramatic the correction.”

There is much on-point research in the fields of chaos theory, complexity theory and critical states which I am prevented from sharing with you due to space limitations. However, I am noting one research project by a group of physicists who developed a computer model to add millions of grains of sand, one at a time, in a pile. As more grains were added, instability increased until a critical state was reached from which the outcome was unpredictable and potentially catastrophic.

That is precisely the state the USA is in today. By all outward appearances there is stability. The government keeps issuing more debt; people (mostly the Fed) buy it; interest rates remain incredibly low. People go about their affairs without apparent care. Even most (but not all) sophisticated investors continue to invest as normal. Those of us warning of the all but certain future calamity are, for the most part, ignored. But all the while the grains of sand are building and leading to instability until the United States of America reaches its Minsky Moment.

The Minsky Moment

The Minsky Moment is that unknown and unknowable instant when an unsustainable economic phenomenon suddenly collapses. No one ever sees it coming but after it happens they all wonder how they could have missed it. There was a Minsky Moment in 2008 when global financial systems collapsed and no one would buy US mortgage debt.

“After experiencing its Minsky Moment, the United States
of America will be akin to a bug in search of a windshield.”

The specific time and circumstances under which a Minsky Moment happens and an economy collapses cannot be predicted and is not the real issue. A collapse occurs because the economy has entered an unstable phase and any seemingly insignificant event is capable of producing Armageddon – much as a single grain of sand can avalanche the entire sand pile.

The grain of sand did not cause the avalanche; the inherent instability caused it. Perhaps one morning an innocuous report goes out on Bloomberg; someone sees something in it and starts selling Treasuries. By the end of that day no one on the entire planet will buy US government debt and the United States of America will be reduced to a bug in search of a windshield.

The next and final blog post in this series is part three – Gotterdammerung! What happens to the United States of America after its Minsky Moment. The question is not whether the US government will default, but what form(s) the default will take.


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