Our governments are always in over their heads, but the financial situation has put them in an impossible situation.

Like with my local bank situation in the previous post, the reactions are to react in a closed fashion saying ‘NO’ like health care companies do every day.

I was noting yesterday that the treasury bond bubble may finally have been pricked. Today, I woke up to read Mish’s great post ‘The Brink of Debt Disaster ‘ and I agree. It does not really matter though whether I AGREE. The market is telling me this is happening just by watching price movements.

Mish concludes:

Bankruptcy or Inflation

Clearly GDP needs to rise or debt levels reduced to reach a sustainable path. Kemp argues “widespread bankruptcies are probably socially and politically unacceptable.”

While I agree with that statement in theory, practice is another matter. I do not believe government has a realistic choice in an environment of global wage arbitrage, changing consumer attitudes towards debt, and demographics of boomer retirement.

Attempts to inflate out of this mess, cannot possibly work for three reasons.

1) The burden of consumer debt will only decrease under inflation if employment recovers, wages rapidly rise, and outsourcing of jobs to India and China stops. The odds of that happening are extremely slim.

2) Government cannot really “create” any jobs per se. It can raise taxes and shift private sector jobs creation to government jobs creation (typically a malinvestment), and it can bring production and consumption forward for those jobs that are genuinely needed (filling potholes), but once the potholes are filled, one has to ask the question, “What will we do for an encore?”

3) Even if by some miracle the economy rapidly picks up, interest rates will rise. Homeowners who now are seeing rates fall, will once again be put in jeopardy by rising rates. Furthermore, interest on the national debt will soar. The National Debt is $10.7 Trillion as of January 7, 2009. As interest on the national debt rises, so will taxes have to rise to cover it. In Fiscal Year 2008, the U. S. Government spent $412 Billion of your money on interest payments to the holders of the National Debt.

In short, there is no free lunch of inflating consumer debt away. Attempts to do so will only create bigger problems elsewhere.

Expect to see a long-term period of extremely slow growth with the economy slipping into and out of deflation and recessions for years, to come. This is the path of Japan, not the path of the Weimar Republic

The reflation trade is just not happening despite herculean efforts. I have not given up on oil just yet though.