Busted

How the end arrives

“The world of finance is a mysterious world in which, incredible as the fact may appear, evaporation precedes liquidation. First the capital evaporates, and then the company goes into liquidation.” Joseph Conrad, Victory

“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result: happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result: misery.” Charles Dickens’s Micawber in David Copperfield

“‘How did you go bankrupt?’ Bill asked. ‘Two ways,’ Mike said. ‘Gradually and then suddenly.’” Ernest Hemingway, The Sun Also Rises

“If something cannot go on forever, it will stop.” Herbert Stein

This last assertion, which the author helpfully called Stein’s Law, was from a statement about the federal debt. Stein, an economist who headed the Council of Economic Advisers for Richard Nixon and Gerald Ford, was speaking in 1986. He said, “I recently came to a remarkable conclusion which I commend to you and that is that if something cannot go on forever it will stop. So, what we have learned about all these things is that the federal debt cannot rise forever relative to the GNP. Our foreign debt cannot rise forever relative to the GNP. But, of course, if they can’t, they will stop.”

Stein’s adage is a truism. But four decades later, it still hasn’t come true. These days the standard of reference is GDP (gross domestic product) rather than GNP (gross national product, which includes production abroad by a country’s nationals). In 1986 the American federal debt was 38 percent of GDP. In 2026 it is 124 percent.

What is happening? What will happen?

The references above depend on two things: the fact that people are sometimes willing to lend money to others, and the fact that they are not always willing to lend the money. When they lend the money, the borrowers become debtors. When the lenders stop lending, the debtors become bankrupts.

Joseph Conrad likened the process to physical changes of state. In most substances, liquidation occurs before evaporation. Ice becomes liquid water before it becomes water vapor or steam. Thus the incredibility, as he describes it, of bankruptcy.

Dickens expressed the Victorian horror of bankruptcy, or ruin, as it was often called. Living within one’s means was the road to happiness. Exceeding one’s means, even by a little, was the road to ruin.

Hemingway is the most commonly quoted on bankruptcy, which often arrives just as Mike said. He knew he was flirting with trouble, but when it came it took him by surprise.

Stein doesn’t quite predict that national bankruptcy is certain, but he comes close to saying that default of some sort is inevitable. A government that controls its own money supply, as the American government does, can devalue its currency and default, in effect, a little at a time.

Yet this works for a limited time only. If I run a pension fund that holds thirty-year U.S. bonds, and if the Federal Reserve lets inflation rise above what the market expected when I bought the bonds, my investment can be eaten up before I get my money back. But other investors, seeing this happen, will demand a higher interest rate when the debt is rolled over or will simply refuse the bonds. Because the federal debt is being rolled over all the time, default can come suddenly.

Modern theorists—“modern monetary theorists”—have argued that the Steinian day of reckoning need not come at all. They haven’t convinced a majority of the profession, but neither have they been proved wrong.

The question won’t be settled until Mike’s sudden bankruptcy occurs. If it never does, the modern monetarists win.

But they’ve never won in the past. Every previous hegemon hit a financial wall. Rome couldn’t collect the money to pay the troops to keep the Vandals and Goths from the gate. The Spanish empire rose on the gold and silver of the Americas, and it fell when the imports of precious metal slowed while Spanish spending didn’t. Britain’s first-mover advantage in the industrial revolution funded a navy that commanded the waves and an army of administrators who ruled from the Cape of Good Hope to the Canadian Arctic, but two world wars were more than the pound could support, and it gave way to the dollar.

The last American president to take Herb Stein seriously was Dwight Eisenhower. The former general understood that American power rested on American solvency, and he labored mightily to balance the budget. He succeeded in three of his eight years in office. Since then, balanced budgets have been rare, and the imbalances have grown, regardless of the party holding the White House or controlling Congress.

The debt topped $38 trillion last fall, and of late it’s been growing at around $2 trillion per year. Interest rates are much above what they were several years ago, indicating that U.S. debt is less attractive than it was.

Are we in Mike’s gradual phase? Very likely. Is the sudden phase far behind? Mike didn’t know when one gave way to the other, until it did. We’re equally ignorant.

Under the circumstances, it would be reassuring if someone in Washington appeared more worried. Once the collapse begins, other problems are minor by comparison.