In his weekly market comment, John Hussman (Hussman Funds) explains why the “Simple Arithmetic” of European sovereign debt forecasts necessary defaults. Hussman demonstrates the severely large portion of Greek GDP simply used to pay interest on sovereign debt given current outstanding amounts and interest rates. While some form of Greece default is now widely accepted, the size of outstanding Italian debt makes it increasingly clear how close interest rates are to rendering principal repayment nearly impossible. Italy announced today that it would forgo planned debt issuance in August due to concerns about prevailing market rates. If interest rates remain heightened in September, we could be looking back on July as the last time Italy had access to credit markets.
Despite focusing on Europe in this week’s comment, Hussman makes a very poignant remark about the maturity of outstanding US debt. Hussman states “it's precisely that short average maturity that makes the debt problematic from a long-run perspective, because it can't be inflated away easily. In the event of sustained inflation, the debt would have to be constantly refinanced at higher and higher yields. Contrary to the assertion that the U.S. can easily inflate its debts away, it is clear that sustained inflation would create enormous risks to our long-run fiscal condition by driving interest costs to an intolerable share of revenues.”
Recent efforts by the Fed through quantitative easing have further shortened the average maturity of outstanding debt. Regardless, many economists and investors argue for betting on long-term inflation because of the US debt burden. As Hussman makes clear, unless the US actively extends the maturity of outstanding debt, attempts to inflate away the problem will more likely exaggerate the risks.
Personally I remain of the view that US inflation is likely to be subdued (below 2%) for several years, with greater potential risk of deflation than high inflation. Long-term treasuries therefore remain a good value at current yields (4.3%) for investors with 3-5 year time horizons.
Despite focusing on Europe in this week’s comment, Hussman makes a very poignant remark about the maturity of outstanding US debt. Hussman states “it's precisely that short average maturity that makes the debt problematic from a long-run perspective, because it can't be inflated away easily. In the event of sustained inflation, the debt would have to be constantly refinanced at higher and higher yields. Contrary to the assertion that the U.S. can easily inflate its debts away, it is clear that sustained inflation would create enormous risks to our long-run fiscal condition by driving interest costs to an intolerable share of revenues.”
Recent efforts by the Fed through quantitative easing have further shortened the average maturity of outstanding debt. Regardless, many economists and investors argue for betting on long-term inflation because of the US debt burden. As Hussman makes clear, unless the US actively extends the maturity of outstanding debt, attempts to inflate away the problem will more likely exaggerate the risks.
Personally I remain of the view that US inflation is likely to be subdued (below 2%) for several years, with greater potential risk of deflation than high inflation. Long-term treasuries therefore remain a good value at current yields (4.3%) for investors with 3-5 year time horizons.
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