The Psychology of an Erupting Massive Fear

Dialogue with the Alter Ego on Lawrence Kotlikoff and the US debt

Russ Roberts: “Now, you’ve been writing for some time about America’s fiscal problems. A lot of people disagree about how serious those problems are. You argue that they are serious. How bad is it?”

Lawrence Kotlikoff:  “I think it’s terrible. I think we are probably in worse fiscal shape than any developed country. The reason, Russ, is we’ve been piling up debts for over 6 decades; and when I say ‘we’ I’m referring to Republican and Democratic administrations and Congresses. And we’ve been hiding them. We’ve been keeping them off the books and using economic labels, words, to pretend that they are not real liabilities of the government. ( … ) The accounting here is much worse, far worse than anything that Bernie Madoff, who ran that big pension Ponzi scheme engaged in, and anything that Enron engaged in. It’s really horrendous because the true debts of the country total about $205 trillion. The official debt that’s being reported is only about $12 trillion …. (…)

So at some point the entire bond market will flip and we will have interest rates go up and we’ll have inflation take off. The United States cannot indefinitely print, pay for these obligations with money creation.  – Excerpt from “EconTalk with Russ Roberts” and Lawrence Kotlikoff, January 13, 2014 (see: http://www.econtalk.org/archives/2014/01/laurence_kotlik.html)

Question by Alter Ego of Noah denkt ™ (AE): It is high time that we talk about the systematic risk which the skyrocketing US debt is posing to financial markets. Boston University professor Lawrence Kotlikoff is arguing for quite some time now that the US is dramatically broke and that it is only a question until society and financial markets will react to this in a similar devastating fashion as they have done in the cause of the Greek and Argentinean debt crisis. What is Noah denkt™’s view on this issue?

Answer by Noah denkt (Nd). We have no doubt that professor Kotlikoff’s analysis of a 207 trillion US$ public debt (- which contrary to the official statistics also includes health care and entitlement obligations by the US government – ) is correct. Furthermore, we also believe that he is right in pointing out that this level of debt is a ticking time bomb that will wreak havoc of biblical proportions to the world economy if it eventually goes off.  In deed, we share Mr. Kotlikoff’s view that it is mistaken to believe that the US will be able to spend its way out of the economic crisis. And we would also concur with him that current Wall Street evaluations aren’t an adequate indicator as to the level of the threat that is inherent in this public debt. Having said all that, we are no sure, however, whether a sudden switch in Wall Street attitude towards that debt is as imminent as Mr. Kotlikoff has us believe.

AE: Why do you say that?Nd: Because history tells us that the sudden eruption of massive fear which would in fact precede the radical change of Wall Street perceptions tends to happen in an environment where an apparent exuberance in valuations has already led way to a subconscious unease or fear about the unprecedented level of confidence and optimism that is reigning in those financial markets. At this time, however there is still a lot of open and manifested unease about the solidity of the recovery baked into the valuations. So, in our mind, the conditions aren’t right for such a radical shift in perception to happen now.

AE: Can you point to a specific historic situation that validates your argument?

Nd: Well, look at the French Revolution. It did not happen when the exercise of feudal rights was the most excruciating and immediate. Instead, it happened when that feudal reality had already lost considerable weight due to the centralization of the absolutist administration. In other words, the eruption of massive public emotions did not come when the issue they were fighting against was as at its hottest but when its severity had already cooled down somewhat. (See: Alexis de Tocqueville, The Old Regime and the Revolution). A similar pattern can be discerned with respect to the breaking point of the 2007/8 financial crisis. There had been quite some talk about an imminent recession well before the sub-prime crisis actually broke. But these fears had already died down somewhat by the time the BearStearns and Lehman disaster actually happened. At the time, it appeared as if the market would in deed be more resilient than observers had originally anticipated. The development of the BearStearns share price speaks to that observation. On May 21, 2007, rumors are already spreading that BearStearns might be overly exposed to the sub-prime market. The share price closes that day at US$ 50,49. Until March 14, 2008, it falls to US$ 32,50, only to pick up again until it reaches US$ 42,60 on the day the last and final shareholder meeting of BearStearns takes place.

AE: So it does seem in deed that the conditions for a radical shift must be overly ripe before that shift can actually happen.

Nd. Correct

AE: And we aren’t there yet, are we, – even though the general environment in which we are operating at this time shows a lot of signs of exhaustion, mission creep and overreaching?  Just look at the ever deteriorating quality of public education, the disorientation of kids, the drug problem, the chaos in politics and so on. Doesn’t that make you think that a correcting reset might be more imminent than you believe?

Nd: Obviously, the need for a reset cannot be denied. But we also have to ask ourselves whether we truly deserve to be punished at this moment in time. And this project happens to be believe that we do not deserve that punishment as yet. After all, it can’t be denied that governments all over the world (with a few exceptions notably) are trying their best, to do what they think is right. Obviously, the money printing that is going on in the US and elsewhere isn’t being done for personal gains. Much rather is it being pursued because those responsible shy away from submitting their people to the severe hardship that an honest correction would entail. That may be a big analytical mistake, but it certainly isn’t a morale failure of Biblical proportions.

AE: Professor Kotlikoff doesn’t seem to agree with you?

Nd. We are not so sure about that. After all, he too believes that with the right approach the worst can still be avoided. ( See his reform suggestions at: http://www.thepurpleplans.org/)

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