Search This Blog

Thursday, November 02, 2006

Skeptical Optimist Watch: Bankruptcy

English is a fluid and massive language, and different words have somewhat different meanings to different people speaking different slightly different dialects. The dialect spoken by CFOs and ex-CFOs is likely different from much of the rest of the population.

Today, I'd like to consider the word "bankruptcy". From dictionary.com we get the following definition:
bank‧rupt‧cy[bangk-ruhpt-see, -ruhp-see]
-–noun
1.the state of being or becoming bankrupt.
2.utter ruin, failure, depletion, or the like.
Definition (1) includes the concept of being legally bankrupt and I can imagine that is what comes to mind when CFOs hear the word. Definition (2) is pretty broad and allows "bankruptcy" and "bankrupt" to be used correctly in a much wider variety of contexts.

In a recent post by the "Skeptical Optimist", Steve Conover asks:
Next time we hear anyone warning us of impending "bankruptcy," let's interrupt and ask, "Wait, don't you mean 'hyperinflation' instead of 'bankruptcy'?"
But isn't 'hyperinflation' virtually synonymous with "utter ruin"? Has there ever been a hyperinflation that didn't leave an economic system in shambles? Certainly a hyperinflation represents some sort of "failure", no? Thus, I think that if one means 'hyperinflation' it would also be correct for one to say 'bankruptcy'.

Steve asks us to reread the following sentence:
In any scenario short of hyperinflation, it is impossible for the federal government of the USA to become incapable of paying its obligations in money backed by the federal government of the USA.
While I agree that it's unlikely, it's definitely not impossible. For example, Mexico became "incapable of paying its obligations" on its debt in the early 1980s, but there was no associated hyperinflation.

If the United States takes on obligations that aren't specified in dollars, is it possible that it will be unable to meet those obligations. For example, if medical breakthroughs push average life spans to 200 years, and most people continue to retire in their sixties, it is possible, perhaps even likely, that the United States may not be able to meet both its Social Security and Medicare obligations given the current relevant legislation. Would the United States hyperinflate, or default, or change the program, or do something else because it can't meet its obligations? Who knows, but in each case, the entitlement would face "failure" and "depletion".

In other words, the programs would be bankrupt.

6 comments:

Steve said...

Thanks for linking to my website. There are two points here:

(1) when scare-mongers use the word bankruptcy in connection with the federal government, listeners picture personal bankruptcy (i.e., running out of money, with none left to pay creditors), just as the scare-mongers intended; however, that analogy is false, because, unlike individuals, corporations, and local governments, there is no way the US government could ever "run out" of money backed by the US government, and therefore become unable to pay its creditors in that money.

Therefore...

(2) Hyperinflation -- a total loss of confidence in the government resulting in a worthless currency -- is the only condition that "federal government bankruptcy" could possibly mean. Therefore, anyone using the word "bankruptcy" is in fact predicting hyperinflation. Some have even said the USA is "bankrupt" right now, but never explain why the currency is not hyperinflating now, and why interest rates on long-term Treasury securities are low and steady at just under 5%.

Will Medicare "bankrupt" us (i.e., push us past the hyperinflation tipping point)? When, and why? Just where is the tipping point, anyway? Our debt-to-GDP ratio was 121% after WW2, and we were nowhere near financial catastrophe; it is 65% today, and we are even further away.

Politicians, partisans, and talking heads who use the term "government bankruptcy" without defining the term and getting more specific on timing are merely engaging in emotional bluster. Why don't journalists start calling them on it? All they'd have to do is say, "Bankruptcy? Just when are you saying hyperinflation will kick in, and why?" The fear-peddlers won't have any answers, only evasions.

Thanks again for linking to my blog.

Bret said...

Steve wrote: "...when scare-mongers use the word bankruptcy in connection with the federal government, listeners picture personal bankruptcy (i.e., running out of money, with none left to pay creditors)..."

Are you sure? My feeling is that when someone (a scare-monger, for instance) says something like "Medicare is or will be a bankrupt program" most people just take that to mean the the program is unsustainable. I'll do a quick, informal survey and see what some people around here think.

Steve also wrote: "Hyperinflation -- a total loss of confidence in the government resulting in a worthless currency -- is the only condition that "federal government bankruptcy" could possibly mean."

Well, that may be, though it seems to me there are alternate paths of insolvency. For example, the Government could potentially default on various contractual obligations. If it did that and the Fed worked hard to keep the money supply from hyper-inflating you might get a mess of a different kind. Hopefully, we won't have the opportunity to find out.

Steve also wrote: "Will Medicare "bankrupt" us (i.e., push us past the hyperinflation tipping point)? When, and why?"

Would you agree that if a government obligation was more than 100% of GDP it would be likely to push us past some tipping point? In my example, above (we all start living a really long time - hundreds of years - and nothing else changed, then the Governments Medicare and SS obligation would exceed 100% of GDP. That's a "why" - I don't expect this so there isn't a when. I'm in agreement with you that I don't see the government being unable to meet its obligations any time in the future.

Steve also wrote: "All they'd have to do is say, "Bankruptcy? Just when are you saying hyperinflation will kick in, and why?" The fear-peddlers won't have any answers, only evasions."

And people will be less fearful of the term hyperinflation than the term bankruptcy? I'm skeptical.

Anonymous said...

I will go with Steve; he deals in reality. Suggesting people will live to be 200 years old without looking at other variables is irresponsible. Maybe the advances that will allow people to live that long will allow them to be productive past age 65. Or maybe technological advances that allow people to live that long will also increase productivity so that one worker will be able to produce what it takes a million workers to produce today. Then we can all take 11 months of vacation each year. Let's stick with reality!

David said...

Wasn't the Mexican debt denominated in dollars, and doesn't that make all the difference?

Bret said...

david,
Yes, that makes an important difference. The Mexican government, had it borrowed only in Pesos, could have ensured that it could continue to borrow additional funds.

However, the point is that obligations such as Medicare are also not denominated in dollars. Such entitlements are not denominated in any currency and are nearly completely open-ended. In which case, it is theoretically possible for it to become impossible to pay for this obligation.

Dave Justus said...

You are using 'obligation' in two different ways.

Paying back treasury debt, honoring the notes we have sold, is a different animal than choosing to continue social programs in their existing forms.

So you are correct in that there are scenarios in which it would be impossible to continue social programs as they currently exist, social security with a 200 year lifespan would be an example of that. Such a change in the basic premise would require a change in the program.

That would be true regardless of how much money was in the bank account for those programs. If we had a massive vault filled with trillions of greenbacks, we still probably could not support the majority of our population not working. Social Security has to distribute real resources that are produced each year (food, places to live etc.) from productive people to non-productive people. If the ratio goes too high it will be impossible to maintain. Having extra cash on hand won't change this any.

But of course we can (and have) change the program. In your example, it is a certainty that retirement age would change.

I also think that your second definition of bankruptcy would not be an appropriate definition for talking about financial matters, whether one was a CFO or not. It would apply to moral bankruptcy, for example or other similar uses of the word, but when one is talking finances, the first definition is the only appropriate one to use.