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An academic finally “get’s it”!

From Financial Armageddon:

In a new paper, “Guessing the Trigger Point for a U.S. Debt Crisis,” George Mason University professor and economics blogger Arnold Kling speculates on when the U.S. might have to pay the piper for its many (fiscal) sins.

Here is the abstract:

“Leading authorities in the United States, including the Congressional Budget Office, use the term unsustainable to describe the long-term fiscal outlook. By the year 2080, spending on entitlements alone could exceed total federal tax revenues. In the very long run (meaning from the year 2035 through 2080), the problem is primarily one of excess costs in health care, meaning the tendency for health spending to grow faster than the rest of GDP. However, in the medium run, meaning from 2010 through 2035, the aging of the U.S. population is the dominant factor.

“This paper explores the possibility of the U.S. experiencing a debt crisis in the medium run, meaning somewhere between 2015 and 2035. It is impossible to state precisely the trigger point for a crisis. At best, we can make guesses about some of the key parameters.”

As I noted in “A Bad Assumption,” one factor that many mainstream analysts did not eally take account of before the financial crisis erupted — and still seem to be downplaying — is the importance of confidence in a system built on a dense latticework of promises. If at some point faith begins to waver on a large-enough scale, then things can fall to pieces, as Professor Cling suggests, rather quickly:

“A debt crisis can be thought of as a sudden transition from the high-confidence regime to the low-confidence regime. In the former, investors have high confidence in the sovereign’s willingness and ability to repay its debt. In the latter, investors lack such confidence. The loss of confidence leads to higher interest rates, which in turn exacerbates the sovereign’s difficulties with repaying debt, and that in turn reduces confidence still further. Hence, the shift is discontinuous, not a gradual smooth shift. There is no “in-between” regime in which investors have medium confidence in the sovereign’s debt, because the strong self-reinforcing feedback loop that characterizes investor confidence, interest rates, and fiscal viability drives those variables in either one direction or the other.”

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