One of the reasons it is so hard to see the Debt Trap in operation is that in the United States fear of mounting government debt manifests itself in a peculiar way: People buy more government bonds.
The bond rush we've seen in recent months is a terrific indicator of financial distress. People are basically demanding a safe place to store wealth, even if they have to pay for it. So yields on short-term government bonds go negative and yields on longer-term debt approach zero once you take inflation into account.
But one of the reasons people are so pessimistic is that we've passed the debt threshold, the point at which debt starts to drag on the economy.
This is hard to wrap your mind around. People worry because the government has incurred so much debt—so they buy more government debt.
This seems irrational until you remember the government of the United States is never at risk of not being able to pay back its debt.
It can always—and most likely will always—pay back whatever it owes.
The reason for this is simple: The government is not income-constrained when it comes to spending. It can spend what it needs to.
The only check on this is inflation policy. If the government spends too much, including making debt payments, inflation may exceed the levels desired by policy makers.
But this rush into government bonds means that wealth that might otherwise be directed into real economic projects, consumption, or business expansion is being stored in what amounts to a government safe deposit box. So fear of extreme levels of debt leads to lower yields and lower growth.
That's the Debt Trap.
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