YOU DON'T HAVE TO OUT-RUN THE BEAR.

Arnold Kling argues, "U.S. Government Bonds are Junk Bonds."  For the moment, they're still the lowest-risk asset, because the joint venture of Brazil, China, India, Russia, and Saudi Arabia is about as stable as Dementia Joe on a bicycle.  All, though, is not well.

If you buy a ten-year U.S. government bond, what are the chances that you will be repaid in full? Are they 99 percent or more?

If we are talking about being paid back in dollars, I would say that the answer is “yes.” But what about the purchasing power of those dollars?

To keep the arithmetic simple, suppose that you invest $100 in a bond, and you get no interest until the bond matures. Interest is, say, $5 per year, so that in ten years, when the bond matures, you get $150.

Suppose that $150 ten years from now will buy the equivalent of $100 today. Then you just break even on the bond. That corresponds to inflation of roughly 5 percent per year, not compounded. If inflation is less than that, you do better than break-even, and if it is more than that, you do worse.

I think that it is fair to say that if inflation averages more than, say, 8 percent over the next ten years, then long-term government bonds that you buy today will have effectively defaulted. So if you are going to rate long-term government bonds as being investment grade, you have to assign a very low probability to such a high-inflation scenario.

Or you offer less than $100 for that bond, which is the manifestation of the real debt ceiling.

What is the real debt ceiling?  The value of the federal debt beyond which bond traders will not buy Treasuries.

When will the day of default be?  Nobody knows the day or the hour.

That day, though, is coming.

As you may have heard, one of the credit rating agencies recently downgraded U.S. debt from AAA to AA, which is nothing. Government debt is still considered high quality. That is because its rating only concerns the risk of hard default, not the soft default of rapid inflation. I agree that the risk of hard default is low, but I think that soft default is something to be worried about.

One way to avoid soft default is for there to be a dramatic pickup in the rate of economic growth. That would boost tax revenue and enable the U.S. government to run a balanced budget, or even to enjoy surpluses. This scenario assumes spectacular gains from the application of innovation in biotech and AI. Call this scenario A.

Another way to avoid soft default is for a bipartisan effort to reduce growth in government spending. This almost certainly would require cuts in Social Security, Medicare, and Medicaid. Call this scenario B.

If we have neither scenario A nor scenario B, then government will have to issue more and more debt to finance its spending, including spending to pay the interest and principal on past, present, and future debt. That is what analysts at the Congressional Budget Office and elsewhere worry about when they describe the U.S. fiscal position as unsustainable.

This ever-increasing debt issuance will flood the economy with paper wealth that is not derived from economic activity. This flood of government bonds seems certain to fuel inflation. As inflation goes up, government interest cost goes up, the cost of entitlements and other forms of government spending goes up, and you get into a vicious spiral.

It does not reassure the rating services that Congresses, repeatedly, Democrats, Republicans, divided, have not passed a regular order appropriation since 1996 or so, nor have we seen anyone doing something serious about those Social Security and Medicare "trust funds" being depleted.