The Classic Toxic Mix
The classic toxic mix of forces that brings about big internal conflicts consists of 1) the country and the people
in the country (or state or city) being in bad financial shape (e.g., they have big debt and non-debt obligations
like pension and healthcare obligations), 2) large income, wealth, and values gaps within that entity, and 3) a
severe negative economic shock. The economic shock can come about for many reasons, including financial
bubbles that burst; acts of nature such as diseases, droughts, and floods; and wars. It creates a financial stress test.
The financial conditions (as measured by incomes relative to expenses and assets relative to liabilities) that exist at
the time of the stress test are the shock absorbers; the sizes of the gaps in incomes, wealth, and values are the
degrees of fragility of the system. When the financial problems occur, they typically first hit the private sector and
then the public sector. Because governments will never let the private sector’s financial problems sink the entire
system, it is the government’s financial condition that matters most. When the government runs out of buying
power, there is a collapse. But on the way to a collapse there is a lot of fighting for money and political power.
From studying 50+ civil wars and revolutions, it became clear that the single most reliable leading indicator of
civil war/revolution is bankrupt government finances, often after an economic shock and when there are big
wealth gaps. That is because when the government lacks financial power, it can’t financially save those entities in
the private sector that the government needs to save to keep the system running (as most governments, led by the
United States, did at the end of 2008), it can’t buy what it needs, and it can’t pay people to do what it needs them
to do. It is out of power.
A classic marker of being in Stage 5 and a leading indicator of the loss of borrowing and spending power,
which is one of the triggers for going into Stage 6, is that the government has large deficits that are creating
more debt to be sold than buyers other than the government’s own central bank are willing to buy—i.e.,
that leading indicator is turned on when governments that can’t print money have to raise taxes and cut
spending, or when those that can print money print a lot of it and buy a lot of government debt. To be more
specific, when the government runs out of money (by running a big deficit, having large debts, and not having
access to adequate credit) it has limited options. It can either 1) raise taxes and cut spending a lot or 2) print a lot of
money, which depreciates its value. Those governments that have the option to print money always do so because
that is the much less painful path, but it leads investors to run out of the money and debt that is being printed.
Those governments that can’t print money have to raise taxes and cut spending, which drives those with money to
run out of the country, state, or other jurisdiction because paying more taxes and losing services is intolerable. If
these entities that can’t print money have large wealth gaps among their constituents, these moves typically lead to
some form of civil war/revolution.5
This late-cycle debt dynamic is now playing out in the United States at both the state and federal levels, with the
main difference between them being that state governments can’t print money to pay their debts while the federal
government can. Near the beginning of this chapter I showed where debt levels, wealth gaps, and political gaps—
which are all at the highest since the 1930s—now stand in the United States.
For example, in the United States now, the federal government and many state and city governments have large
deficits, large debts, and large wealth gaps, and the central bank (the Federal Reserve) has the power to print
money. So, it now prints a lot of money and buys a lot of federal government debt, which finances the government
spending that is much bigger than the federal government’s intake. That has helped the federal government and
those it is trying to help, though it has also cost those who are holding dollars and dollar debt a lot in real
purchasing power. Thus far this money printing and buying of debt has not materially helped state and municipal
governments that also have big shortfalls to deal with and can’t easily get printed money to fill them.
As a rule, those places (cities, states, and countries) that have the largest wealth gaps, the largest debts, and the
worst declines in incomes are most likely to have the greatest conflicts. Interestingly, those states and cities in the
US that have the highest per capita income and wealth levels tend to be the states and cities that are the most
indebted and have the largest wealth gaps—e.g., New York City, Chicago, San Francisco, Connecticut, Illinois,
Massachusetts, New York State, and New Jersey. If you are interested in seeing these numbers for the major states
and cities in the US, they are shown in the appendix.