A World of Debt

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“The principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.” – Thomas Jefferson

“If ever again our nation stumbles upon unfunded paper, it shall surely be like death to our body politic. This country will crash.” – George Washington

“We have $128 trillion worth of unfunded liabilities and the total net worth of our country is $94 trillion and we have another $17 trillion worth of debt.”
– Sen. Tom Coburn (R-Okla.), interview on NBC’s “Meet the Press,” Oct. 20, 2013

It's a Small World, After All!

It’s a Small World, After All!

In the conclusion of The Financial Report of the US Government, written by the Treasury Department in 2012, the treasury congratulates the administration on enacting ObamaCare as cost savings legislation. At the time of the report, ObamaCare had yet to be fully implemented. It’s problematic rollout and lack-luster enrollment of the young and healthy (required to meet its financial projections) became an embarrassment to the administration.

But assuming that the true goal of the Affordable Care Act was to save the taxpayer money may be too generous. As one financial analyst, David Merkel, writes, “First, the true cost of PPACA was a lie. Taxes were front-ended. Benefits were back-ended. The net benefit is gone now, and we face the black hole of insufficient taxes to meet benefits. Second, Medicare was raided by reducing reimbursements, which Congress then undoes. There is no true savings, and there can’t be; government almost never produces anything as efficiently as the private sector. It is normal for government to downplay the initial cost so that the program will be approved. Once approved, cost overruns are the norm.”

Consistent with this theorem, the LA Times is already reporting that at least $16.5 billion in subsidies paid out to encourage enrollment numbers have pushed projections well above initial estimates. It’s not likely to end there.
Entitlement programs, like ObamaCare, have always been ‘budget busters’. Even before ObamaCare in 2010, costs for entitlement programs as a percent of gross domestic product was like this: Medicaid = 239% at $35 trillion, Social Security = 54% at $8 trillion, and Medicare = 156% at $23 trillion. These three programs alone represent 58% of the entire current federal budget or, in GDP terms, 449%!  Obviously, there is a shortfall between revenues generated and costs for these programs. In the past the US government, through the operations of the treasury department, have made up for this fiscal gap by borrowing. Total borrowing to date is estimated at $17 trillion and it’s continuing to grow.

imageJeffery Berwick of the Dollar Vigilante adds, “That total doesn’t take into account the liabilities of the federal government. These are funds that have been extorted in the past for programs such as Medicare, Medicaid and Socialist Insecurity (sic) that are theoretically supposed to be paid back. If accounted for under Generally Accepted Accounting Principles (GAAP), like every other company in the US does, total US government debt and liabilities stands above $90 trillion and is rising at about $5 trillion per year.”

The treasury department’s own official government report inserts one understatement that seems to agree with these harsh assessments:  “But even with these new laws, the Government’s debt-to-GDP ratio is projected to increase continuously over the next 75 years and beyond if current policy is kept in place, which implies that current policy is not sustainable.”

We may be witnessing this same sentiment steadily growing among traditional purchasers of our debt reflected as a lack of appetite for purchasing US treasuries. Thailand was an aggressive net seller of treasuries, dumping one third of her holdings last year in 2013. Russia also cut her holdings by a third, as well during this time. And the official data gets a little murky, but it appears other European central banks were also selling treasuries. China, still a net purchaser of USTs, has slowed its accumulation of debt and has publicly announced looking for ways to diversify her foreign holdings. This predictable behavior of selling government treasuries in the face of irresponsible fiscal behavior results in a fiscal gap that cannot be funded. In the past, these sellers of treasuries (or ‘bond vigilantes’ as they were called), would force our Nation to reign in spending and develop fiscally responsible policies to maintain reasonable foreign appetite for our debt.

Since it appears that ‘bond vigilantes’ are on the move in Asia and Europe, then who must be buying up the slack?

According to the US government’s own official reports, the Caribbean and the tiny nation of Belgium have suddenly developed an immense appetite for USTs, countering the need for fiscal responsibility. Some analysts believe that these nations are acting only as a front for these purchases. David Chu of the China Money Report says, “in reality, it is the Fed doing credit swaps and buying its own financial vomit, i.e., the Fed is buying its own USTs via its QE’s publicly and through front countries like Belgium and the “Caribbean Banking Centers” not so publicly.” In February 2014, the NY Times agreed. “The Federal Reserve was the principal purchaser of United States Treasury securities in 2013,” it printed, providing evidence to support the claim. In simple language: we are now loaning money to ourselves!

And another question one would have to ask is just how much we will need to borrow if we continue along this fiscal path. The difference between anticipated revenues collected and obligations already committed to is enormous, if not breath taking. The Wall Street Journal wrote on June 25, 2013, the “Fiscal gap separating the present value of all future projected federal expenditures -social security, Medicare, medicaid, ObamaCare, defense, gassing up Air Force 1, servicing the existing debt, you name it- and all future federal taxes and other receipts based on the CBOs projection is a staggering $222 trillion.”

So, depending on who you talk to, these obligations going forward through the contracted period (called the ‘infinite horizon’) can vary quite a bit. At its best, it is $178 trillion by conservative (and still stunning) estimates and at its mind numbing worst, it’s $222 trillion dollars.

But that’s just government debt owed by future generations of taxpayers. Most of us already know that current US debt is somewhere between $9-17 trillion. But total debt in the US may be much higher. According to a recent Zerohedge article, when one combines private debt such as mortgages, credit cards, and business obligations along with current government debt, the current account amounts to $60 trillion. This is “27 times more than the $2.2 trillion owed 40 years ago,” the article goes onto say.

According to the Wall Street Journal in May of 2014, a Credit Suisse report estimated private wealth in the US at $72 trillion. Another report released this week by the Federal Reserve estimated new net worth topped $80 trillion. And on June 10th this year, Bloomberg news reported, “private wealth in the Asia-Pacific region excluding Japan jumped 31 percent to $37 trillion in 2013, supporting a 15 percent advance to $152 trillion globally….and expects rich households to have almost $200 trillion worldwide by 2018, with the Asia-Pacific region contributing about half of global growth.”

If these numbers are accurate, then it appears all the wealth of the world present today could not satisfy the loan the US government has taken going forward. It would take half of the wealth of the world to satisfy public and private debt due today. What does that mean if the entire net worth of the world is less than the financial obligations of one country? It would appear that the US is bankrupt.

Politicians and some economists are loathe to express it that way, however. Perhaps a better way, they suggest, is to express these numbers as a percentage of the gross domestic product- the broadest measure of the U.S. economy. Analysts use this information to determine if taxable income can service the debt going forward and could be considered ‘sustainable’. In other words, can the “unfunded obligation through the infinite horizon” be met through taxation within reason?  This is a reasonable consideration given that the net worth of the nation is always changing and that new technologies and services can contribute rapidly to an increasing net worth for any nation or the world, even improving this outlook.  So, let’s go with it.

It is a bit like trying to determine how much house one could afford by taking on a mortgage with consideration to one’s anticipated salary. If, for argument’s sake, one were making a $50,000 salary and had good credit, one might afford a house for $250,000 if the loan were at 5% and fixed over 30 years, for example. That would equate to a mortgage payment of $1300/mos on $4150 take home pay over that same period. And, if one is also lucky or industrious, one’s salary should continue to rise and one’s home should always increase in value (or at least stay the same.). Seems reasonable, right? One might be able to examine the financial situation again in a few years and see that, if no major surprises have occurred and things have gone even modestly as expected, that one’s net wealth has increased over that period, as well. This would be a good measure of financial sustainability, correct? What could possibly go wrong?

So, some analysts believe the current spending environment is within reason with the only evidence provided as the government’s own projections of Social Security costs through the infinite horizon at 1.4% GDP.  Everything is fine based on this one projection (never mind that this is the least costly of the three existing entitlement programs and the costs of ObamaCare have yet to be determined).  If this is working and sustainable, then we should be able to put actual numbers aside and expect to see, in retrospect, a similar trend in America’s net worth:  That it should be increasing.

image

Absolute net worth figures do show an ever increasing trend (with some expected hiccups).  But if we express the total net worth of the US by the same yardstick- as a percent of GDP- we get an entirely different and much more intuitive trend.  Net liabilities appear to be climbing consistently over time. This is true whether considering the blue line in the graph, (typically overly optimistic stated growth in the economy), but especially true when looking at the red line (adjusted-and actual growth).

Liabilities as a percent GDP

Today, an opinion-editorial in the Wall Street Journal written by past Federal Reserve Governor, Kevin Warsh, summed up America’s debt problem like this: “Wealth creation comes from strong, sustainable growth that turns a proper mix of labor, capital and know-how into productivity, productivity into labor income, income into savings, savings into capital, capital into investment, and investment into asset appreciation.” Borrowing from others does not appear to be a variable in this equation.

According to Warsh, absolute net worth estimates and projections can be, and are, accommodated by fiscal policy, it appears: “Balance-sheet wealth is sustainable only when it comes from earned success, not government fiat.”

For increased spending to be sustainable, GDP must increase- by real growth, not by balance sheet tricks and illusions- so that tax revenues may also increase OR non-sustainable spending needs to stop. Either way, going forward, tax revenues will still need to be large. We’ve already written those contracts to the tune of $178-222 trillion.

Ibn Khaldun, a wise 14th century Muslim philosopher, once said, “it should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.”

All things considered, the most accurate guess as to what the future holds for us is that we are at the end of our Dynasty.

Ibn Khaldun

Ibn Khaldun

 

References (in no particular order):

http://alephblog.com/2013/01/22/2012-financial-report-of-the-us-government/

http://www.fms.treas.gov/fr/12frusg/12frusg.pdf

USA Inc.- a Basic Summary of America’s Financial Statements, published by Kleiner, Perkins, Caufield and Byers. (Available online thru Scribed)

http://www.thedailybell.com/editorials/35388/Jeffrey-Berwick-The-US-Government-Has-Nearly-As-Much-Debt-As-The-World-Has-Wealth/

http://www.tradingeconomics.com/united-states/gdp

http://www.nytimes.com/2014/02/22/business/economy/no-surprise-fed-was-biggest-buyer-of-treasuries-in-2013.html?_r=0

http://www.zerohedge.com/news/2014-06-17/united-states-debt-total-debt-america-hits-new-record-high-nearly-60-trillion-dollar

http://www.thechinamoneyreport.com/2014/05/16/shock-thailand-sells-20-3-billion-or-42of-their-u-s-treasuries-in-2013-second-largest-net-seller-behind-russia/

http://www.latimes.com/nation/politics/la-na-obamacare-subsidies-20140617-story.html

http://online.wsj.com/articles/warsh-and-druckenmiller-the-asset-rich-income-poor-economy-1403220446

http://www.tradingeconomics.com/united-states/gdp

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