Minyan Mailbag - America the Bankrupt?
You're speaking my language
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Last month, the Treasury Department put out the 2004 Financial Report of the United States Government.
The report reads very much like an annual report for a publicly traded company. I often read through such reports in search of companies that I believe are hopelessly indebted and destined for bankruptcy. After reading this report, I am convinced that the U.S. Government is headed for its own type of bankruptcy.
When the government talks publicly about the National Debt, it typically just talks about the difference between its current assets and liabilities, which yielded a total of $7.710 Trillion as of 9/30/04. However, less than half of the government's assets are liquid, and don't have the ability to generate significant revenue. You may as well just ignore them when looking at the big picture. Also, the biggest liabilities and financial responsibilities aren't even accounted for in the quoted debt totals. The government should account for these financial obligations to give a better picture of its financial condition, and that is exactly what the 2004 Financial report attempts to do. Looking on page 11, we find:
$4.329 Trillion - Total debt held by the public.
$4.062 Trillion - Federal employee and veterans pensions/benefits
$0.716 Trillion - Other liabilities
$0.903 Trillion - Other responsibilities
$12.552 Trillion - Social Security
$24.615 Trillion - Medicare (Parts A, B & D)
$0.112 Trillion - Other Social Insurance
$47.289 Trillion - Total Liabilities and net Responsibilities
That total is the government's best estimate of exactly how much money the government would have to raise right now to pay off all its debts and adequately fund the commitments it has already made. It represents an increase of $11.070 Trillion over the total from September of 2003. $8.119 billion of that came from the addition of the President's Medicare Prescription Drug Plan (Medicare Part D). Outside of that new program, the total debt still rose by about $3 Billion during the year. That is far greater than the politically sanitized, official federal deficit figure of $412 Million, which excludes the undesirable effects of making promises the government can't keep.
The estimates required to calculate future responsibilities are imperfect, and could end up underestimating or overestimating the extent of the government's financial problems. Political motivations may play a significant role in determining those estimates. My personal belief is that the extent of the problems for Medicare parts A&B and Social Security are intentionally overstated in order to help promote the privatization of Social Security, and that the Defense department intentionally understates the future costs of veterans benefits so that the military can spend more money on boys and toys. For example, the Social Security Administration estimates a 5.8% rate of interest in the future, while the Department of Defense estimates interest rates of 6.25% (the Social Security trust had $1.4526 Trillion in Federal Debt Securities while the DoD's military retirement fund had $182.8 Billion) . The DoD also estimates lower annual inflation in the cost of health care than the civilian government.
While a politically motivated overstatement of the totals for Social Security and Medicare might mean the above liabilities and responsibilities aren't quite as bad as the $47 Trillion figure suggests, the government has many other liabilities that aren't included in that total and could end up pushing the eventual debt crisis much higher. Some of those liabilities would likely include: corporate pension plan guarantees, bailing out the FDIC, a wide range of loan guarantees, and state unemployment insurance bailouts. Sticking with the government's own $47 Trillion figure seems like it may be best for weighing the government's solvency, considering all positive and negative scenarios.
Some people think that the U.S. government will never go bankrupt because:
1. It can just tax people and businesses to raise as much money as it wants.
2. It can just print as much money as it wants.
It turns out that the Government's total liabilities are far too big for either of those solutions to be practical.
So how much is $47 Trillion and what would happen if the government tried to raise that much through increased taxes? Well, that's about $160,000 for every person in the United States. If you think that American's don't have that much money to spend on average, you are correct. In fact, according to the Fed's latest release, total M3 money supply is around $9.4 Trillion. The government could tax and confiscate every dollar in existence and only reduce the problem by about 20%.
The government doesn't really create much money on its own (although it could give itself the ability to create as much money as it wanted). Instead, the Federal Reserve system and the banking system creates money and loans it out. How much has the Fed created in its history? Well, about $750 Billion. Almost all of the rest of the money created is simply a representation of a debt between two parties and is backed by the collateral behind the debts. If you borrow money to buy a new house, your bank creates that money out of thin air and gives it to you, but also records the debt you owe them on their books. The vast majority of all dollars in existence would disappear if all debtors repaid their debts. If the government were to just create $47 Trillion of new money, the way the Fed gets to, it would increase the amount of money that wasn't backed by any real assets by about 6300%. To put it mildly, that would be inflationary. To put it less mildly, imagine using dollar bills to heat your home, rather than natural gas or heating oil. The economic consequences of such a money printing endeavor would likely lead to a complete economic collapse, and many of the government's liabilities would grow just as fast inflation, driving up the total amount of money needed for printing by orders of magnitude.
The government could take drastic steps to bring the budget in line now to slow the bleeding of red ink, by raising taxes and cutting spending. While the debt is already too large for that to prevent default, it would at least make the eventual fallout less severe. Unfortunately, Congress and the President aren't willing to behave responsibly. So that leaves the government heading toward bankruptcy of one form or another at an accelerating rate. Continuing deficits are driving the total debt higher every day, and eventually the government will have to default on treasuries and/or break promises for social and economic insurance programs, because eventually creditors will stop lending it money.
Politics will undoubtedly play a big role in determining who loses out. Currently the President is making Social Security the first target of default by cutting the plans for pay outs and taking the first steps toward wiping it out through privatization. Although the administration isn't stating this publicly, privatization now will make it easier to eliminate Social Security entirely when the debt crisis becomes inescapable. However, Social Security is the portion of the total debt picture that is least deserving of cuts. The program is very well funded now and is generating a huge surplus every year. It is possible that it will become underfunded in the future, but that is unknown. Retirees should only have their payments cut if it turns out that the money they put into the system wasn't enough to pay for the social insurance that is needed. While Social insurance programs have nearly $3 Trillion invested in U.S. treasuries, all that money has technically been spent to help pay for past government deficits. It is highly questionable whether the government will ever return the money that working people have paid into the system in the form of payroll taxes. The safe assumption for working people is that they will end up getting back much less than they expected in retirement, and if they don't fight the president's plan now, they'll end up getting back next to nothing.
Medicare deserves much of the blame for the government's problem, mainly because health care costs have risen dramatically in recent years. It is extremely hypocritical for the Bush administration to say that Social Security is in trouble when his $8 Trillion prescription drug plan isn't funded at all. Medicare isn't under attack now because it generates big profits for the health care and drug companies that make campaign contributions to the Republican party. Social Security is under attack because it benefits poor people who tend to vote Democratic. Medicare could be fixed if health care costs (and health care profits) were brought under control, and the recognition made that expensive procedures for the dying are not affordable under the current system.
The national debt would actually begin reversing itself for a while if defense spending was brought in line with what was necessary. Total U.S. defense spending is almost equal to the amount spent on defense by every other country in the world in total. Unfortunately defense is about 4.5% of GDP and cutting it drastically would also reduce tax revenues. It is a necessary step, which will be forced on us if we don't take it voluntarily, but nowhere near enough to solve the total debt problem.
Other corporate welfare programs, like the FDIC insurance, the pension benefit guarantee corp, and a multitude of loan guarantee programs will likely generate huge expenses for the government in the future. FDIC insurance has encouraged reckless lending practices by banks, and bank failures will lead to massive pay outs in the future. People will get their insured $100,000 back, but the deflated value of those dollars will be less than they expected. PBGC typically cuts the size of pension payments when they take over failed plans. PBGC has even started taking over plans from corporations that haven't failed yet, as a form of corporate welfare (see United Pilots). The way things are going, virtually all corporate pension plans will end up underwater and in the government's hands (in my opinion) and again people should expect to receive much less than has been promised to them in retirement.
This brings us to the actual "debt held by the public," now at over $4.3 Trillion and counting. More than half of this is held by foreign central banks, and much of the rest is held by private pension plans and mutual funds. The debt is currently earning a very low level of interest because the Fed has kept rates artificially low and because the buyers of the debt don't really care that they are getting ripped off. Fund managers are playing with other people's money, and are buying treasuries because people think they are safe. Of course the money that comes out will end up being worth much less than the money that went in, but the fund manager job description says buy U.S. treasuries, so that's what they do.
The foreign central banks, on the other hand, know that investing in treasuries is a losing proposition, but they do it to keep their currencies weak so that manufacturing jobs will leave the U.S. and go to their countries. The net amount of U.S. assets owned by foreign interests (which subtracts the foreign assets owned by Americans) is now over $3 trillion. Japan has stayed strong as a manufacturer and China has become a manufacturing power at the expense of U.S. manufacturing companies and U.S. labor by letting the U.S. run up as much debt as it wants. While foreign central bankers have continued to invest trade gap dollars back into U.S. economy, the ratio of investments has recently shifted dramatically away from U.S. treasuries and toward asset backed securities. Perhaps this is a sign that the U.S. debt is getting too large even for our economic rivals' comfort. When they give up on buying U.S. treasuries completely, then America will finally be bankrupt. At that point, the U.S. might just take Russia's course and default on its debt, (also known as going bankrupt).
In summary, the federal deficit, that many of our leaders have told us doesn't matter, will soon come back to haunt us. The economic prosperity and high standard of living we've been enjoying as a nation has come at a severe cost. Wealth has been slowly and steadily drained out of the country. America's once dominant technological and educational assets are no longer significantly better than the assets of other countries. Once our line of credit runs out, we will face grave economic consequences.
Minyan Mike Shedlock
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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