Spending Crisis – Part IV

We chose to steal from our children and grandchildren rather than control our spending.
Spending Crisis – Part IV
Can Catastrophe Be Averted?
By: George Noga – May 19, 2019

        This is the fourth and final post in our Spending Crisis series, available in its entirety at www.mllg.us. Our headline asks, “Can Catastrophe Be Averted?” The answer (spoiler alert) in one word is: no! If something cannot go on forever, it won’t; the spending cannot go on forever, so it won’t. America today is only 2-3 years from the point-of-no-return, from which no nation ever has escaped without grave harm.

          The USA will blow past the point-of-no-return because there is no constituency for action and there won’t be until the crisis affects people’s daily lives. Politically, there is no incentive, and in fact there is a strong disincentive, to act absent a manifest crisis. When the crisis arrives, government initially will take only quarter-measures and it will be far too little, far too late. We simply have dug the spending, debt and deficit hole too deep; but instead of beginning to fill in the hole or even to stop digging, we blithely continue to dig the hole ever deeper, oblivious to the consequences.

         The most likely initial government response to the crisis will be to hold short-term interest rates at or near zero – and perhaps even negative. If the interest rate is ultra low, the amount of debt theoretically is unlimited. However, although the Fed exerts strong control over short-term rates, they don’t have similar control over long-term rates. Alternatively, the Fed can simply buy an unlimited amount of debt in a massive quantitative easing process. Neither of these actions is without consequence and at some point everyone will know that the emperor has no clothes.

Comments from Reviewers

        Three highly knowledgeable people, to whom I am grateful, reviewed this series. No one disputed the data or the analysis. Most were less pessimistic about the final outcome, although they didn’t present solutions; one wrote, “Things are never as good or as bad as they at first seem; the sky is not falling – it never does.” Another wrote, “As long as (people) continue to invest in our Treasury debt, the crisis will not happen. The point-of-no-return comes when no one will invest.” All the reviewers noted that, despite everything, we are better off than in the past and than most other countries.

         One reviewer suggested we might be able to reduce the debt to acceptable levels, over many years, by a combination of inflation and weakening the dollar such that foreign holders of our debt absorb most of the pain. Officially, foreigners hold only 39% of the debt, but this reviewer believes the real number is higher as some foreigners mask their ownership. However, this reviewer acknowledges this tactic can only succeed if the US gets its budget into balance; otherwise, it doesn’t matter.

Two Dimensions to Crisis: Excess Debt and Balancing the Budget

        There are two distinct dimensions to the spending crisis. First, we must purge the system of all excess debt to return the debt/GDP ratio to an acceptable level. Second, we must get our spending under control and balance our budget. Even if aliens from another galaxy showed up and miraculously repaid our national debt, we would be right back in the same position unless we got our budget into reasonable balance.

        Timing: When Will the Crisis Begin?

         The most frequent questions I get are about timing. The short answer is that there is no way to know. No bell goes off when the crisis begins; no bell went off in Japan or Greece; at first, the crisis may seem transitory. I can make a credible argument that the crisis already may have begun given the ultra low interest rates. In all of recorded history (since 3000 BCE) there never before have been zero or negative interest rates.

        The best answer I can muster is the crisis will be in full bloom when the ratio is 125% to 150%. But it could happen much sooner; once markets see where things are headed, it isn’t necessary to wait until they get there. It also could happen much later. I recall Adam Smith’s admonition, “Be assured, that there is a great deal of ruin in a nation“. By that, Smith meant it requires much to completely ruin a nation, which can survive mistakes, stupidity and disastrous policies far longer than is assumed.


Concluding Thoughts

            The spending crisis has many moving parts and it is easy to get overwhelmed by the data. Fundamentally however, it is simple. The US has spent and borrowed too much in relation to the size of its economy. It is rapidly approaching a hard and fast tipping point (90%) determined by the inexorable laws of mathematical compounding and from which no nation ever has escaped without great pain and a lost generation.

           By the time the crisis is manifest, the budget gap will be over $1.5 trillion per year, or 30%, amidst punishing demographic forces. There is no realistic way to bridge that gap. Perhaps, catastrophe can be postponed or ameliorated with extreme financial repression – which in itself will put America in crisis; moreover, it won’t permanently solve the fundamental problem. Ultimately, all excess debt must be purged and the budget brought into some semblance of balance. There is no other way out!

       Charles Murray, one of the titans of our time, recently said, “The American experiment in self-government is essentially over“. I fear he is correct, as America in 2019 panders to people’s fears and prejudices, while it ignores existential threats. The spending crisis, which will cost America a lost generation, was eminently foreseeable and preventable. It is at root a moral crisis because we lacked the will to act.

          We chose to take from our children and grandchildren rather than to control our own spending. To make matters even worse, the money we stole was not put to good use. Instead of borrowing to save our nation from calamity (as in World War II), we stole the money from future generations to finance a perpetual New Year’s Eve party.

Note: Email us with questions or comments. We may publish a follow up post in a few weeks with reader questions. We also are open to publishing other viewpoints; if you are interested, email us for guidelines. We will continue to publish regular updates about the spending crisis.

Next up: MLLG’s Complete Principles of American Politics

Spending Crisis – Part III

Possible solutions: grow, cut, tax, inflate, repress, restructure, repudiate, seize, MMT
Spending Crisis – Part III
Possible Solutions to Spending Crisis
By: George Noga – May 12, 2019

           This is the third of four posts in our Spending Crisis series, which is available in its entirety at www.mllg.us. There are many theoretical ways a spending crisis could be averted; we could grow, cut, tax, inflate, repress, restructure, repudiate, seize, or MMT our way out. More likely, we will employ a combination of these measures.

          Grow: There once was a time, as recently as 5-10 years ago, where growth was a possibility: no longer. There is no way the economy can grow at a faster rate than the debt, which currently is growing by 5.25% and increasing to 8.00% by 2025.

         Cut (Spending): FY 2019-2020 spending will be about $4.7 trillion with a deficit of $1.1 trillion. To balance the budget requires spending cuts of 23.4% but, by the time an impending crisis gets Congress’s attention, cuts of 30% will be necessary. Social Security, Medicare, Medicaid, pensions and defense would have to be savaged to such an extent as to sow the seeds of civil unrest. Moreover, the cuts would have to remain in effect for 15 straight years just to get back to today’s 78% debt ratio.

       Tax: Balancing the budget will require a 36% tax increase. Even if possible, it would be self defeating, as sky-high taxes would lead to economic stagnation. Note: tax hikes are a higher percentage than spending cuts due to starting from a lower base.

        Inflate: Inflation is the cruelest tax of all and devastates everyone’s plans, hopes and dreams. Just to cut the debt in half requires 10 years of 7.5% inflation provided the deficit is not increasing during that same time. Realistically, it would require 20%  inflation for ten or more consecutive years just to maintain the status quo.

       Repress: Repression is government action that insidiously transfers wealth from the private to the public sector to facilitate financing massive public debt. It includes: (1) low or negative interest rates; (2) war on cash; (3) currency/capital controls; and (4) bail-ins. We already have repression; it will get much worse as the crisis approaches.   See our post of November 11, 2018, devoted entirely to financial repression.

       Restructure: Debt restructure likely will be part of the government crisis response. It takes many forms including: (1) lengthening maturities; (2) requiring roll-over; (3) imposing haircuts; (4) lowering interest rates; and (5) conversion to other securities.

       Repudiate: Nations that have repudiated are unable to borrow again for decades. Any repudiation would be perpetually tied up in courts and would decimate the savings of ordinary Americans who own government debt, directly or indirectly, in money market accounts, pensions and annuities. A direct repudiation is unlikely.

       Seize: When crisis hits, there will be $25 trillion of IRA, 401(k) and pension assets; government could seize some or all such assets in exchange for government pensions. In recent years, Poland, Hungary, Bulgaria, Ireland and France have, through one artifice or another, seized money from pension assets. Government, like Willie Sutton, will go where the money is and that place is pensions.

         Modern Monetary Theory: MMT has been around for a while but recently has been embraced by the democratic socialist crowd as a justification for unlimited spending. MMT asserts that a sovereign government that issues debt in its own currency, has flexible exchange rates and controls its central bank can spend without limit or constraint. With MMT, the state simply creates unlimited amounts of money.

Combination of Most of the Above

          Just to stabilize (not to fix) the ratio requires $1.25 to $1.50 trillion per year from the above sources for up to 15 years. In the early stages of the crisis, a panicky government will: (1) enact VAT and/or carbon taxes; (2) make modest spending cuts; (3) increase repression; and (4) tweak Social Security and entitlements. It will be too little, too late; at most, it could slow the progression of the crisis for a few years.

          In the advanced stages of the crisis anything is possible including: (1) massive tax increases; (2) hyperinflation; (3) severe financial repression including negative interest and currency/capital controls; (4) debt restructure; and (5) reliance on MMT to create unlimited amounts of money. When the crisis reaches the desperation stage, I would not rule out government seizure of most or all IRA, 401(k) and pension assets.

        Our final post in this series (next week) addresses the ultimate question of whether or not a spending crisis catastrophe can be averted. Don’t miss it.

Spending Crisis – Part II

Official government data are frightening – despite being wildly optimistic.
Spending Crisis – Part II
Analyzing the Data
By: George Noga – May 5, 2019

       This is the second of four posts on the spending crisis. The entire series is available on our website: www.mllg.us. Parts III and IV will be distributed on May 12 and 19 respectively. We begin with some data. The current public debt to GDP ratio is 78% and is increasing rapidly. GDP has been growing at 2.5% (with no recessions); we assume it continues to grow at 2.5% in the future, but at a net rate of 2.0% after taking into account the inevitable periodic recessions. The debt is now growing at 5.25%; we assume it grows at 6% until 2025, 8% to 2028 and 10% thereafter – again net of recessions. This assumption is consistent with projected deficits and demographics. These are conservative assumptions and actual results are likely to be worse.

          Based on the assumptions supra, the US will exceed a 90% ratio in 2022 and a 100% ratio in 2025. After 2025 it gets really ugly, with the ratio approaching 150% by 2030. Social Security is now devouring its reserves, Medicare exceeds its funding in a few years and interest on the debt skyrockets. Deficits will average $1.5 trillion over the coming decade. The deficit easily will exceed $2 trillion during the next recession and it would not be shocking for it to be as high as $2.5 trillion, or even $3.0 trillion.

          The really bad news is that the above data (mostly from government sources) are wildly optimistic. For example, CBO projected in 2018 that the deficit would not go above $1 trillion until 2022, but now is expected to exceed that in FY 2019-2020. CBO is touted as being non-political, but it really isn’t; it is required to follow the rules established by Congress. Hence, CBO is severely constrained and its data are neither objective nor accurate. MLLG’s data have proven to be far more accurate.

Caution: Don’t get hung up on the source of the numbers or the specific timing. There is no significant difference whether you use CBO, MLLG or other data; they all lead to the same ultimate outcome, only the timing differs slightly

Significance of a 90% Public Debt to GDP Ratio

          The 90% ratio is not arbitrarily plucked from the ether. Governments have been borrowing money for 600 years and there is no example of recovery from a 90% ratio without social and economic upheaval, usually accompanied by a lost generation until excess debt is purged. The 90% ratio is valid because beyond 90% the mathematics of interest and compounding results in an economic death spiral. Note: The World Bank asserts the tipping point is reached at 77%, which the US already has exceeded.

          The crisis doesn’t begin on cue when the debt ratio hits 90%; that just represents the point-of-no-return. The crisis may not begin until years later when the ratio reaches 125%, or even higher. The 90% ratio is analogous to Titanic hitting the iceberg. The ship remained afloat for quite some time after the iceberg encounter and no crisis was immediately evident to passengers. Nonetheless, the moment Titanic hit the iceberg its fate was irreversible as is a nation’s fate once its debt exceeds 90% of its GDP.

The Mathematics of a 100% Public Debt to GDP Ratio

          When GDP and the debt are equal, i.e. the ratio is 100%, it is much easier to grasp the mathematics of the death spiral. At a 100% ratio, the economy (GDP) must grow as fast as the debt to prevent a meltdown. Herein we assume that GDP grows at a sustained 2% rate net of recessions and in 2025 debt grows at 8%. The differential between the growth of the economy and the debt is then 6% per year; debt grows $2.0 trillion while GDP grows $400 billion. The annual addition to the debt now is up to $2.0 trillion and increasing; soon thereafter, the debt reaches critical mass.

           Clearly, our debt is growing at a much faster rate than our means to discharge it. This is readily apparent to creditors who are likely to demand much higher interest rates. If interest on the debt simply reverted to its historic level of a composite 6%, it would amount to $1.5 trillion a year in 2025, equal to about 25% of the budget. Long before America reaches that point, the spending crisis will be in full bloom.

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Next on May 12th – Part III: Possible solutions to the spending crisis.

Spending Crisis – Part I

At root, the spending crisis is moral rather than economic.
Spending Crisis – Part I
Introduction and Background

By: George Noga – April 28, 2019

           This is the first post in our series about the spending crisis. It is a spending crisis and not a debt or deficit crisis because it is the spending that drives both the debt and deficits. It is a moral rather than an economic crisis because preventing the crisis requires only summoning the national will to control spending. It is about who we are as a people, what kind of country we bequeath to our children and our national security and survival. I have marshalled all the facts, logic and wordsmithery I possess to explain this crisis in an objective and non-political manner.

Our series is in four parts. Part II, Analyzing the Data, will be distributed May 5, Part III, Possible Solutions, on May 12, and Part IV, Can Catastrophe Be Averted?, on May 19. The full series is now on our website www.mllg.us. The series was reviewed in advance by three experts with diverse viewpoints. I carefully considered all their feedback, incorporated much of it and offered to publish any dissenting opinions.

         In addition to my MBA, CPA background, I have studied economics for 50 years. I devoted much of one summer in Montana to constructing a quantitative model of the US economy, including the deficit, which has proven to be highly accurate. I have been writing about the crisis of spending, debt and deficits for over a decade.

Background Information

         US GDP now is $21.0 trillion; the public debt is $16.3 trillion, while the total debt is $22.2 trillion. This results in a public debt to GDP ratio of 77.6% and a total debt to GDP ratio of 105.7%. The $5.9 trillion difference between the total debt and the public debt consists of intragovernmental debt, which mostly is money owed to Social Security and, to a lesser extent, to FHA and other agencies. For example, when Treasury spent the Social Security surplus, it issued special non-negotiable bonds.

        Throughout this series we use the public debt ratio and not the total debt ratio because intragovernmental debt is notional, with interest accrued and not paid in cash. It is analogous to writing yourself an IOU. Most who cite the higher total debt ratio do so out of ignorance or as a scare tactic. However, there are some credible sources who believe total debt is more relevant than public debt. If they are right, our debt ratio is 105.7% and not 77.6% and America is much worse off than described in this series.

           There are some who minimize the seriousness of the current ratio because it was higher (115%) in the aftermath of WWII (the only time prior to 2009 it was above 50%) and America easily recovered. However, the WWII deficit saved America from totalitarianism and was transitory. Afterward, war expenses ceased, Social Security ran surpluses, Medicare didn’t exist and demographics were favorable. Now, the deficit is structural; Social Security, Medicare and pensions run huge deficits and demographics are bleak. We are in the tenth year of an economic expansion and growth is 3%; yet, the FY 2019-2020 deficit will be $1.1 trillion and increasing each year thereafter.

       It must be noted that many states, counties and cities also are in serious debt trouble and will, at some point, require federal government bailouts. Private debt is hovering at an all-time high. The world debt to GWP (Gross World Product) ratio currently is 84% and spiraling upward. Global debt (public and private) is $230 trillion and is over 300% of GWP. Although these issues are beyond the scope of this spending crisis series, they deserve at least some recognition.

          We close with some examples that seem to defy expectations. Japan’s debt ratio is 250%, but dedicated pension assets lower the effective ratio to 110%. The NIKKEI index is down 46% from 1989 and economic growth is 1% amidst chronic deflation. Greece’s ratio hit 180%; it avoided default due to its small size and bailout by the EU. It’s economy contracted, pensions were halved and there was social and political upheaval. Italy, with a 130% ratio, is following in Greece’s tracks. Even though they avoided default, Japan, Greece and Italy did not escape the consequences of massive debt; they all have suffered lost generations and their crises are far from resolved.

Next on May 5th is Part II of our series about the spending crisis.

Protect Your Assets During the Spending Crisis

Protect assets during the spending crisis; fortunes will be made at the bottom.
Protect Your Assets During the Spending Crisis
By: George Noga – October 21, 2018

         This is the second and final post about protection during the coming spending crisis. Last week’s post, available on our website www.mllg.us, focused on timing issues and on protection for your family. This post is about protecting your assets.

         Protecting assets during the crisis is hugely complex as it is difficult to know what peril to protect against and when. We must consider (1) deflation and depression; (2) economic collapse; (3) inflation and hyperinflation; and (4) repudiation, restructure and repression. Moreover, we must consider these perils singly, successively and in combination. We will address each scenario and suggest essential protective actions. Finally, we will reveal how you can profit from the greatest crisis of our time.

Deflation and Depression

           Deflation, followed by depression, is likely but may follow a period of inflation, as government initially floods America with newly printed money. Assets that provide the most protection from deflation and related perils are cash (treasury bills), US dollars, long bonds and quality dividend-paying stocks of companies that make products essential for survival. Avoid real estate, commodities and precious metals.

Economic Collapse

       A prolonged depression (or hyperinflation) could lead to economic collapse. Many banks will go under. For protection, you should have an account at an ultra safe US bank, of which there are only a few; research this on the internet. You also should have a foreign bank account; for simplicity, consider opening an account in a Canadian bank denominated in Canadian dollars. During the crisis, government will prohibit new foreign accounts and will impose exchange controls to prevent money leaving the US.

      Avoid debts and US government securities. Be dependent on government for as little as possible. Protection can be gained from precious metals and foreign currencies. Consider government or corporate bond funds in developed countries with low debt ratios such as New Zealand (22%), Chile (24%), Switzerland (44%), Nordic countries (40%), Germany (64%) and Canada, which has a high, but stable or declining, ratio.

Inflation and Hyperinflation

      Government’s first instinct will be to print money, at least temporarily while it gropes for solutions. Prolonged inflation is distinctly possible. Protect with TIPS (Treasury Inflation Protected Securities), commodities, real estate, precious metals and foreign assets. Avoid stocks, bonds, cash and US dollars. It is better to be a borrower than a lender. To combat hyperinflation, own blue chip foreign equities and assets in resource rich countries such as Australia, Brazil, Canada and New Zealand.

Repudiation, Restructure and Repression

      Although outright and total debt repudiation is unlikely, restructure and repression are very much in play. Government could: (1) reduce interest rates or even impose negative rates; (2) lengthen maturities; (3) accrue (rather than pay) interest; and (4) mandate conversion into some other (less desirable) security. As happened in Poland, government could confiscate a portion of all IRA, 401(k) and pension assets. As in Cyprus, there could be a forced “bail in” whereby government overnight confiscates a percentage of all bank accounts. Cash transactions can be banned. To counter this, avoid government debt directly and indirectly in money market accounts. Keep funds outside the US and denominated in other currencies to the extent possible.

Five Low Risk Actions to Consider Now

       To get started, following are five actions to take now. These are the most obvious, embody relatively low risk, work under the most crisis scenarios and deliver the most bang for the buck. Nor will they be unduly penal in the unlikely event you are wrong.

  1. Open a foreign bank account denominated in foreign currency. Switch most of your cash into uber-strong US banks – of which there are only a precious few.
  2. Hold 5% to 10% of your assets in precious metals. Keep small denomination gold and silver coins at home for use during a crisis.
  3. Invest a portion of your assets in TIPS.
  4. Own bond funds focusing on highly rated bonds in places with low debt ratios.
  5. Retain some portion in a quality stock portfolio, invested mainly in dividend paying stocks of companies producing essential products.

How to Profit from the Spending Crisis

You can profit by leveraging safe assets, shorting government bonds and through options, derivatives or hedge funds geared to benefit from the crisis. However, merely protecting and preserving your assets will result in considerable profit. If you preserve your assets intact while everyone around you loses most of theirs, you are a big winner.

The bottom of the spending crisis will represent the best buying opportunity of a lifetime. Many fortunes will be made acquiring valuable assets at or near the bottom. This is harder than it appears. Everything seems darkest at the bottom and precious few investors will be able to summon the courage to act at that time. Will you?

Next we present ultra short topics including socialism and the Supreme Court.

Protection For Your Assets and Your Family

Protect your assets and your family against the inevitable spending crisis.
Protection For Your Assets and Your Family
By: George Noga – October 14, 2018

         The United States is on track to surpass the critical 90% public Debt to GDP ratio within the next few years; however, the crisis may not begin until years later when the ratio is much higher. The timing is highly uncertain and depends on economic cycles, interest rates and events, many of which are unknown and/or unknowable.

      The crisis will begin abruptly at the Minsky Moment, after which nothing is the same. The Minsky Moment could be an event of seemingly little consequence like a routine Reuters or Bloomberg story that goes viral and, by the end of the day, the government no longer can borrow on acceptable terms and the crisis is upon us.

     Timing is crucial. Repositioning your assets too soon may mean many years of missing out on higher returns. Waiting too long has serious and obvious consequences. The best approach is to reposition assets gradually, beginning now and culminating as the debt ratio is around say 125%. Your actions can be phased such that early changes won’t be unduly penal if the timing proves wrong. There is one timing issue about which we can be fairly confident. After the Minsky Moment, the Fed will create money to keep the government running, but it soon will become apparent that this is a short term fix to buy time. Printing money can work for only about 6-18 months.

       I am confident about the final outcome but the timing is highly uncertain. For example, if the Fed keeps interest rates ultra low, the US may be able to survive a much higher debt ratio and postpone a full blown crisis for many more years.

The Spending Crisis Goes Thermonuclear

      After the Fed money printing is no longer effective and it becomes obvious no magic solutions exist, the crisis will be in full bloom. Treasury securities owned by banks, insurance companies, mutual funds and pensions will plummet in value like Venezuelan bonds, triggering a financial meltdown of epic proportion. Simultaneously, government must slash spending, including on Social Security, Medicare and pensions.

       There is but one certainty, i.e. all the excess debt must be purged. The only ways to accomplish this are through some combination of: (1) tax increases and spending cuts; (2) hyperinflation; (3) debt restructure and repudiation; and (4) financial repression. No matter how we purge the debt, it will require a generation (15-25 years) to accomplish and when the US crisis hits, it will plunge the entire planet into a period of darkness. Note: MLLG will publish a post in the next several weeks about financial repression.

Protecting Your Family

         Before the crisis begins, it is prudent to plan for civil unrest, breakdowns of law and order, interruptions in public services and financial/monetary chaos. I have faith in the American people that lawlessness will be limited, but given the volatile situation in our country, anything could happen. During the crisis we also will be highly vulnerable to foreign threats due to defense cutbacks. Even if you consider societal collapse or foreign aggression to be remote, it is judicious to take steps to protect your family.

        Caution dictates you do at least the following: (1) maintain a supply of gold and silver coins in small denominations; (2) have firearms and ammo; (3) stockpile water, available in 55 gallon drums; (4) keep a supply of non-perishable foodstuffs; and (5) have a supply of propane or a generator as well as batteries, flashlights and candles.

Part II Next Sunday

       The second and final part of this posting focuses on protecting your assets from the various perils that could happen during the worst of the spending crisis. And yes, it is possible to profit from the crisis and that will be addressed as well in Part II.

Balanced Budget Amendment and Spending Cap

The debt crisis is misnamed. At root, it is not an economic crisis, it is a moral crisis and it is not a debt crisis, it is a spending crisis.
MLLG’s Continuing Series About the Spending Crisis
Balanced Budget Amendment and Spending Cap
By: George Noga – September 23, 2018

        This is the latest in MLLG’s ongoing series about the US spending crisis. I will publish regular, periodic (non-consecutive) posts as the runaway debt train hurtles toward the cliff. I have been inundated with requests to write about what actions can be taken to protect you and your family against (or to profit from) the greatest and most predictable crisis of our time. I listened and in October I will publish such a post.

        Americans overwhelmingly (80%) favor a balanced budget amendment (“BBA”) in the belief it will force fiscal discipline on the government. However, a BBA is doomed to fail and the following list identifies twenty one of its numerous flaws.

  1. Writing a BBA is tough; how do we define budget; what does balanced mean?
  2. How do we deal with economic cycles; do we balance annually or over a cycle?
  3. What about exceptions/waivers for wars or disasters; how are they defined?
  4. Lawsuits will challenge the BBA and judges will wield enormous influence.
  5. Do we distinguish annual expenses from capital; how?
  6. How do we deal with off budget spending such as Fannie, Freddie and USPS?
  7. Is interest on the debt exempt; what happens if interest rates skyrocket?
  8. How about special taxing districts of which there are 50,000 nationwide?
  9. Are entitlements like Social Security, Medicare and pensions included?
  10. Are there restraints on user fees? If not, watch out for  outrageous new fees.
  11. Loan guarantees can be used to fund programs off budget. Isn’t this spending?
  12. Regulations can be used instead of taxes for de facto government spending.
  13. California, Illinois and New Jersey have BBAs; what does that tell you?
  14. Greece, Italy and France have anti-deficit laws but are in or near bankruptcy.
  15. A BBA would be the only part of the Constitution subject to waiver/exception.
  16. The tax code can be larded with tax expenditures, incentives and earmarks.
  17. Don’t forget mandates; the Obamacare mandate survived judicial scrutiny.
  18. A budget can be balanced via tax increases instead of spending cuts.
  19. You can’t take the politics out of politics. Watch for unintended consequences.
  20. There are myriad paths around, through, over and under a BBA to eviscerate it.
  21. A BBA would beguile us into falsely believing the crisis is permanently solved.

The debt crisis is misunderstood. At its heart, it is a moral crisis, not an economic crisis. The debt crisis also is misnamed. It is a spending crisis not a deficit or debt crisis and in the future MLLG always will refer to it as the spending crisis. It can’t be solved by artifices like a BBA. It can’t be solved until the American people make some incredibly difficult and painful choices, which they are not yet prepared to make. Moreover, the USA has, in all likelihood, already passed the point of no return.

If a BBA can’t work, can anything else work? Since we really are in a spendingcrisis, a hard constitutional spending cap is a better alternative. Switzerland (Article 126) and Hong Kong (Article 107) have constitutional spending caps that work as did Colorado (TABOR) for many years until voters opted for a “time out” in 2005. A hard spending cap takes tax increases off the table and is much better than a BBA; however, spending caps are subject to most of the same 21 problems noted supra for BBAs.

The ineluctable and bitter truth is nothing will work because we have dug the hole too deep and are blissfully continuing to dig it deeper. Also, there isn’t enough time. Simply to freeze the debt ratio at its present level requires permanent spending cuts of $1.25 trillion a year, equal to over 25% of federal government spending, most of which must come from entitlements. This is impossible politically and absolutely nothing will happen until America is deeply enmeshed in the worst crisis of our time.

Our next post on September 30th declares victory in America’s war on poverty.

When Debt Becomes Equal to GDP

By: George Noga – June 10, 2013

     Having blogged extensively about the crisis of spending, debt and deficits, I am constantly alert for new perspectives to present the crisis in terms easier to understand. I have discovered one compelling new way to do this and it is presented herein.

       First however, the media have widely reported the  decline in the projected federal deficit which normally would be welcome news. Please note I referred to the projected deficit; the actual deficit continues its inexorable march to oblivion. The decline is due to two factors: (1) higher tax collections in late 2012 in advance of the Obama tax increases; and (2) payments from Fannie Mae. Both are one-time phenomena. So you may wonder, won’t the tax increases permanently shrink the deficit? If you believe thusly, you have forgotten Hauser’s Law which teaches tax rates may rise or fall, but the overall percent of revenue to GDP remains unchanged.

The Special Mathematics of a 100% Debt/GDP Ratio

    Now for the fresh perspective. As the Debt/GDP ratio approaches 100%, some simple but gripping mathematics come into play. First, a few numbers. GDP now is $16 trillion and the public debt is $12 trillion (75% ratio). At the end of Obama’s term GDP will be $17 trillion, assuming a perhaps optimistic 2.0% compound growth rate. The public debt also will be right at $17 trillion based on continued annual structural deficits of just under $1 trillion combined with the frightening demographics and high annual compound growth of Medicare, Medicaid, Social Security and ObamaCare. Please note I use public debt and not total debt; this is because we must pay interest only on the public portion – a key distinction to bear in mind as you read on.

    When the interest-bearing public debt equals GDP, the math gets interesting. Historically, the average maturity of US government debt is 5 years, while the average interest rate is 6%. When public debt equals GDP in 2016-2017, we can make the following observations.

“When debt and GDP are the same, the economy must grow at a rate  equal to the composite rate on the debt to prevent a death spiral.”

    First, the economy must grow at the same rate as the overall interest rate on government debt to keep from exploding interest costs and the deficit. If interest rates revert to the historic average of 6% while GDP grows at 2%, this will, ceteris paribus, result in a 4% larger deficit. At $17 trillion, the annual debt service (interest) will be over $1 trillion with 4%, or $680 billion, resulting from the gap between GDP growth and interest rates. Note: Interest now consumes less than 1% of GDP because of historically low interest rates – which will not last.

    Second, if (miracle of miracles) the interest rate becomes equal to GDP growth, the entire benefits of the expansion of the US economy are offset by and consumed by higher debt service. To put it straight: the US economy never can grow net of interest. One can only imagine the impact of this on unemployment and every other measure of economic well being.

“If both GDP growth and interest rates were at their historic averages, there would be a differential of -2.7% , adding $400 billion a year to the deficit.”

    Third, again using historic data, if the US economy grew at its average post WWII rate of 3.3%  (phat chance) and also experienced its average interest rate of 6%, that would result in a  differential of -2.7%, i.e. debt service would explode by nearly $400 billion more each year compounded. Even if economic growth was high at say 3+%, interest rates would be higher given the concomitant strong economy. Thus, even under such sanguine conditions, debt service would grow much faster than the economy resulting in a debt death spiral.

    I hope the above perspective helps readers better understand why countries whose Debt/GDP ratios blow past 90% of their economies rarely, if ever, recover. These United States of America are headed toward a 100% Debt/GDP ratio by the end of the current presidential term. The only alternatives are: (1) massive spending cuts on the order of 30% which will wreck the social contract; (2) Draconian tax increases which will tank the economy further; (3) runaway inflation; (4) repudiation of the debt; and (5) a lost generation much like Greece is experiencing today. In fact, we are likely to experience several of the aforementioned perils. Avoiding widespread civil unrest and maintaining the rule of law will be no small feat.