Category: Debt and Deficits

        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.

           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.

       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.

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.