Spending Crisis – Part IV

        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.