The Debt Ceiling Charade

The circus surrounding the debt ceiling makes interesting theater but all the babble is irrelevant. How the debt ceiling is eventually resolved only changes the timing and extent of the economic collapse. In that sense, it has no bearing on the ultimate fate of the nation.

But what a spectacle! Politicians fight for political points while blaming the opposition for unreasonableness, cruelty and wanting the world to end. Journalists keep score as to which side is winning as if they were covering a major sporting event. Economists propose solutions to problems they still don’t understand.

The irreverent H. L. Mencken must be chuckling in his grave over this theatre. Politicians are making P.T. Barnum proud with a performance only equaled by Nero and his fiddle.

The debt ceiling will almost certainly be raised although Gallup suggests only 22% of the public supports such action. This action might prevent some short-term discomfort but only at the expense of longer-term tragedy. Both time frames are explored below.

A  Short-Term Perspective

The Immediate Problem

August 2 is the date that Treasury Secretary Geithner estimates the government runs out of money. That apparently is when the Federal Government exhausts its ability to “steal” from governmental retirement and other sundry accounts. July 22 has been mentioned as the “drop dead” decision point in order to prepare for a government spending scale-back.

August Federal government revenues are anticipated to be $172.4 billion; spending, $306.7 billion. This shortfall of $134 billion is no surprise. The monthly shortfall annualized represents a yearly deficit of $1.6 trillion, in line with the deficits of the last two years.

If The Debt Ceiling Is Not Raised

If the debt ceiling is not raised the government will have to cover the shortfall in two ways:

  1. Raise Revenues
  2. Cut Spending

Additional revenues cannot be obtained for the month of August. Nor is it likely revenues could be raised for subsequent near-term months. Thus a decision to not raise the debt ceiling leaves government only the option of cutting spending.

Which payments will be honored if spending must equal revenues? This chart  from Zerohedge details August government spending and offers one possibility:

 

Contrary to much of the wailing, government need not default on its debt obligations unless it chooses to do so. They can easily be met within the expected revenue stream. The claim that we will default on debt payments is a political red herring.

Deck Chairs on Titanic

The items below the dotted line could not be paid in the scenario shown above. Other scenarios might differ in terms of priorities, but the fact is that there is $134 billion shortfall in August and similar shortfalls in subsequent months. All one can do is move items around, an exercise akin to furniture rearrangement on the Titanic.

The quandary shown above is what will likely lead to an increased debt ceiling. That does not solve the country’s problem, yet it solves the politicians’ problem. It appears to make the problem go away, but only cutting spending will solve the real problem. That hard decision recognizes that resources are limited. It kills the image of government as Santa Claus, something politicians are unwilling to do.

If The Debt Ceiling is Raised

Raising the debt ceiling may provide a third option. However, the key word is “may.” Just because it becomes permissible under US law to borrow more does not mean that markets will cooperate.

There are disturbing signs the US is close to being unable to borrow in credit markets. Our profligacy has been criticized by major buyers of Treasuries like China and Russia. Both maintain they are cutting back their holdings. Allies like Japan and Britain are defending against their own financial apocalypses leaving little money available for anything else.

The profligacy of the US government cannot continue. It cannot continue to spend 42 cents more than every $1.00 it collects. We are potentially  close to the point When Lenders Stop Lending, perhaps one event away from a financial catastrophe that will reduce us to Greece.

Markets may have already made a judgment. QE2 ended June 30. For the prior six months the Fed purchased about 75% of US deficit financing.  Absent the Fed’s involvement, would these bonds have been purchased in traditional credit markets?  If so, what interest rates would have to be offered?

A debt ceiling increase does not guarantee a short-term solution to US deficit financing. If others decide they will no longer continue to support our Blanche du Bois lifestyle, a rise in the debt ceiling is meaningless.

Two factors are likely to prejudice the rest of the world against additional Treasury purchases:

The Political Charade

Congress’ behavior has not been confidence inspiring. Their behavior is more like that of the Keystone Kops rather than responsible borrowers. Even their “aggressive” proposal, expecting to cut spending by $s2 – 4 trillion, is weak.

It is backloaded over a ten-year period and could be changed by any future Congress. It would not even cover the costs of interest rates returning to normal levels. Lawrence B. Lindsey, former economic advisor to President Bush, estimates a return to “normal” interest rates of the past two decades would result in a ten-year cost to government of $4.9 trillion. He used a gradual “ramp-up”in  interest rates to estimate costs:

… annual interest expenses would be roughly $420 billion higher in 2014 and $700 billion higher in 2020.

Markets may not cooperate with Mr. Lindsay’s scenario. It is not difficult to imagine the US in an accelerating debt death spiral where debt must be added just to service existing debt. In an upset condition, fear and panic would cause interest rates to spike suddenly.  Greek debt, for example, now yields 25 – 30%, ten times what we currently pay. A mere 5% overall rise from current levels would increase annual government interest cost by $700 billion. That widens future deficits by a like amount.

Rollover Risk

Adding to the risk of financing the increasing and continuing deficits is rollover risk. Since the days of Robert Rubin’s term as Treasury Secretary the government has used primarily short-term funding. While this strategy minimizes the interest expense, it requires frequent refinancing of debt that matures magnifying the risk of being unable to meet obligations.

From Zerohedge is this table of Treasury securities that mature in August:

The US government must fund both its deficits plus the maturing debt. In August that amounts to  $600 billion. Can this be done month after month? Not indefinitely! Annualized, the US government must sell new and rollover debt of about $7 trillion this year. Next year the amount will be larger.

New QE

QE3 is almost certainly coming. It is not because it will help the economy. Additional QE is coming because the US government is unable to finance additional deficits at reasonable interest rates. Is that a condition of bankruptcy? Technically no, but it is usually the final event before sovereign bankruptcy.

The US condition is very close to the condition of Greece. They are unable to raise funds in credit markets so request that the European Central Bank “print” money for them. The US government has the Federal Reserve purchase debt when markets refuse to buy. That is money printing and virtually identical to what Greece is asking for.

Late – breaking: As I finish this article Ben Bernanke has admitted that QE3 is likely coming in testimony before the House. Markets have responded dramatically, especially gold.

A Longer Term Perspective

Assuming the short-term obligations can be navigated with additional debt, the longer-term outlook becomes even gloomier. Buying time, even if possible via a debt ceiling increase, does nothing to solve the real problem. It only adds to it.

In a spiraling debt crisis, time is the enemy. The problem worsens as time passes. This is especially so with regard to the spiraling costs associated with US unfunded liabilities. These represent the hole in the boat that cannot be plugged.

The total obligations of the US government include the funded debt (about $14.5 trillion) plus the unfunded liabilities associated with Social Security, Medicare and Medicaid. The trustees of these programs estimate the present value of these obligations to be over $100 trillion dollars. These estimates have traditionally trailed reality. Recent deterioration in the funds flowing into these programs and the increase in healthcare costs as a result of ObamaCare is likely to require significant upward revisions in the estimates.

The magnitude of numbers in the billions or trillions is incomprehensible to most. To reduce these numbers to measures that can be understood, the following assumptions are used:

  • The population of the US is 330 million people.
  • The number of households in the US is 150 million.
  • The funded debt of the US government is $14.5 trillion.
  • The total liabilities (funded and unfunded promises) of the US government are $120 trillion.

By converting government obligations to individual and household portions, the numbers become understandable (and unconscionable):

  • Funded Debt: Each individual in the US has been put into debt by government borrowing to the amount of $44,000. Each household, on the same basis, owes $97,000. A family of four, $176,000.
  • Total Liabilities: Each individual’s share of total government liabilities is $364,000. Each household owes  $800,000. A family of four, $1,456,000.

These numbers represent pro rata shares of government debt. Any personal debt like mortgages, car loans, credit cards, etc. would be on top of these numbers.

The government has promised to pay about $120 trillion dollars. The total net worth of the country is estimated at half of this amount. Thus, the government could confiscate every car, home, savings account etc. and still not be solvent in terms of what it has borrowed or promised. That would leave all people and corporations with nothing, including the likelihood of not receiving future healthcare or Social Security as they are now structured.

Summary

Solving the debt ceiling problem in ways floated before the American public is nothing but a political fix. It is not a solution to the underlying insolvency/bankruptcy problem facing the US government. A series of similar political fixes is why we are in this position.

The US government has been insolvent for years. Now bankruptcy is a risk because it is potentially “borrowed out.”

E3 is not a solution. It is currency destruction that leads to eventual hyperinflation which wipes out fixed incomes and most savings. It is nothing more than a temporary political escape from reality. It ensures the ultimate political and economic collapse of the country.

Government has no one to blame but itself for this problem. No one but government is capable of solving it. Unfortunately, government knows how to create problems but not solve them.

The only solution is to pare back government to where it is no longer destructive to the productive sector. It must be defanged and caged.

Immediate cuts of 50% in spending would be my starting point. Additional cuts would follow.

This article originally appeared in American Thinker

15 Comments

  1. Monty,

    As catastrophic as your projections are, they are probably optimistic. Add a couple points of interest, and the world melts down.

    So how does one bet? Is there a longshot? I think so, although it’s very long indeed. Assume that we had an honest President who understood basic math and could explain our debt crisis to the American people without lying (ridiculous, I know). That might create space for real spending cuts and tax and entitlement reform. How to get there? Today, I see no one with the courage or the political skill to pull it off. But hope springs eternal–Perry? Christie?

    In the meantime, get ready for a crash that will make 1929 look like Disneyworld.

    1. Old Dad,

      I agree with your comments, although believe we are too far gone to resurrect from the debt crisis. At some point a tipping point is passed and no matter who does what, even if it is the correct thing, the problem cannot be solved. Unfortunately, we probably need to rebuild from the ashes that you foresee.

      1. I read I think in When Money Dies by Adam Ferguson that Weimar Republic had balanced its budget before the hyperinflation had set in–a single balanced budget did not make up for ten years of bad monetary policy. So even if the US fixes its deficit problems, it seems too late to stop hyperinflation. The confidence in the dollar has already been lost by the international community that has been propping up the world’s reserve currency. Today, the Chinese buy another $2.1 billion of Canadian oil: http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/china-buys-another-piece-of-oil-patch/article2103126/

        Ultimately, if you want to do well in investing you have to own what the people who have money want. They have told explicitly that they don’t want US dollars any more–though they continue to prop it up biding their time so that they may exit this trade with the least damage to themselves; what they really want are hard assets, oil, gold, silver, rare earths, food and all other commodities. That’s why I am long physical gold and silver (Sprott Physical Gold and Silver Trusts) and Canadian oil & gas and gold mining. But to tell the truth, I am not sure if that is going to work either. But these are things that the world’s creditors want, so I think for now I’ll be ok.

  2. Best current situation summary essay I’ve seen so far. I’m half hoping the Republicrats collapse again, raise the debt ceiling, give us (me) another few months to prepare for inevitable Ponzi collapse. Half-hoping they CRASH THIS PONZI RIGHT NOW!

  3. During the last Presidential election, CSpan2 Book TV aired a program where the author discussed the results of his or her research, which suggested that something like 5-10% of Democrats , and 5-10% of Republicans, essentially debated and defined the ideological constructs of each party. The point was that the vast, vast, vast majority of the citizens of this country have their lives dictated by the most active and vocal members of society, who also happen to be more privileged .

    I strongly suspect that the same thing is occurring with the debt ceiling debate. The debate is not really about the debt ceiling per se, but rather a very deep, long-standing debate about the role and size of government. It’s never been resolved, and never will be resolved in our representative democracy. However, in the mean time, the regular folks in our society run the risk of being irreparably damaged. The elites (the upper and upper middle socio-economic classes) on each side of the fence have theirs, their corporate contributions, decent jobs and income, and will fare just fine economically. It’s the ordinary citizens (lower middle socio-economic class) who will most likely get screwed, no matter which side ultimately prevails in the short term.

  4. Monty, I was only disappointed that I didn’t read your commentary in the Wall Street Journal’s editorial page. It deserves the widest audience. Let me add that actions have consequences and while reality can be ignored, it cannot be denied. Reality is hitting this world like a whip hitting a horse. The worst lies ahead while the Obamanation and his congressional lackeys lie incessantly to their media mouthpieces who ooze unctuous drivel to try and soothe the restive masses.

    There is an old Chinese curse, “may you live in interesting times.” Our interesting times will get more interesting regardless of what happens in Washington between now and a month from now. Let me provide a bit of confirmation.

    I spoke to an old friend this week with excellent connections and who has appeared on your TV screen from time-to-time and is a limited government advocate within the private sector inside the DC beltway. Washington is transfixed by this issue and deadline. Trivialities like meeting at Camp David or remaining in DC keeps the chattering class babbling. Motion without result continues. The political “fiddling” continues while the fiscal fires rage in our 21st century “Rome.”

    Meanwhile Europe implodes like a pricked balloon and I remain vigilant in trying to spot any additional “black swans” trying to land within my field of vision.

  5. Monty, I believe that the best we can do at this point in time is a “political” fix. The majority of the 78 percent who don’t want the debt ceiling raised have no clue what would ensue and as soon as the immediate pain hits, that number will drop precipitously. I’ve found it interesting that conservative commentators I like are split on the issue. There are those that believe that republicans should hold the line, refuse to raise the debt limit unless matching cuts are made, then there are those that think that we should give Obama the rope to hang himself, my view also.

    I believe, as your article states, that we are doomed anyway. The question is, who will be left standing to resurrect our nation? I prefer it be conservatives. Lets face it, we’re not going to get meaningful cuts from Obama and the senate, and even those “draconian” cuts proposed by conservatives such as Ryan aren’t enough to rescue the nation. I think that the extra year or so that raising the debt ceiling will give us will be more time for more people to prepare. I’ve told my friends that they need to get prepared, that way there will be one less person I’ll have to shoot when the starving dazed masses start prowling around to steal what they can just to survive. (I wouldn’t shoot them except as a last resort. Remember Sun Tsu, when you are weak, act strong, when you are strong, act weak).

    Too many Americans think we can survive any disaster, but we can’t any longer. We’re no longer an agrarian society, there’s no one out there that can bail us out. When the shelves are emptied out at Walmart, they’ll not be refilled. The best we can hope for is that a conservative government will take power. They will have to take care of the military just to use them to maintain order and defend the nation. The inner cities will burn and what food stores there are will be used to pacify them. Mexicans will scurry back across the border, liberals will cry, spoiled kids will learn there’s more to life than whether their ipod works or not, the liberal media will be done in because there’s no one to buy their crap and some people might think of God and realize that just maybe they shouldn’t have ignored or ridiculed him all their lives.

    Keep up the good work of sounding the alarm!!

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