The Hidden Debt Risk That Could End the Empire

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Recently by Michael S. Rozeff: The Free Market Currency Manifesto

     

The debt limit will be raised. Neither side will get its way.

The U.S. government always raises the debt limit. How else would the debt and the government have gotten so large?

Not raising the debt limit means that the government takes the road to financial suicide. That step would shock its creditors. The government would increase its own debt costs dramatically. Washington is not that stupid.

After this episode, budget-cutters will seek other remedies to narrow the gap between government spending and government revenues. They should have done that last December. They should have started cutting at that time, but they were naive and afraid of losing votes.

The debt limit threat is not a viable threat for either side. Obama has to sign whatever comes to his desk. The Republicans cannot make draconian cuts without some sort of American consensus. They won't do it. Obama wants his way in forging such a consensus. He can't get it. He's harping on a non-solution, which is tax increases on higher income Americans.

The debate simply showed stalemate and lack of consensus for anything but moderate change. The debt limit will be raised. The budget problem will not be resolved.

The budget problem is very big and getting bigger. For the nine months of fiscal year 2011 to date (October 2010 to June 2011), the U.S. has paid out $386 billion in interest on the national debt. The government has had revenues of $1,733 billions. Its spending has been $2,705 billions. It borrowed $972 billion. That's $2,705-$1,733.

I define a financial or bond default as an interruption in paying the stipulated terms on the government's borrowings. Most of its borrowings are in dollar terms, so that if it pays them off in depreciated dollars, that is not a default.

The interest on the national debt is running about 22.3 percent of the revenues. The government is in no immediate danger of a financial default from not paying its interest. If the debt limit is supposed to get us excited about financial default due to non-payment of interest, it shouldn't. The government above all is going to pay its bond obligations. That has priority one.

There's another factor that looms large. In order to avoid default, the government has to pay off the principal amount of the debt, which is the face value of any debt that is maturing. I estimate that roughly 29 percent of the debt matures in a year, and the debt is about $14,300 billion. Therefore, each year the government has to pay off about $4,150 billion on principal in order to avoid default. It accomplishes this by rolling the debt over. That is, it issues new debt and uses the proceeds to pay off the maturing debt.

The government has a rollover risk. It might fail to get enough new funds to pay off the maturing bonds.

The government's revenues are now $1,733 billion a year, so it cannot refund the $4,150 billion of maturing debt from current revenues. It has no choice but to roll the debt over. If it fails to roll the debt over, then its back is really against the wall. If such a failure occurred, we can mention such hypotheticals as cutting spending or selling assets, but there is no way that realistic cuts could ever add up to enough to pay off bondholders if they refused to fund the U.S. government. The entire amount of government spending, including the borrowing is $2,705 billions. If every bit of it were eliminated, the government still wouldn't be able to avoid bankruptcy if bond buyers went on a massive strike.

If the rollover risk ever came to pass, the government would have to seize assets, such as assets in pension funds. Any such scenario is a nightmare. It is government failure on clear display. It is blood on the streets. Consensus breaks down. Large battles occur for which the current debate is a mere warmup exercise.

The government has borrowed "short", that is, its debt maturity is rather short, and yet it has many expenditures that are long-term in nature. Many persons are relying on a continuing stream of government checks, and if they do not appear, they will be hurting very badly.

This scenario — inability to roll over a massive amount of debt — is not imminent, but it's a possibility because the absolute amount of the debt has gotten so large. Even a partial realization of rollover risk via a withdrawal of some bond buyers from the market means that interest costs will rise steeply. That will place enormous pressure on the government too.

These kinds of scenarios, based on a realization of rollover risk or even a strong anticipation of it, mean that U.S. debt is nowhere near as secure as it's cracked up to be.

The U.S. is having something of a free ride in the bond markets. Any shock to the confidence in U.S. credit will be very serious. If there is one shock, people will realize that there can be more such shocks. Any failure to pay interest or principal on a timely basis is a negative shock. This can only make the financial problem more salient, lead to greater reluctance to roll over debt, and make more likely the scenario of government's inability to pay its financial obligations. A bond default makes further bond defaults more likely and more serious.

A bond default is extremely unlikely because it means the unwinding of big government and the Empire. Presumably legislators and Obama know this, although we cannot be sure. They do not want to commit suicide, but they might do so inadvertently if they are stupid enough.

Any kind of default sends a signal that bond default becomes more likely. That can start a run on the government in which its creditors stop funding it. Poof! That's the end of the U.S. government. That's the end of the checks. Game over. A new game begins.

A run is not imminent. There's plenty of inertia in human affairs. The largest creditors (China, Japan, the United Kingdom) are not pulling out the rug suddenly. However, China is slowly abandoning U.S. Treasury securities. In a variety of countries, there is an unmistakable move away from the dollar toward hard assets. The rollover risk looks to be slowly coming to pass. The creditors are slowly withdrawing funding of the U.S. deficits and debt. A gradual withdrawal can still lead to sudden problems and sudden withdrawals in discrete jumps. These processes are not necessarily linear.

If the government has trouble rolling over its debt, it may cram it down into pension funds. Or the FED may again come to its rescue. Or it may make the FED come to its rescue. Does any of this matter? All such desperation measures spell doom for the American economy.

If our creditors say "No more", we've had it. At that point, it's best to wipe the slate clean and start over fresh. It's best to cut spending. Better late than never.

America's welfare-warfare state is finished right now. It's only a matter of time. It cannot be funded indefinitely by such huge borrowing. The borrowers won't roll it over forever. They have too many other better alternatives.

Before the severe cutbacks occur, we will struggle along with rising interest costs, new and higher taxes, forced financing, asset seizures, and some retrenchments. Political economic life is coming into a rough and messy spell that will go on for years. It will seem like forever. It will be depressing. The arguments will get louder. Inane proposals will fill the air.

It's possible that a large war will be engineered by the U.S. government in order to justify cutbacks.

The American air will not be suddenly cleaned. There will be no fresh start. There will be no reset. Instead, the powers that be will continue to improvise and administer messy arrangements that add to our problems and create an atmosphere of oppression and hopelessness, a dreary political economic world. They didn't reset the bad debts of the banks. They don't want to reset money to gold. They can't reset Greece.

Major powers mention a new world currency ("bancor") backed by other currencies and commodities (a basket). This is an attempt to stop funding America. The U.S. won't support it unless it can neuter the whole arrangement behind the scenes. The bancor won't solve the political economic problems of the BRIC countries or those of the Middle East or Africa.

Rollover risk will be realized. It's the financial side of a larger struggle of the major powers in the rest of the world seeking their independence from American domination. Dollar hegemony is an aspect of American hegemony. Both are being resisted.

In this worldwide battle to divorce from the American dollar and stop funding the U.S. deficits, the BRIC countries and others will continue to increase their armaments and enlarge their domestic economies. They will not rely so heavily on the American market. These trends will take decades.

World government under American control is being resisted. It won't come to pass. It's too costly to achieve. Encirclement of Russia and China won't succeed. Russia can ally itself with Germany and France. China can reach out to Africa and South America and Asia. Europe will prove a weak link. Conquest of central Asia and the Middle East will prove impossible.

The trilateral world of America-Great Britain-Japan will not come to pass. America will not rule the world.

Americans have a choice: cut back the welfare-warfare state or continue the quest for world domination. If they do nothing or continue the quest, the rest of the world will stop funding America and will build itself up militarily and economically. America won't succeed, and the process of failing will be painful. America will go backwards. It's more rational to cut back the welfare-warfare state. That too is painful. That too cannot be done easily and without many Americans re-orienting their thinking, plans, and lives. But in that choice, America will go forward.

Neither political party offers the option of ending the welfare-warfare state. Americans don't want that option, not yet. A lot stands in the way of rationally deconstructing the state and empire: a dysfunctional political system, political divisions, ignorance, miseducation, and entrenched interests. Will Americans have to learn the hard way?

Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire: Liberty vs. Domination and the free e-book The U.S. Constitution and Money: Corruption and Decline.

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