You may not have watched my video seminar, "Retirement Armageddon." It's here.
Let me explain why you should.
In fiscal 2010, the Federal debt will increase by an estimated $1.5 trillion, give or take $100 billion.
Have you estimated your share yet? Probably not.
Divide $1.5 trillion by 300 million Americans. The figure is $5,000.
Every American resident, from oldsters to infants, just got hit with an extra $5,000 tab. This is on top of what he already owes. What does he already owe? Something in the range of $300,000: a $90 trillion total debt divided by 300 million.
It will happen again next year. And the next. We are told that the deficit over the next decade will be in the range of $900 billion a year. That is $3,000 per person. This is a low-ball estimate.
We are talking about the on-budget debt, which is in the range of $12.7 trillion this week. What about the off-budget debt of the two trust funds: Social Security and Medicare? The estimated unfunded liability is about $75 trillion this year. Some say it is more. I will be conservative.
This will not be funded. Congress will kick the can, as always.
In a mortgage in which the debtor pays nothing — interest or principal — each missed payment is added to the principal owed. This is sometimes called a backward-walking mortgage. Option ARM mortgages are backward-walking. The trust funds are comparable to mortgages. They are therefore backward walking.
If we assume that the interest rate on these obligations is in the range of 5% over 75 years, and principal repayment is 1.33% (100% divided by 75), then the amortization rate is about 6.3%. Let's be conservative. Call it 6%. If you multiply $75 trillion by .06, you get $4.5 trillion. This is the unfunded liability for fiscal 2010. It is tacked onto the existing $75 trillion.
So, the increased debt per person of the two forms of Federal debt totals $6 trillion ($4.5t + $1.5t). Divided by 300 million Americans, that is $20,000. In one year. This will continue until the debt is paid off.
It will happen again in fiscal 2011. But in fiscal 2011, the "mortgage" will be $79.5 trillion, not this year's $75 trillion.
How many Americans understand this? The infants do not understand. The oldsters don't care. Neither do the people in the middle.
As we all know, most Americans pay relatively few taxes. The tax burden is borne by others. So, your share is way above $20,000 this year. It will be way above $20,000 next year.
Will these debts ever be paid off? No. Will there be a default? Of course. Do the politicians factor this into their plans? Of course not. Do the economists sound a warning? Only Austrian School economists.
Do you believe this scenario? I mean, really, truly believe it? Sit down with a copy of Quicken or your financial software. How much money did you invest last year in assets that will not be wiped out in the inevitable default? That exercise will tell you how much you believe it.
THE GDP/DEBT RATIO
We are now facing a monumental debt crisis. We were warned. From the recession of 2001 until his death in August 2007, Dr. Kurt Richebächer warned in his monthly newsletter about an ominous development in the U.S. economy. The level of increased debt necessary to produce one additional dollar in GDP was rising. He said repeatedly that this would eventually produce a major financial crisis. The increased debt would require increased production to finance it, quarter by quarter, let alone repay it. If economic output per dollar of increased debt is declining, there will come a day when an increased dollar of debt will lead to negative returns.
We are there. We reached that point in 2008. It continued through 2009. GDP fell, yet total debt increased. Here is a chart that describes this falling ratio, GDP to debt, 1965—2000.
The problem is debt financing. If creditors see that their loans will not be able to be funded by the borrowers, quarter by quarter, they will cease lending money at low interest rates. They will demand a higher return in order to compensate them for the increased risk of default. Borrowers will have to pay rising interest rates in order to persuade lenders to continue lending. The cost of capital will rise. The return on investment will fall.
At that point, rolling over the existing debt will become a matter of institutional survival for borrowers. Corporate borrowers use banks as a way to keep the doors open. Governments rely on non-bank lenders, such as insurance companies and retirement funds. But all of them are in the same ship of debt. They cannot afford to have the flow of funds cut off. If this were to happen, they would have to shut their doors and declare bankruptcy.
Small businesses are already facing a crisis. Commercial banks have ceased lending. Banks are actually contracting their loan portfolios.
Borrowers are still able to get lenders to lend at low rates. This is because of the state of the economy. It is no longer suffering from the threat of immediate price inflation. Interest rates have fallen. Lenders have decided that T-bills are safe. They are letting the Treasury borrow at rates well under two-tenths of a percent. This has affected other rates. They are lower. Lenders are not yet ready to consider the long-run implications of the incredibly low return on investment in terms of economic output — negative in 2008 and 2009. The rate of return may have been slightly positive since mid-2009. We will find out next quarter, when the report is published.
THE KEYNESIAN BUCK
The phrase, "More bang for the buck," became popular in Washington during the Vietnam War. It referred to Defense Secretary McNamara's attempt to increase the efficiency of the military forces in Vietnam. He wanted larger kill/budget ratios. He demanded that all assessments be accompanied with objective data. He used this phrase to filter all assessments not based on objective data: "I'm not interested in your poetry." The commanders got the message. They supplied him with impressive information on kill ratios. The dead were always military forces, never civilians, by definition. Then the North Vietnamese won the war. The kill ratio kept rising, but the war was lost. The North Vietnamese turned out to be exceptionally good poets. They won the war in the American media and in undermining the will to resist in South Vietnam's troops.
Keynesians are equally committed to data. They believe that an economic downturn can be reversed by increased debt, especially government debt. They argue that the recession is the result of insufficient aggregate demand. The Federal government must step in and supply this demand. How? By borrowing money. But won't this borrowing reduce the supply of capital to the private sectors? No, say Keynesians. Then where does the money come from? From people who would have converted their money to currency and hidden it under the mattress.
Keynesian theory is based on 1936 models of how people behave. People withdrew currency from banks, 1931—34, before the FDIC. Therefore, they will do it again if the Federal government does not increase spending by increasing its debt. Forget about the FDIC. Forget about the fact that money saved is invested.
You may think I am exaggerating for effect. I wish I were. I have discussed this Keynesian outlook elsewhere.
Keynesians view increased government spending/debt as a way to increase aggregate demand, despite the fact that the money lent to the government comes from private savers, with this exception: when it comes from central banks. These days, about half of the Treasury's debt is bought by foreign central banks, which create domestic fiat money, buy U.S. dollars, and purchase U.S. Treasury debt.
To the extent that foreign central banks do this, and would not otherwise buy the U.S. dollar, the Keynesians have a legitimate point. There is an increase in demand. But this increase keeps prices higher in the U.S. than they would have been. Without this increased demand for Treasury debt, the Federal government could not have spent the borrowed money. Then Americans would have purchased either consumer goods or production goods. When they put money in a bank, the bank lends it. Historically, this has meant lending the deposits to borrowers.
This time, however, there has been a change. Commercial banks have deposited over $1 trillion in their excess reserve accounts at the Federal Reserve. This sterilizes the money. It does not get spent. This is the fault of prior Federal Reserve policies. Commercial bankers are afraid to lend money in this economy.
This is why prices from January to February this year were flat. The CPI did not change. Neither did the Median CPI. In a free market with stable money, prices would generally decline as output increases. Central banks have not allowed this in the modern world. But now, because of excess reserves, it is happening.
INCREASED DEBT INCREASES THE GDP, SAY KEYNESIANS
The basis of Keynesian fiscal policies in an economic slump is a theory that increased government debt will increase aggregate demand, which will in turn lead producers to hire more people and buy more resources in order to meet future rising demand. The increased debt gives the economy a much-needed shot in the arm — or, these days, a shot in the ARMs. The government stabilizes demand, and this increases the confidence of producers.
The commercial bankers are not yet persuaded. They refuse to lend. They see big trouble ahead: commercial real estate loan losses. They want liquid reserves available to keep them from having to call in commercial loans to cover the expected losses in their portfolios.
We are told repeatedly that the recovery is weak. Bernanke keeps telling anyone who will listen that the FED will keep rates — meaning the federal funds rate — at or below 0.25%. The market is doing this, not the FED. The FED need only do nothing to achieve this result. Banks are not lending overnight to other banks, because they have such high excess reserves at the FED that they do not need overnight loans to keep from exceeding their legal reserve requirement.
As the increased output per dollar of increased debt has gone negative, the Keynesians have called for even more debt. They have said that the $787 billion stimulus passed in October 2008 was not enough. But the trend of the GDP to debt has been falling for decades. This was not some overnight problem in late 2008. The ratio went sharply negative. This was a surprise to everyone except Austrian School economists. But this was merely the result of the severity of the recession in relation to the massive Federal stimulus. The numbers got much worse very fast. But this was an extension of a long trend.
The Keynesians have taken credit for the recovery, such as it is. They have argued that things would have been much worse if Congress had not ignored the voters and passed the bailout. But the weakness of the recovery and the size of the Federal deficit indicate that the Keynesian prescription for prosperity is about to produce undeniably negative results.
The size of the predicted annual Federal deficits is so large that the economic recovery must be unprecedented in its rate of increase and sustained for a decade if the decline in the GDP to debt ratio is to return to pre-2008 levels. No one in authority in Washington is predicting either outcome. On the contrary, they are predicting a weak recovery.
Keynesians are facing a crisis in faith. If the GDP/debt ratio continues to hover around 0, the Keynesian prescription will not solve the problem: massive escalating debt without an even greater percentage increase in output. That will mean that the U.S. economy cannot grow its way out of the present crisis. Such a failure will call all school of economic thought into question. The exception is the Austrian School.
We are way beyond the point of return economically. There is no possibility that the economy will grow its way out of this level of debt. There is no way that there will not be a default. The experts keep telling us that the economy can grow its way out, but they do not say how. They talk as if growth were automatic, as if capital accumulation were automatic, as if the Treasury were not absorbing $1.5 trillion in additional capital this year, as if the numbers really did add up. The numbers do add up: to default.
What have you done so far to protect yourself?
What extra will you do to protect yourself?
April 2, 2010
Copyright © 2010 Gary North