The U.S. government
is insolvent. Who says so? Timothy F. Geithner, the U.S. Secretary
of the Treasury.
a letter to Congress on Jan. 6, 2011 asking for the debt limit to
be raised. If it is not raised, he warned, the U.S. will default
on its debt. In
our history has Congress failed to increase the debt limit when
necessary. Failure to raise the limit would precipitate a default
by the United States."
He didn't say
that the government will be inconvenienced. He didn't say that the
government would be forced to muddle through by delaying payments,
raising taxes, and cutting non-obligatory programs and services.
He said the government will default. This means that the
government doesn't have enough cash to pay its obligations to the
many and sundry persons to whom it owes cash unless Congress
authorizes an issue of even more debt.
After the government
issues the new debt, its overall debt will be even higher than before.
Unless its obligations that require cash payments are reduced, or
unless it finds new sources of revenue, or unless the interest rates
that it pays decline, the same situation will surely occur again
and occur even faster because its overall debt will have risen.
It will run short of cash to pay its obligations.
you had a debt of $10,000 that required a payment of $500 in order
to stave off your creditors' seizing your assets. Suppose that you
didn't have the $500. One way out would be to borrow $500 from a
new lender and use that $500 to pay off the old lenders. That buys
you time. However, now you have debts of $10,500. You have to find
ways of lowering this or else you will again be faced with an even
You are approaching
insolvency when you begin to run out of new lenders who are willing
to add to your debt. The willing lenders dry up because they know
that they have to get in line to get their promised payments while
you continually seek out new borrowers, all the while making your
situation worse and worse.
precarious position, the new lenders are likely to demand rising
default risk premiums.
they demand higher interest rates.
your cash payment obligations go up. That hastens your approach
occurs when you cannot find enough cash from any source, even new
lenders, in order to make required payments.
The U.S. is
approaching insolvency, according to its Treasury Secretary. He
didn't put the matter in precisely that way, but he put it in words
that are as close as you can get to it. He said that the U.S. would
default, and its only way out at this moment is to issue more debt.
increases in the debt limit have necessarily accompanied the
increase in the government's overall debt. Those increases have
been especially astonishing in the last 10 years. The ceiling is
now $14.29 trillion. The ceiling was $5.73 trillion in September
of 2001. That's a growth rate of over 10 percent a year.
A few months
Kotlikoff wrote that "The U.S. is bankrupt." Using
the government's numbers properly labeled, he found that the U.S.
fiscal gap, which is the difference between the present value of
projected spending and revenues, is $202 trillion. An IMF study
of the U.S. finances found that it would have to double taxes to
close its fiscal gap. This is an impossibility. It would destroy
the struggling economy.
statement confirms those of other analysts outside of the U.S. government.
Kotlikoff, the government's sixty-year "massive Ponzi scheme"
will end when there are not enough revenues to pay for Social Security,
Medicare, and Medicaid. He sees large benefit cuts, large tax increases,
and high inflation ahead when the government seeks to survive.
How will the
U.S. extricate itself from this situation? That's a matter of speculation
because there are many interacting variables involved. There are
lots of ifs, ands, and buts.
When a state
cannot meet its promised obligations, there is no bankruptcy code
to guide a reorganization, as there is with a company. There is
no court to oversee a restructuring. There is no judge or panel
that decides on the priority of claims. Instead, the government
itself decides how to handle its inability to pay cash to fulfill
In the immediate
future, the U.S. government will not default on its bonds. They
will have priority of payment. The reason the government will do
that is to maintain its capacity to borrow at reasonable rates of
interest so that it can maintain its size and programs. If the government
defaulted on its bonds as a way of solving its financial problem,
it would have immediately to cut back its spending severely. The
government would shrink radically all at once. The government would
take a big bath. Congress doesn't want to do that. It would rather
stretch out the default process and inflict the pain over time and
among more groups than bondholders. Congressmen prefer to maintain
themselves in power while managing a large government. Other branches
and bureaucracies also prefer to keep their pet programs and activities
as usual, Congress will raise the debt limit again. That doesn't
end the financial problem. It adds to it even as it postpones and
enhances possible insolvency.
The new lenders
that the government seeks out to lend it new cash are likely to
demand higher interest rates, except for one major lender, which
is the Federal Reserve System.
are subject to numerous worldwide influences. They include the default
risk premiums demanded by foreign lenders, including Asian central
banks. Those risk premiums are likely to rise.
the Federal Reserve has committed itself to buying $600 billion
of new government debt in the next few months. Its purchases tend
to support bond prices and keep interest rates down, other things
As the Federal
Reserve keeps buying more and more government debt, with no prospect
of reducing its holdings unless and until the government gets its
house in order, bond yields are likely to rise, despite Fed
buying, because yields also reflect inflation premiums. The prospect
of inflation will rise as the Fed monetizes the debt. We would then
see yields rising accompanied by firm prices of commodities and
participation by the Fed, which postpones the inevitable fiscal
decisions of the government, harms all holders of fixed-dollar assets
and all those whose receipts of dollars are fixed and lag behind
the Fed's production of new dollars. In addition and more importantly,
the inflation sets in motion another boom-bust cycle.
monetization by the Fed is quite likely for many reasons. One is
that the Fed can act even when Congress is deadlocked. Another is
the apparent necessity, in the Fed's view, to avoid the failure
of government debt issues. A third is that the Fed rationalizes
what it's doing by economic slack and low headline CPI inflation.
Fourth, the banking system is still insolvent and the Fed wishes
to raise asset prices. Fifth, the Fed doesn't connect its debt monetization
to higher yields. When it starts to make that connection, either
directly or because headline CPI inflation rises, then it may be
more likely to alter its current policy.
If the U.S.
does not decrease the fiscal gap, rising yields will rapidly force
it into taking action because rising yields raise the likelihood
of insolvency and raise the likelihood of its occurring sooner rather
of the Fed's inflation on stocks vary by individual company. They
depend on the net monetary positions of the companies, the nature
and location of its operations, its hedging, and other factors.
There is no simple prognosis for the whole stock market.
are likely to rise as lenders demand higher default risk premiums
and as they demand higher inflation premiums (when the Fed monetizes
debt), with the Fed's ability to keep rates down only a temporary
and/or only a restraining phenomenon, and since these yield increases
hasten the prospect of insolvency, the government can only avoid
default by either slowing down its borrowing (and spending) or by
raising revenues. Doing nothing means it will default.
borrowing slows down, its spending will have to slow down. Many
Americans will find this very unpleasant as benefits, now and prospective,
are cut, and as various other programs are cut. If government raises
taxes, the impact of its gargantuan borrowing will come home to
Americans, again in a most unpleasant way. Their disposable incomes
will fall sharply.
on U.S. bonds is not in the cards because that immobilizes the entire
U.S. government. The government won't do that. It will look after
itself and its own survival first. The American public comes last.
Default upon promises made to Americans is the more likely course
Thus, the government
will slow budget increases, or stop them altogether, or cut its
spending in absolute terms. Like any borrower, its borrowing capacity
is not unlimited. Its borrowing capacity depends on its taxing power
which, in turn, depends on the productivity of those whom it taxes.
Causation runs in both directions. The productivity also depends
on the tax and regulatory structures. It's inconceivable that the
government could double taxes. If it did, most of the economy would
attempt to go underground. Whatever remained above ground would
have vastly reduced incentives to produce.
and programs will be the object of government cutbacks? That is
again a matter of speculation. It depends on which groups have the
firmest control over the government's purse, which groups make the
largest protests, and which groups have the greatest influence on
votes for key Congressmen and campaign contributions. I agree with
Kotlikoff and Gary North that the most likely targets are the largest
ones, and they are the social welfare programs.
are going to experience the brunt of the actions taken to avoid
default. Others are likely to go relatively unscathed. Government
bureaucrats will try to protect themselves. This is going to create
domestic conflict, protests, and dissension. Life is going to be
much harder for Americans in the future, unless increased productivity
from some unknown sources of invention or technology offsets the
impact of government promises that are going to be defaulted upon.
another option, which is to seize the assets of Americans. This
is a form of taxation. Congress can force pension funds to take
its bond issues. This would force down the prices of corporate stocks
and bonds. It would devastate the economy. A large-scale program
of bond cram-downs is almost tantamount to making the Fed absorb
bonds. It puts pressure on the Fed to create more money so as to
keep asset prices up. Such a program would be an act of desperation
by the government that simply beggared the population. It would
certainly not resolve the insolvency.
When, if ever,
will Congress start to act in size, that is, with cutbacks large
enough to avoid defaulting on its bonds? My answer is this: Not
of rising yields is not yet felt in the minds of those in government.
The prospect of a budget out of control due to a huge and rising
bond interest payment obligation hasn't yet hit home among government
officials. They can't see the tidal wave. They don't believe it's
coming. The Fed's purchase program is obscuring their vision. The
slow economy is helping to hold down bond yields for the moment.
The foreign central banks, as a group, are still supporting the
U.S. bond market. People who are afraid of going back into stocks
are still supporting the U.S. debt market.
the two parties are both enamored of big government. Nearly all
politicians are sensitive to public demands for free lunches. That
is one reason why the fiscal gap is so huge in the first place.
America did not exactly fall all over itself in trying to stop a
prescription drug benefit. Consequently, the government is postponing
actions to close the fiscal gap.
One fine day,
there will be a discontinuity. There will be a many-sigma event.
There will be a fiscal earthquake or a market earthquake or some
combination of both. This will not be a pleasant experience for
Americans, but those in government have little reason to fear it.
They can label it a crisis, as if we do not already have a crisis.
They can use such a "crisis" as the excuse for more radical
government action. The government can demand even more power or
simply exercise it, even if the results are to make matters worse
governments, crises are opportunities, a fact well known among analysts
of government. This fact is one reason why governments postpone
taking actions to remedy what appear to the rest of us to be bad
the fact that governments batten on crises and see them as opportunities
is not well known among the general population which still looks
to government to handle crises.
Since the insolvency
of the U.S. is a fact and a fact that implies hard times ahead for
anyone who depends on government, it is prudent to take measures
to make oneself as independent of government as one possibly can.
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 and the
free e-book Essays
on American Empire.