Skunked
- Medicare, Medicaid and Social Security now account for 44% of total federal spending and are steadily rising.
- Previous Congresses (and Administrations) have relied on the assumption that we can grow our way out of this onerous debt burden.
- Unless entitlements are substantially reformed, the U.S. will likely default on its debt; not in conventional ways, but via inflation, currency devaluation and low to negative real interest rates.
That adorable skunk, Pepé Le Pew, is one of my wife Sue’s favorite cartoon characters. There’s something affable, even romantic about him as he seeks to woo his female companions with a French accent and promises of a skunk bungalow and bedrooms full of little Pepés in future years. It’s easy to love a skunk – but only on the silver screen, and if in real life – at a considerable distance. I think of Congress that way. Every two or six years, they dress up in full makeup, pretending to be the change, vowing to correct what hasn’t been corrected, promising discipline as opposed to profligate overspending and undertaxation, and striving to balance the budget when all others have failed. Oooh Pepé – Mon Chéri! But don’t believe them – hold your nose instead! Oh, I kid the Congress. Perhaps they don’t have black and white stripes with bushy tails. Perhaps there’s just a stink bomb that the Congressional sergeant-at-arms sets off every time they convene and the gavel falls to signify the beginning of the “people’s business.” Perhaps. But, in all cases, citizens of America – hold your noses. You ain’t smelled nothin’ yet.I speak, of course, to the budget deficit and Washington’s inability to recognize the intractable: 75% of the budget is non-discretionary and entitlement based. Without attacking entitlements – Medicare, Medicaid and Social Security – we are smelling $1 trillion deficits as far as the nose can sniff. Once dominated by defense spending, these three categories now account for 44% of total Federal spending and are steadily rising. As Chart 1 points out, after defense and interest payments on the national debt are excluded, remaining discretionary expenses for education, infrastructure, agriculture and housing constitute at most 25% of the 2011 fiscal year federal spending budget of $4 trillion. You could eliminate it all and still wind up with a deficit of nearly $700 billion! So come on you stinkers; enough of the Pepé Le Pew romance and promises. Entitlement spending is where the money is and you need to reform it.
Even then, the situation is almost beyond repair. Check out the Treasury’s and Health and Human Services’ own data for the net present value of entitlement liabilities shown in Chart 2.
The above four multi-trillion-dollar liability balls are staggering in their implications. Remember first of all that the nearly $65 trillion of entitlement liabilities shown above are not some estimate of future spending. They are the discounted net present value of current spending should it continue at the projected demographic rate (importantly – it is much higher than the annual CPI + 1% used as a discounter because demand for healthcare rises much faster than inflation.) And while some Honorable Congressional Le Pews would counter that Medicaid is appropriated annually and therefore requires no discounted reserve, those words would surely count as “sweet nothings,” believable only to those whom they romance every several years at the polls. The incredible reality is that the $9.1 trillion federal debt that constitutes the next-to-tiniest ball in our chart is nothing compared to unfunded Medicaid and Medicare. It is like comparing Pluto to Saturn and Jupiter. The former (the $9.1 trillion current Treasury debt) does not even merit planetary status in our solar system of discounted future liabilities. It’s really just a large asteroid.
Look at it another way and our dire situation becomes equally revealing. Suppose that the $65 trillion of entitlement liabilities were fully funded in a “lockbox,” much like Social Security is falsely imagined to be. Just suppose. And say the cost of that funding (Treasury debt) was the same CPI + 1% that was used to produce the above discounted present value in the first place. Actually, that’s not a bad guesstimate for the average yield of all Treasury debt. If so, then the interest expense on the $75 trillion total debt would equal $2.6 trillion, quite close to the current level of entitlement spending for Social Security, Medicare and Medicaid. What do we pay now in interest? About $250 billion. Our annual “lockbox” tab would rise by $2.35 trillion and our deficit would be close to 15% of GDP! The simple conclusion would be this: Unless you want to drastically reduce entitlement spending or heaven forbid raise taxes, then Pepé, you’ve got a stinker of a problem.
Previous Congresses (and Administrations) have relied on the assumption that we can grow our way out of this onerous debt burden. Perhaps we could, if it was only $9.1 trillion, as shown in Chart 2. That would be 65% of GDP and well within reasonable ranges for sovereign debt burdens. But that is not the reality. As others, such as Pete Peterson of the Blackstone Group and Mary Meeker, have shown much better and for far longer than I, the true but unrecorded debt of the U.S. Treasury is not $9.1 trillion or even $11-12 trillion when Agency and Student Loan liabilities are thrown in, but $65 trillion more! This country appears to have an off-balance-sheet, unrecorded debt burden of close to 500% of GDP! We are out-Greeking the Greeks, dear reader.
If so, and if the USA were a corporation, then it would probably have a negative net worth of $35-40 trillion once our “assets” were properly accounted for, as pointed out by Mary Meeker and endorsed by luminaries such as Paul Volcker and Michael Bloomberg in a recent piece titled “USA Inc.” However approximate and subjective that number is, no lender would lend to such a corporation. Because if that company had a printing press much like the U.S. with an official “reserve currency” seal of approval affixed to every dollar bill, that lender/saver would have to know that the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation – surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation – likely but not significant in its impact, 3) deceptively via a declining dollar– currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain.
If I were sitting before Congress – at a safe olfactory distance – and giving testimony on our current debt crisis, I would pithily say something like this:
Thank you, and like Pepé Le Pew, why don’t you try changing your stripes or at least pretend you’re a French-speaking cat. The odor in these chambers is all too familiar and a skunk needs all the help it can get.“I sit before you as a representative of a $1.2 trillion money manager, historically bond oriented, that has been selling Treasuries because they have little value within the context of a $75 trillion total debt burden.Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates.Our clients, who represent unions, cities, U.S. and global pension funds, foundations, as well as Main Street citizens, do not want to be shortchanged or have their pockets picked. It is incumbent, therefore, in order to preserve the integrity of the U.S. Treasury market along with its favorable global interest rates, and to promote a stable U.S. economy, that entitlement spending be reduced, and that future liabilities be addressed in terms of healthcare and Social Security cost containment. You must attack entitlements and make ‘debt’ a four-letter word.”
I didn't want to clip the whole article so the rest of this great story sent in by Shaza is below. QB
This is a classic setup for systemic failure
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This is a classic setup for systemic failure
"Straight Talk" features thinking from notable minds that the ChrisMartenson.com audience has indicated it wants to learn more about. Readers submit the questions they want addressed and our guests take their best crack at answering. The comments and opinions expressed by our guests are their own.
This week's Straight Talk contributor is 'Jesse', founder and proprieter of Jesse's Café Américain (jessescrossroadscafe.blogspot.com), one of the more esteemed and veteran econoblogs. Jesse publishes regular observations on the macroeconomic factors impacting the financial markets, as well as exceptionally rich technical analysis - his price forecast charts of gold and silver are 'must reads' for anyone who seriously invests or trades precious metals. Recently, his site was rated as the fourth-most-influential blog in financial media by Mindful Money.1. Jesse’s Café Américain has emerged as a well-regarded source for insight into the key indicators driving the markets. Can you summarize your overall outlook for the economy and what macro trends investors and traders should be following most closely?
Stagflation has been my forecast for quite some time as the most likely outcome, with a real protracted deflation or hyperinflation as lesser probabilities.
The reasoning behind this is fairly straightforward. In a fiat monetary regime, the central banking authorities license the shadow banking system to create money through their credit expansion mechanisms. There is a money multiplier, or a natural credit expansion, in a normal growth economy. In the event of a recession due to a business cycle, the Fed can relax reserve requirements and interest rates through their open monetary operations, essentially lowering the standard for credit creation, also known as the interest-rate hurdle, for a profitable return.
The reasoning behind this is fairly straightforward. In a fiat monetary regime, the central banking authorities license the shadow banking system to create money through their credit expansion mechanisms. There is a money multiplier, or a natural credit expansion, in a normal growth economy. In the event of a recession due to a business cycle, the Fed can relax reserve requirements and interest rates through their open monetary operations, essentially lowering the standard for credit creation, also known as the interest-rate hurdle, for a profitable return.
In the event of a financial crisis or a credit collapse such as the one in which we are now, the Fed has the ability to monetize existing and new government debt by purchasing it at extraordinary (non-market) prices, adding it to its balance sheet. Additionally, the ability to pay interest on bank reserves gives them a little more fine control on the effects, and even keeping some liquidity out of the system by paying banks to retain a greater amount than they ordinarily would, and raising the bar a little on interest rates. People also forget that the Fed has always had the power to set reserve and margin requirements. This extraordinary monetization effort by the Fed requires a significant amount of cooperation from bondholders and those external entities who hold dollar assets in their currency reserves.
The problem, of course, is that the Fed is only a part of the bigger picture. It is the responsibility of the Congress and the Executive to set fiscal and regulatory policies for the country and the real economy, including import export, jobs, taxation, and so forth. Today, the government, both the Executive and the Congress of both parties, is presiding over a broken system, made so by a relatively tight coterie of monetary interests who have been promoting an outsized, over-dominant financial sector, and the undermining financial regulation since the early 1990's.
I think a particular event occurred around 1996-7 which I have referred to in the past as a 'financial mystery, a coup d'etat.' I prefer not to speak of it more now, but it involves US government officials and China, and Clinton's chief financial people Greenspan and Rubin. It was at roughly the time of Greenspan's 'irrational exuberance speech,' after which he shortly changed his tune and began the expansion of the money supply, which culminated in the tech bubble.