In the magazine The Economist, they recently reported this interesting bit of news:
Federal Debt could go to 400% of GDP
On January 7th the Congressional Budget Office (CBO), a non-partisan outfit, released projections that show the financial crash and the resulting recession are already wreaking havoc with America’s finances. It reckons that the budget deficit will soar from $455 billion in fiscal 2008 (which ended last September 30th) to an astonishing $1.2 trillion in the current year. At 8.3% that would be the most as a share of gross domestic product since the second world war.
But the underlying picture is worse for several reasons. First, it does not include any estimate of the cost of Mr Obama’s planned fiscal stimulus, which he will seek from Congress soon after being inaugurated. Second, the CBO assumes all of George Bush’s tax cuts will expire as scheduled at the end of next year and that the Alternative Minimum Tax, a parallel levy aimed at the wealthy, is allowed to ensnare a growing share of the middle class each year.
One thing to understand about even the horrendous sounding “8.3% of GDP deficit” is that it is vastly understated. First, as they note in the article, not everything is being counted, such as the cost of the stimulus plan.
But second, even if such excluded costs were counted, it’s important to note that the way the government reports its fiscal condition would be illegal for any public company.
The US government uses a pure cash-based accounting, which simply measures money coming in and money going out, and the difference is reported as the deficit (or surplus in better days). But this ignores the extra Social Security surplus funds that are siphoned off.
The cash-basis accounting favored by the US government also ignores any accrued liabilities that might have resulted during the year, such as veteran benefits or federal retirement funding shortfalls. In your household, the equivalent would be simply looking at your checking account balance at the end of the year and calling that your net position while conveniently ignoring your outstanding credit card bills, mortgage, and auto loan payments.
Including these sorts of “oversights” for the US government would lead us to what is called accrual basis accounting. This is what is used by every major company and should be used as a more honest assessment of the United States’ true economic position.
Even here there are two ways to view the numbers. One would include just the pure accrual obligations, and the second would be to also include the accrued liabilities. The difference is that accrued obligations have to be met and repaid while liabilities can be modified and possibly reneged upon, meaning they might not ever be repaid at all. The two largest liabilities of the US government are Social Security and Medicare/caid.
On an accrual basis, most of the debt numbers have to be bumped up by some $400 to $500 billion, or 2% - 3% of GDP, making the problem much more severe than is currently being discussed.
Over the long term, the US government is insolvent, and the Economist article continues on to the punchline that the US is on track to achieve a debt load of 400% of GDP.
But the real problem is that the first baby-boomers retired last year. In coming decades, spending on entitlements—the three main ones being Social Security (pensions), Medicare (health care for the elderly), and Medicaid (health care for the poor)—will drive deficits and therefore debt, up sharply. But the CBO has previously said that, as America ages and if current policies continue, it could theoretically hit an otherworldly 400% by mid-century.
The problem with the CBO estimate is that by stating the US government could achieve a debt-to-GDP ratio of 400% by “mid-century,” (2050) the CBO is off by 41 years. The US federal government is already nearly at a 400% debt-to-GDP ratio, at least if the Treasury department is to be believed.
If we take the present Value of the net US financial position (which accounts for all accrual based shortfalls and liabilities), currently at negative $53 trillion according to the Treasury department, and divide that into the current GDP of $14 trillion, we get a debt-To-GDP ratio of 378%, which is close enough to 400% for government work.
No questions any longer surround the issue of US solvency – the nation is insolvent by any measure one cares to use. When that reality sinks into the Treasury debt markets, we will enter stage two of this financial crisis. For now, most seem content to continue with the illusion that all of our obligations, entitlements and promises can be funded through some combination of borrowing.
The question, then,, is how these mounting deficits will be financed. Over the past two weeks one of our largest creditors has been making ominous noises about curtailing their purchase of new US debt, as recently reported in the New York Times:
China Losing Taste for Debt From U.S.
HONG KONG — China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.
If China, and possibly other nation states, back away from buying more US debt, at precisely the moment the US is seeking to borrow record amounts, we can reasonably expect a new and larger wave of financial stress to sweep across the global scene. The signatures of a failure of US debt auctions would be rising rates and a falling dollar.
Given that the most recent stimulus plans call for more than a trillion dollars of (cash-basis) shortfall in each of the next few years, this raises the troubling prospect that the US will have to fund much of this shortfall itself. This can only come from savings or new money printing.
Looking back on US savings patterns over the past 20 years, and considering the drain on earnings and savings that a deep recession can often mean to many bank accounts, I do not think the US is capable of self-financing this string of large federal debts.
This leaves printing.
I think this represents a probable source of future disappointment for those thinking that the recent Fed actions of monetizing debt and otherwise increasing the rate of creation of new, out of thin air money, will soon cease and even reverse due to an improving situation in the credit markets.
Again, I can come to few solid conclusions about where and how to protect oneself from this on coming shift in the value of the dollar (and, by extension, nearly all fiat currencies) besides removing ones money from the dollar based financial system itself. Gold, silver, oil, land, and other commodity plays.
When printing is the only option, inflation is the only outcome.
This is a companion discussion topic for the original entry at https://peakprosperity.com/federal-debt-beginning-to-go-vertical-2/