Our nation has some great things going for it, including beautiful and diversified land, overall good infrastructure, gold-standard colleges and universities, and a class-free market based system that has existed since our nation’s birth—that allows anyone to go from rags to riches.
But, a chain is only as strong as its weakest link. Financially, our nation is rotting out. That is our weakest link.
In 2007, when our national debt was under $9 trillion, the Government Accountability Office (GAO) said: “GAO’s current long-term simulations continue to show ever larger deficits resulting in a federal debt burden that ultimately spirals out of control.”
Total debt is now $26 trillion, and by year-end it will very likely exceed $27 trillion—3 times the $9 trillion of 2007 when the GAO made its prognosis. Annual revenue has never topped $3.5 trillion, and we haven’t balanced a budget since 2001.
In 2011, when our national debt was about $15 trillion, Admiral Mike Mullen, the head of the Joint Chiefs of Staff, said: “I’ve said many times that I believe the single, biggest threat to our national security is our debt.”
What happened after the Great Recession of 2008-2009? These huge deficits were run by Democrats and Republicans well after the recession ended:
2011: deficit $1,300,000,000,000 (i.e. $1.3 trillion)
2012: deficit $1.077 trillion
2013: deficit $680 billion
2014: deficit $485 billion
2015: deficit $442 billion
2016 deficit $585 billion
2017 deficit $665 billion
2018 deficit $779 billion
2019 deficit $984 billion
We now have $9.8 trillion dollars more debt than we would have had if we had balanced the budget every year since 2003 except 2008 and 2009.The last six years, the economy has been strong. There was no excuse for running deficits. If we didn’t have those debts, financing coronavirus spending would be easy.
COVID-19 has been compared to a war—much worse than the Great Recession. Imagine how much more debt will be put on the books during and after COVID-19. Importantly, Peter Daszak, president of EcoHealth Alliance was recently quoted in the Wall Street Journal regarding COVID-19. He said: “I’m not holding in my bunker right now. We’re going to get hit by a much bigger one sometime in the next 10 years.” (Emphasis added)
Like pandemic experts regarding the coronavirus, our financial experts, including the Congressional Budget Office (CBO) and the GAO, have been warning of a looming financial crisis. Like the pandemic, no one has listened. Our country is going broke. This pre-coronavirus chart supplies pre-pandemic anticipated growth in the federal debt-to-Gross Domestic Product (GDP) ratio—it shows where we are headed on our current path. (GDP is the annual output of our economy.) The coronavirus has only made the matter worse.
The CBO predicts the nation’s public debt-to-GDP ratio will hit a massive 108 percent next year— the highest in our nation’s history. Throw in debts owed to Social Security and the figure is in the 130 percent range. Recall the PIGS countries (Portugal, Italy, Greece and Spain), that several years ago were mocked for their financial irresponsibility. The debt-to-GDP ratio of the U.S. will soon fit in where that group stood while being mocked.
Our system will likely collapse under the current trajectory, where tax cuts and other subsidies expire as they are supposed to by law. The Alternative Fiscal Scenario in the chart is what can really be expected—tax cuts and subsidies extended, etc.
Relative to revenue and anticipated future revenue, the debt is beyond excessive. While many politicians claim their policies, if enacted, will cause the economy to outgrow the debt, the reality is: Under no realistic set of circumstances can the economy outgrow the debt.
In 2017, Michael Hüther, an economist working at Stanford University, aptly said: “A government loses its democratic legitimacy when it if it start[s] paying a too-high share of its tax income on interest.” Very importantly, this simple concept dominates how the Fed has acted and will act, and finances in general hereafter.
The following chart shows how Treasury rates track the Fed rate:
The Fed rate is zero percent, where it will likely remain for many years, so that federal interest expense won’t get out-of-control. Recall the Hüther quote. We’ll have about $21 trillion of public debt at year-end, and this year’s federal revenue will be less than $2.5 trillion. At a historically normal 10-year Treasury rate of only 5 percent, interest would be $1.05 trillion—over 40 percent of revenue. (In 2007, the Fed rate was 5¼ percent.) We’d be looking at social and economic unrest if that happened. The Fed will act to prevent such. At 1 percent, interest will be $210 billion, less than 10 percent of revenue. So, you can see why the Fed’s rate never exceeded 2.4 percent after the Great Recession. CD rates will be close to zero percent for years, and bond rates will be very low by historical standards, pushing investors into the stock market. Another bubble is now being created. That bubble absolutely will burst if the nation’s debts spiral out of control. The main risk here is this debt, along with excessive debt worldwide, will cause a tipping point to be reached, resulting in a panic. Such a panic could cause interest rates to jump and the stock market to crash. In a best case scenario with the debt continuing to grow, we end up like Japan, with a dead economy (“Japanification”).
The Federal Reserve Bank is now practicing Quantitative Easing (QE) in a large way. It is printing of money, with that money largely used to buy Treasury debts, thus reducing federal interest rates and expense. While we likely won’t see significant inflation in 2020, we may see it in the years to come. If we don’t see it, we’ll likely experience Japanification. These matters are covered in the Monetary Policy section of the website. The Fed has the power to create or prevent inflation. Perhaps it is has too much power.
QE drove down Treasury rates, reduced federal net interest expense, and drove up the stock market. The wealth gap increased. Other investors, including pension plan trustees and foreigners, also more heavily invested in the U.S. stock market, helping produce a bubble. Historically, bubbles tend to burst. Low interest rates produce high private sector pension plan liabilities. Bursting bubbles and high pension liabilities means money that might have been to paid to employees will instead be paid to the pension plan. Many state and local governments have significantly underfunded post-retirement benefit plans.
It is the general nature of a democracy or a republic to experience what is happening. It takes a substantial portion of the population to act unselfishly and prudently to overcome it. There is no rah-rah to this. This is simply application of the laws of finance to a debtor—although a very unique debtor.
The current public debt-to-GDP ratio is roughly equivalent to the ratio at the end of World War II. We eliminated that debt over the course of 35 years via three things: (1) real growth of over 5 percent for two significant strings of years (1950-1955 and 1961-1968); (2) the highest tax rate never dropping below 70 percent; and (3) significant inflation—the rate from 1968 through 1982 averaged 7.4 percent. As a mature economy, we won’t ever see real growth of 5 percent. We can realistically expect average annual growth in the 1-3 percent range. What does that leave? It leaves tax increases and inflation.
Tracing the history of the U.S. since World War II, low Fed and Treasury rates have ordinarily been experienced while the debt was relatively high, and higher rates have been experienced when the debt was relatively low. In 1981, when the Fed rate hit almost 20 percent and the 10-year Treasury note rate broke 15 percent, the public debt-to-GDP ratio was a post-World War II low of 30.6 percent. In 1954, when the public debt-to-GDP ratio was 70 percent, the federal funds rate hovered around 1 percent, while 5 and 10 year Treasury note rates were below 3 percent. Recent low Fed and Treasury rates are well known. So, history shows the Fed has accommodated Congress.
Unlike in the past when interest rate cuts helped spur economic growth, the impossibility of a significant interest rate cut stimulator means deficit spending and QE will be the main remedies used to help the nation dig out of the current recession. Both major parties desperately want to control that spending—and maximize it. The following chart shows how the U.S. is much more in debt (relative to GDP) than it was prior to past recessions:
There is no pool of assets to sell to get out of the problem. We can do three things to eliminate the problem. First, we can print a lot of money (as the Fed has done) and let it remain outstanding, thereby watering down the debt. That creates inflation—a tax on conservative savers. We’ll be told inflation doesn’t exist. (It is now present in groceries; the price of oil is reducing it.) Second, we can have a debt reduction like a Chapter 11 bankruptcy. The stock market could easily crash. Few will even suggest such, but with many nations around the world also heavily indebted, it’s going to be at least partially considered. Former Assistant Deputy Secretary of the Treasury Gene Steuerle said in his 2014 book Dead Men Ruling: “Nations that face exploding debt levels or the kind of problems outlined above [relating to the United States’ financial problems] often refuse to pay their debts and declare bankruptcy. Because so many nations depend on the U.S. dollar to stabilize world markets, a U.S. default could prompt not just a U.S. crisis, but a global depression.” A default would be more honest than inflation. Third, we can get our financial house in order through balanced budgets and reasonable spending cuts. It would require sacrifice. (Allen Buckley advocates doing number 3.)
Rather than implementing one of the three options above to eliminate the problem, the matter can simply be left to get worse. There’s close to a 100 percent chance that is what will happen under Republican and Democratic leadership. The end result will be Japanification, with the tipping point debt panic that results in a market crash possibility always existing. An article in the Monetary Policy of the website discusses this possibility.
At some point, the tipping point will likely be hit. Perhaps the federal government could react to by immediately balancing the budget thereafter, with relatively little harm. That seems very unlikely. If a panic ensues upon hitting it, a huge market loss would likely follow. Consider all of the baby boomer retirees and the impact on their spending habits of a significant loss in stock markets’ values. A repeating downward spiral of lost value, followed by reduced spending, is possible. Imagine a lit match falling on dry hay in an old wooden barn. Interest rates will rise, driving down the value of stocks and bonds. With the huge federal debt load, unlike 2008, a federal bail-out won’t be an option.
A “default” in the form of a bankruptcy-like reorganization (if that is what Mr. Steuerle envisioned) is highly unlikely, as markets would explode. Rather, money printing (unreversed QE) to prevent such from ever happening is much more likely. But, in the event of a market-crushing panic, a bankruptcy-like reorganization might be the best option.
Aside from the possibility of a collapse, payment of interest produces absolutely no return on tax dollars paid. And, a 2010 World Bank study concluded that countries whose debt-to-GDP ratio exceeds 77 percent for a prolonged period experience slowing of growth. Other reputable studies with similar results exist. (Japan’s debt-to-GDP ratio exceeds 200 percent; its economy has been in the doldrums for decades.) Reduced growth means reduced job opportunities.
Making matters more complex are the similar financial problems of many foreign nations. Watering down of currencies can be expected. Politically, it’s easier to print when it’s necessary for a country to remain competitive.
The Fed and the Treasury Department are now cornered. In 2020, the Fed is applying QE in a major way. As discussed in the Monetary Policy section, it can be reversed to any degree, by money destruction. If not reversed, it will very likely eventually produce significant inflation. The Fed might rationalize doing so in light of its three-pronged statutory objective (stable prices, low unemployment and moderate long-term interest rates) on the theory that a collapse would result in huge unemployment and potentially huge inflation. In contrast, large inflation would produce unstable prices, but it could possibly produce low unemployment and moderate long-term interest rates. One might think the existence of Treasury Inflation Protected Securities (TIPS) would discourage a money print bail-out. However, as of August 31, 2019, they comprised only 9 percent of the public debt.
Inflation is a tax on savings. Under the Constitution, only Congress can tax. However, Congress created the Fed, and it’s unlikely any federal appellate court would practically permit a legal challenge. The wealthy will be more able to deal with inflation than others, exacerbating the wealth gap. Loss of the middle class is another way for a republic to collapse. A depression coupled with a wealth gap increase could spell the end of the U.S. system of government.
While no one can predict exactly what will happen, ultimately, the laws of finance will rule. Those laws provide that the riskier a debtor is, the more it must pay in interest and the more security it must provide. Those laws will overpower whatever power the Fed and any federal institution may possess.
Allen Buckley thinks we need to get the debt-to-GDP ratio down below 70 percent, and keep it there. If we can balance the budget in non-recession years, and the economy grows (as it ordinarily does), the debt-to-GDP ratio will decrease. It would take many years to get there, since reasonable deficits should be run during recessions. If we do nothing and the federal government financially implodes, none of the other issues—the environment, abortion, anything–matter. Unbelievably, it’s still not too late to prevent what seems inevitable.