2009 August 30 Sunday
US To Become World's Largest Banana Republic?
Richard Russell puts the growing US national debt in a perspective that rarely gets mention: as the debt increases a larger fraction of all tax revenue will go toward debt service. The big expansion of US government spending happening now will be matched by a contraction in government programs as more money goes toward bond interest payments.
When the primary trend of the stock market is "blocked," I look for the law of unintended consequences to become operative. We already know that one of the consequences of the Bernanke-Geithner-Obama battle to halt the bear market is a build-up in debt in the US beyond anything ever seen in human history before. Over the next ten years the US will be adding $9 trillion to its national debt. If this occurs, the US will end up being the "world's largest banana republic." The dollar will have lost its reserve status. And the word "bankruptcy" will have a new dimension.
The US national debt is now over $11 trillion dollars. The interest on our national debt is now $340 billion. This is about at 3.04% rate of interest. In ten years the Obama administration admits that they will add $9 trillion to the national debt. That would take it to $20 trillion. Let's say that by some miracle the interest on the national debt in 10 years will still be 3.09%. That would mean that the interest on the national debt would be $618 billion a year or over one billion a day. No nation can hold up in the face of those kinds of expenses. Either the dollar would collapse or interest rates would go through the roof.
The interest rate could of course go much higher. A surge in interest rates could cause an acute crisis as programs must be cut back and taxes raised to pay the higher interest costs. Foreigners will eventually become reluctant to buy huge amounts of US sovereign debt. At that point interest rates will go up up up.
I do not write posts about this topic with the hopes of persuading a substantial fraction of the US population to oppose this madness. My own platform here is too small to make much of a difference. Rather, I write to warn my readers of what is coming. Plan your own financial affairs and make peace with the fact that a country you might feel pride and emotional attachment for is headed for a long lasting financial crisis. Too many developing problems will reach critical mass for this to be avoided.
It seems prudent to me to invest some money abroad. Americans need to reduce their risks from holding assets in the US and reduce the extent of our personal reliance on the health of the US economy.
Paul Krugman tries to argue that we aren't in all that much trouble since the US had an even higher level of debt at the end of World War II. But as James Hamilton rightly points out, the WWII spending surge was of short duration whereas all the unfunded liabilities for old folks medical care and other programs are of long duration.
And whereas in 1945 Americans could reasonably look ahead to a huge decrease in military expenditures, in 2009 when I look ahead what I see is a looming increase in federal medical expenditures.
I also believe it is relevant to compare these deficits not just with GDP but also with current federal tax revenues. $1 trillion is approximately the total personal income tax receipts of the federal government in 2006. My preferred metric for what each additional trillion dollars would require from me personally is to take what I paid in federal income taxes in 2006 and double that amount. To pay off $9 trillion, I'd have to do that for 9 years.
Unfortunately, $9 trillion may not be the whole iceberg.
Diane Lim Rogers highlights the Concord Coalition estimate that current policy would imply a cumulative $14.4 trillion deficit over the next ten years.
At the end of the 10 years even bigger unfunded liabilities await. That's the real problem. We aren't just on a spending bender for the next 10 years. Beyond that lies even bigger demands for government hand-outs. Plus, the government's interest rate payments on accumulated debt will compete with the expanding entitlements programs.
As the tax burden rises so will the opposition of the non-recipients of this largesse. The next 20 years is going to be a continual battle over tax increases and debt. On top of all this the economists are ignoring Peak Oil and America's decaying demographics. Therefore they grossly underestimate the size of the problem.
My advice: work harder now to save money because in the future the marginal tax rates will be a lot higher. Salt money away now. Save and work longer hours. Look for ways to start up small side ventures to bring in extra bucks.
I'm not necessarily saying that huge debt is fine, but a crucial distinction that goes unmentioned in these USA - banana republic analogies is that the debts in the Latin American banana republics were priced not in their own currencies but in the USD or other foreign currencies.
US public/private debts are priced in USD.
This makes a huge difference - enough so that these analogies can be quite misleading.
The ability of the US government to sell debt in its own currency has the main effect of allowing the debt problem to grow larger before it becomes an acute crisis. The crisis stage still is reached. It is just reached later.
This is what amazes me about the path we are on: Nothing short of a massive crisis will stop the trend. There's little sign of prudence and restraint in our elites. The longer we can get away with irresponsible behavior the bigger the irresponsibility grows.
Is gold a wise investment?
Invest in guns, ammo and pharmaceutical warehouses.
Unless the United States is saved from collapse by the Republican National Committee.
To save the United States from utter collapse into chaos, the Republican National Committee must not only adopt the single plank platform of the Citizen's Dividend previously described over at FuturePundit -- a platform that could sweep them to 2/3rds control of the House in 2010 if they required pledges of support for it from candidates they back -- but they should then adopt the following platform to monetize the residual debt:
Replace all taxes on economic activities with a net asset tax on in-place liquidation value beyond an inflation-adjusted homestead value (say around $(2009)300,000 net assets)—value assessed as the taxing authority’s offer to buy said assets—and then monetize the debt by increasing the citizen’s dividend.
You’re thinking in terms of a hard currency world.
The "debt" does not need to be monetized. It already is monetized. The dollar is a fiat currency. It's just a piece of paper backed by the USG. A T-Bill is just a piece of paper backed by the USG. A T-Bill is simply a dollar with a not-valid date.
Since T-Bill's pay interest, and dollars do not, most people who do not need dollars for an immediate transaction tend to hold on to T-Bills instead (directly or via a bank account or money market fund). There is no reason that the debt cannot be rolled over forever.
Think of it another way:
Imagine the Fed printed dollars and bought all the T-bills in the world at market prices. Would this cause inflation? No. No one's balance sheet has changed a bit (since the t-bills were bought at market prices). Since no private actors financial position has changed, they cannot increase spending and bid up the price of goods. So you get no inflation.
Note that this is not the result under a gold standard. If the U.S. was under a gold standard, its credit rating would be F-. Whenever it issued new bonds, it's credit rating would fall further, and the mark-to-market value of the bonds would fall far below face value. If the government somehow built an alchemy device, and "monetized" its debt, that result would cause enormous inflation. The market value of all its debts would zoom back up to face value, everyone's balance sheet would bulge, and people could afford to spend more and bid up the prices of goods.
But the U.S. is not under a gold standard. When USG issues new T-Bills, its credit rating does not drop, nor does the market value of existing t-bills drop. Since the U.S.G. can issue an arbitrary number of T-Bills without ruining its credit rating, the treasuries cause inflation at the time they are issued.
So deficits can indeed be a large problem. The deficit to GDP ratio is one component of the overall inflation rate. If that gets too high, bad things will happen. On the plus, side the government's budget is naturally counter-cyclical. So as inflation heats up, tax revenues rise and the deficit falls.
But the overall level of "debt" is not a problem. Once the "debt" is issued, it's water under the bridge. "Paying off the debt" would be deflationary, and as destructive as contracting the money supply sharply.
One final way to look at it:
Imagine the Federal Reserve stopped calling "the national debt" the national debt. They simply called it "T-Bills outstanding" and updated their statistics to show T-Bills as a component of the money supply, rather than as debt. All government publications were purged of the word "debt" and replaced by "T-Bill". T-Bills are interesting paying dollars, when they mature, the T-Bill disappears and you get a dollar. Or you can trade your dollar in for a another T-Bill.
If the Fed did this, absolutely nothing would change. This is already how the monetary function system functions. Thus with a simple change in nomenclature, the national debt disappears.
They won't get away with simply monetizing the debt without the other changes I posit because of the wealth centralization problem.
The situation in the US is as though Stalin had accomplished the Holomodor by socioeconomic engineering instead of direct starvation, and then attempted to replace the missing Ukranian population with ethnicities more compliant with Central Planning than the Ukranians. When the consequences of central control of all assets come home to roost, you can't solve it by simply handing out a bunch of money to your friends to monetize the government debts you incurred during your program of race replacement. That way lies Zimbabwe.
Gold: Depends on the scenario you are planning for. There are better investments than gold in a Peak Oil environment: stocks of companies that'll continue to have energy to sell for example (e.g. nuclear reactors). Certainly there are better investments in a more Business As Usual environment.
Gold becomes attractive if inflation is going to soar. But so do some commodity stocks and some other stocks.
If there's a total breakdown in order then I'd recommend guns, food, solar panels on your house, and other survivalist-related goods first.
If the Fed bought up all the US Treasury notes then that would be inflationary. All the people now holding notes would hold cash instead. The supply of money would expand by several trillion dollars.
Again, you’re thinking in terms of a hard currency world. Like I said mentioned above, US Treasury notes are already monetized for all practical purposes. The dollar is a fiat currency.
Under the fiat currency regime we live under, for all practical purposes Treasury bonds are dollars with not-valid-until dates printed on them. Guess what, if you hold T-Bills, the gov't will pay you back - by electronically crediting your account with dollars, handing you actual paper dollars, etc. It doesn't scrounge around looking for gold, or tax people to make sure claims for gold (dollar bills under a gold standard) outstanding are reduced so that it can pay you back with claims for gold (dollars) without running the risk of there being too many claims outstanding in excess of gov't gold reserves.
USG does not need your dollars. What do you think happens when you mail in your income taxes? That it goes into a giant vault with all the other collected taxes, and that the government then draws upon this vault to pay for stuff? It tears up the hard earned tax dollars you mail in and throws them right out. It can print its own without any trouble at all. It taxes you simply because otherwise, everyone would be too rich, and prices would go up i.e. inflation. In other words, the purpose of taxation (along with issuing and monetizing bonds) under a fiat-currency regime is not to finance government expenditures, but to minimize monetary dilution and thus manage inflation.
Your income tax dollars aren’t dumped into a giant pot in the basement of the Treasury building, and then drawn out sometime later to pay for say, Predator drones that will be used to bomb Afghani peasants and tear them to pieces. And the government can and does print its own scrip. It’s not physically constrained by anything like say a limited stock of gold or something.
Guns, ammo, foodstuffs with a nice, long shelf-life and a place in a white area, or the in sticks is a good idea. Start a garden, get some chickens too. NYC has 3 days of food without deliveries. I don't want to be anywhere near the place to find out what it will be like when the animals get hungry. Got friends and/or family in a rural area? Give them a call. Get a shotgun, get a .22, get a decent rifle and pistol, you don't need to spend big $, KISS works really well for firearms. Think ammo is expensive now? It is. Wait until things get really hairy. Don't wait, get common calibers... Might want to think about silver too. Makes handy "small change." I see what are called "populations at risk" being really risky to be anywhere near. Bad times coming...
I think a man would be wise to pay off his house and car if he can at this time, and operate on a no-debt basis unless that debt is for business purposes (not debt to drive an expensive car, or buy too much house, etc).
Im optimistic that solar DISHES (not panels), coupled with a domestic windmill, put in peoples' back yards will indeed allow regular homeowners to make quite a bit of electricity every month because they will be able to make electricity on both sunny and cloudy #cloudy days are usually breezy# days. In this way we could "make" some backyard "wealth" as homeowners.
Please *look* at this picture of a solar dish, http://www.internationalrivers.org/files/images/solar_thermal_web.jpg
All it is is a simple dish with mirrors on it that concentrates light to a point, where the light is then magnified (magnifying glass and ants? remember that?), it heats up a fluid that boils and a small generator is run from it, making electricity from mid-morning until evening, the hours of peak use in the spring, summer, and early fall. They have dishes that are merely 44'inches to much larger ones. They "follow" the sun throughout the day. These things make quite a bit of juice, much more than the old solar panels---which aren't very effective. If a man had a solar dish about 6 feet in circumference in one corner of his backyard, and a 6-to-8 foot windmill in the other back corner of his backyard, he'd be making "some" energy (enough to run a computer and a TV set anyway) most of the hours of the day. Just imagine if our government had any common sense and provided every homeowner in America with one of each? We'd suddenly be making a great deal more electricity for basically nothing. I think that businesess, factories, telephone polls, billboards, store roofs (like grocery stores, Wal-Marts) could all have mixtures of these things placed upon them for a lot of cheapo energy put onto the grid for basically nothing after initial costs. What would the upkeep be? The homeonwer windexing the panels once a week and oiling the little 6-foot turbine once a month? Not having things like this, in my opinion, is just throwing away free money. The extra juice, which should lower electricity prices, could also give our factories a financial advantage in terms of lesser energy costs. We've got a lot of land and suburbia out there, with a lot of backyards. A bazillion telephone polls also.
For big installations concentrating solar power (CSP) may be cheaper. But so far on home roofs concentrating solar power costs more and is more problematic. Also, large ground installations as in your picture can have trained maintenance guys to go around and service the long rows of CSP devices far more cheaply than with individual CSP devices scattered across suburbia.
I like CSP because it lends itself much better to storage (molten salts) and therefore use into the evening. I can see it working out in the country where people have more space to put stuff on the ground. But I'm more doubtful about CSP in suburbia.
Backyard wealth as homeowners: Take the more severely disruptive future scenarios. Not sure if an electric grid collapse will ever happen (though a Carrington Event could cause one). My more general advice is if you think really bad times are coming and you can afford to prepare then spend on things that will allow you do to more yourself. Everything from wrenches and saws to grain grinders and canning equipment. If you can get solar panels then electric ovens and electric freezers can work even if you do not have electric power at night. You can freeze stuff during the day to severely cold temperatures and if your electric freezer has very thick insulation it will keep stuff frozen until the sun comes up again.
Think of the home as a piece of capital equipment. Can you make it more productive and less dependent on outside supplies? Look at the cost effectiveness of various options that decrease your dependency on the larger society.
> You can freeze stuff during the day to severely cold temperatures and if your electric freezer has very thick insulation it will keep stuff frozen until the sun comes up again.
Or put a few one-gallon jugs of water inside the freezer, and leave the temperature the same, ie not particularly far below freezing. This is mo' better. By Newton's law of cooling, the rate of heat gain by your freezer tracks ([air temp] - [temp of the outside surface of the freezer]).
Of course, better insulation is even better - other than the cost of purchasing it.
Oops, nix that. If the ice starts melting, taking up heat for the phase transition, well then obviously at that point your food is also beginning to melt.
However, it'd probably work with saltwater of the appropriate concentration. "A 10-percent salt solution freezes at 20 °F (-6 °C)." So 7% might be roughly appropriate. That's double the saltiness of the ocean, so much saltier than any of your food, so it will melt readily (thus keeping the freezer cold) before your food starts to melt.
So Myers, on your view, what happens as the issuing of T-bills approaches infinity? In a proper banana republic, the T-bill interest rate soars because the currency is not fiat and there might be a default (properly, it is fiat - only not the banana republic's fiat).
Here in the USA we won't default cause we can always issue more debt - and thus stick it to dollar holders and T-bill holders alike by semi-cryptically diluting their holdings. Major holders feel the pain. This is why China "hates" us so much lately, right? But what exactly is the pain? Is it the decline of the dollar vs the euro, yen, and yuan?
And what limits the process? Dollar and T-bill holders - mostly American ones - can get irritated and put a brake the further debt issuance politically, I suppose. (Eg, electing Romney president.) And if they don't, what happens? Inflation, right? And eventually penty of it? At some point, shouldn't the threat of inflation make people T-bill-averse, and thus force the interest rate on the T-bill to rise in compensation for this?
Myers, its a tipping point scenario.
What happens when the world wakes up one morning and decides that the US dollar is no longer the fiat currency? Will that point come when China sufficiently diversifies out of its US$ holdings and then begins to insist that its oil purchases are priced in non-US dollar denominations. At that point will the demand for US dollars evaporate and will lenders start pricing higher risk into future US lending? Will that increased risk take the form of higher interest rates and consequent increases is debt servicing costs at the same time as the US economic base shrinks?
The fundamental problem is that the global financial system is built around a pyramid scheme in which the rest of the world lends the US the cheap money it needs to import and consume the world's production.
One day the tipping point will be reached and it'll be a wild ride down.
Randall, maybe you should STFU and just buy TBT if you expect higher interest rates...
I actually think a Japanese scenario is highly likely on interest rates...
BTW, too many people expect higher interests. Markets rarely do what the majority thinks. Even when interest rates do rise... no one expects it... for example 1994 when Greenspan raised interest rates. Inflation was low and the budget deficit was falling, yet there was a massive bond market sell off since everyone was long on duration.
Stephen, I think you only tell half the story. Some say the fertility and age distribution in the USA, though not too wonderful, are better than elsewhere in the rich world + China. That makes for eagerness to lend to the USA. Does China necessarily have that many red hot options for diversifying its holdings?
Don't take my word for it, though, I know almost no econ.
the argentinian-like fiscal collapse of the US has absolutely no chance of occurring during Obama´s first term and only a residual chance of occurring during the rest of the decade (2010s).
yet the mere fact that people consider the existence of that probability is, by itself, a remarkable event.
The "financial collapse" wouldn't be all that bad if it causes collapse of the US government.
The similar event in the USSR - effectively getting rid of any government in 1991 (and until Putin's ascendance) got the country which was on the brink of hunger (the only available food staple in 91 was half-rotten potatoes...) to experience fantastic economic growth. In a few years the contents of shelves of supermarkets become pretty close to what you'd expect in less-developed Western countries, and a whole new middle-class of professionals appeared.
Of course, as soon as Putin's KGB mafia got their hands on the till of power, the growth stalled. By now you'd need a license to wipe an arsehole; just like in US. (Taxes are still, mercifully, lower).
Public banks backed up by the full faith and credit of the citizenry are the American system as envisioned by Benjamin Franklin. When the bank of England flooded counterfeit scrip into the Philadelphia colonies, the Public Philadelphia Bank simply stopped issuing new loans. Public banks can create and extinguish money to match the economy, thus preventing inflation and deflation. Even with counterfeit money circulating in the colonies, Philadelphia remained prosperous. Meanwhile, England was suffering high unemployment and a recession. Benjamin warned the English that the when the bulk of money in circulation is usury (debt money to be repaid to bankers), then the population becomes debt slaves, and less productive. Also, usury money goes to enrich private bankers, and does not benefit the citizenry.
In a public banking scheme (American system) if a state bank issues a note, then new money is created, and that note can fund private or public works. The American Bank can also NOT issue new notes, and just receive payments on old loans. Receiving payments on old loans extinguishes money, thus reducing the money supply and supressing inflation. Usury money returned to state banks can also be used to offset taxes. The Philadelphia colonies had virtually no taxes, and yet their public works were funded.
The root problem with our banking system is that it is private. Worse, our private banking system is fractional reserve, with a reserve requirement of about 1/12. A private banker makes a loan to you for a home, say $120K, then he sets aside $10K of his own money. The banker monetized you, the buyer, because of the wealth you are to create in the future. The private banker puts aside $10K, but you are on the hook for $100K or so in interest (usury) money. The banker gets to list your home as an asset on his books. The private banker created money out of thin air and created assests just by making a loan to you.
Real wealth exists in the lands of a country and in the ingenuity and capability of its people. Money is just a proxy measurement of actual wealth...it is only a medium of exchange that is a representation of something else that is real. If the United States economic system forces all of its people into becoming debt slaves, or debt peons as the Bank of England envisioned, then we simply need to heed Benjamin Franklin and Thomas Jefferson's warning about private bankers. We also need to follow the template envisioned by them, and that is the American Banking System, which is Public Banking supervised by an aware citizenry with regulatory power. Public banks are like roads and bridges; they are infrastructure needed by the citizenry, so said citizenry can engage in commerce and the activities of free men.
Private banks at their core, are all about creating debt peonage, or debt slaves. If most of the money in circulation is debt money, then everybody is working for the bankers. Ironically, communist China comes closest to the American system of banking. Nobody can argue that Chinese banking is somehow inadequate, especially when the private banks of the West are in crisis.
My view is that if it comes to a debt implosion in America, some States will simply create their own banks (similar to North Dakota's state bank), and thus stabilize their individual economies. New money, or even new currency can be issued so the citizeny can continue to create wealth. Some states may even seceed in order to delink from the private banking tentacles.