"Economic Suicide"
- From: "Deckard" <deckardmort@xxxxxxxxxxx>
- Date: 29 Apr 2006 21:36:40 -0700
http://www.goldmoney.com
"Economic Suicide"
By James Turk
Anybody who has been lending money to the US federal government by
buying T-Bills and its other debt instruments received a brutal one-two
punch last week. It was hopefully a sobering experience, causing them
to
question why they would want to hold any US government paper.
The Washington Post landed the first punch with the following report on
March 6th. "WASHINGTON -- Treasury Secretary John Snow notified
Congress
on Monday that the administration has now taken "all prudent and legal
actions," including tapping certain government retirement funds, to
keep
from hitting the $8.2 trillion national debt limit.Treasury officials,
briefing congressional aides last week, said that the government will
run out of maneuvering room to keep from exceeding the current limit
sometime during the week of March 20."
The second punch was delivered a couple of days later by this Dow Jones
Newswires dispatch: "WASHINGTON (Dow Jones) -- The U.S. government ran
a
monthly budget deficit of $119.20 billion in February, an all-time
monthly record that was still slightly less than forecast, according to
a Treasury report Friday. The February federal government deficit was
5%
greater than a year earlier, according to the Treasury Department's
monthly budget statement."
These two reports make clear the dire financial straits the federal
government is facing, but its financial position is even worse than it
appears. The $8.2 trillion debt limit -- that has proven inadequate to
meet the federal government's borrowing needs -- covers only its direct
liabilities. In other words, this $8.2 trillion is the total amount of
dollars owed to all the holders of US government debt instruments.
Excluded from this total debt are all of the federal government's other
liabilities, which total another $38 trillion. In "The 2005 Financial
Report of the United States Government", US Comptroller General David
Walker reported that "the federal government's fiscal exposures now
total more than $46 trillion, up from $20 trillion in 2000."
Yes, it's insane. But it's even more insane that people buy the US
government's T-Bonds and T-Bills thinking that they are a safe,
low-risk
investment. Maybe they used to be that, but things change. US
government
debt instruments are no longer a safe place to park your dollars. To
substantiate this assertion, here are some shocking facts to mull over.
1) REVENUE -- Federal revenue peaked at $2.03 trillion in 2000, and
then
declined for three years, bottoming in 2003 at $1.78 trillion. That's
never happened before. Revenue typically declines during a recession,
but the most it has ever declined before was two years in a row, during
the severe recession of 1958 and 1959. Revenue has rebounded the last
two years and reached $2.15 trillion in 2005, but in constant
2000-dollars (i.e., adjusted for inflation), revenue remains 6.3% below
that received in 2000.
2) EXPENDITURES -- While the federal government's revenue has been
constrained, not so with expenditures, which have continued to soar.
They were $2.47 trillion in 2005, an alarming 38.2% above the federal
government's expenditures in 2000. Expenditures soared even in constant
2000-dollars, scoring a shocking 21.8% increase over the five years
from
2000 to 2005.
3) RELIANCE UPON DEBT -- As a consequence of constrained revenue and
uncontrolled spending, the federal government has come to increasingly
rely upon debt in order to obtain the dollars it spends with gay
abandon. In 2000, 1.1% of the federal government's cash flow (revenue
plus the annual increase in debt) came from new debt. This reliance on
debt grew to 20.4% in 2005. In other words, for every $100 spent by the
federal government in 2005, $20.40 came from borrowed money, compared
to
only $1.10 in 2000.
4) INTEREST RATES -- Of all the major expenditure categories of the
federal government, only one declined from 2000 to 2005 -- interest
expense. It paid $361.9 billion in interest in 2000, and its interest
expense burden fell to $352.3 billion in 2005. During this period, the
federal debt climbed 40.5% from $5.63 trillion to $7.91 trillion. So
given this increase in debt, it is obvious that the federal
government's
interest expense burden declined for only one reason -- interest rates
fell. In fact, the average interest rate paid by the federal government
on its debt in 2000 was 6.4%; it was only 4.6% in both 2004 and 2005.
5) INTEREST EXPENSE BURDEN -- During the 1990's, 24.0% of the federal
government's revenue on average was used to pay interest on its debt.
During the Bush administration that burden has declined to only 17.5%
on
average. The reason is that the 5.2% average interest rate paid by the
federal government during the Bush administration so far is
significantly less than the 7.2% rate it paid on average in the 1990's.
It is clear that the lower interest rates engineered by the Federal
Reserve after the 2000 stock market peak have favorably impacted the
federal government's budget. Lower interest rates reduced its interest
expense burden, thereby making the deficits incurred so far during the
Bush administration much smaller than they would have been if higher
interest rates prevailed.
The above facts are indeed shocking as they clearly highlight that both
the runaway growth in federal spending during the Bush administration
and the resulting deterioration in the financial position of the
federal
government have been cloaked and little noticed because interest rates
have been falling in recent years. So the above facts therefore make
the
immediate future frightening because as we all know, the Federal
Reserve
has been raising interest rates.
What will happen to the federal government's financial condition now
that the Federal Reserve is raising rates in order to try suppressing
the growing inflationary pressures in the economy? The federal
government faces a potentially toxic mix of constrained revenue,
soaring
expenditures, ballooning debt and rising interest rates.
The federal government desperately needs strong economic activity in
order to generate the highest possible tax revenue to decrease its
reliance on debt. But rising interest rates work against this
objective.
Rising interest rates dampen economic activity. We have already seen
what has happened to the housing market since the Federal Reserve began
raising interest rates.
In addition to adversely impacting revenue, rising interest rates also
have an unfavorable impact on expenditures. This impact is purely
mathematical. A 6% average interest rate on $8.2 trillion of debt
results in a higher interest expense burden than a 4.6% rate.
Thus, higher interest rates restrain tax revenue while increasing the
level of expenditures. Together these factors worsen the budget
deficit,
which then causes the federal government to borrow even more money. The
resulting higher level of debt leads to a greater interest expense
burden, further worsening the deficit. Consequently, the federal
government is rapidly moving to the point where its borrowing becomes
an
increasingly important source of the dollars that it needs to meet its
interest expense obligations.
It is clear that these circumstances create a vicious circle where the
federal government borrows money to obtain the dollars needed to meet
its debt obligations. This condition is not sustainable, and it will
end
in one of two alternatives -- either the dollar is saved or it isn't.
If
the vicious circle is not addressed and corrected, it will turn into a
death spiral in which the dollar is destroyed.
To explain this point, the federal government will never default on its
debt. With the ever-helping hand of the Federal Reserve and the banking
system, the federal government will always come up with the dollars it
needs to meet its interest expense and other debt obligations. But if
the vicious circle described above is not addressed, the federal
government will repay its debt obligations with dollars that are worth
less and less until they become worthless when the death spiral occurs.
The vicious circle does two things. First, it increases the supply of
dollars by creating 'out of thin air' the dollars needed by the federal
government to meet its debt obligations. The second point is less
obvious but just as pernicious. The vicious circle lessens the demand
for the dollar as people over time come to understand the ruinous,
underlying dynamics of what's happening to the currency. Higher supply
and lower demand mean only one thing -- the purchasing power of the
dollar is being inflated away.
These circumstances are not new. They are experienced by every fiat
currency sooner or later when the discipline of the gold standard is
removed. The discipline of the gold standard is needed to constrain
government spending. In the absence of that discipline, a fiat currency
inevitably reaches the vicious circle. In fact, it's even happened
before with the dollar.
The dollar was in a vicious circle during the waning years of the
Carter
administration. Paul Volcker was appointed Federal Reserve chairman to
break the vicious circle, and he did it by raising interest rates. He
kept raising interest rates until real rates (nominal interest rates
less the inflation rate) soared to greater than 6%, historically a
phenomenally high rate. It was not surprising therefore that the demand
for the dollar started rising, thereby breaking the vicious circle and
saving the dollar from a death spiral. But Mr. Volcker had an advantage
not available today to Mr. Bernanke.
Back then the federal debt was not the burden it is today. Recall that
the US was the largest creditor nation in the world back then. The
total
level of dollar debt was not only much less, but manageable in the
environment of rapidly rising interest rates and the high real interest
rates ushered in by Mr. Volcker.
Today the US is the world's largest debtor. The US savings rate is
negative. American home owners have consumed most of the equity in
their
houses. In short, the federal government and many consumers are
borrowing just to try keeping their head above water. What's worse,
there is all the uncertainty arising from trillions of dollars of
outstanding financial derivatives, essentially none of which existed
during Mr. Volcker's era.
In short, Mr. Bernanke cannot raise interest rates the way Volcker did,
which I believe is well understood by both Mr. Bernanke and Mr.
Greenspan. After all, look at what happened during the last year of so
of Mr. Greenspan's tenure at the Fed. He raised interest rates, but
throughout this period, real interest rates remained close to zero and
at times were negative, which is a condition that creates a highly
inflationary framework for the dollar. In other words, there was a lot
of jawboning from Mr. Greenspan to save the dollar from inflation by
raising interest rates, but he did not even come close to following in
the footsteps of Mr. Volcker. Mr. Bernanke won't either.
Today's monetary system is not only broken, it's completely crazy. For
this reason I found the following quote in the current issue of
Barron's
to be of interest. It's by Richard Daughty, from the March 8th issue of
his newsletter, The Mogambo Guru (9241 54th St. N., Pinellas Park, Fla.
33782):
"What a scam! The week [before last], the Fed snaps its fingers and
creates $2.2 billion, and then uses it to buy $2.2 billion in
government
debt! What in the hell can you do but laugh at the sheer audacity!
Somehow, a government creating more and more money and spending it is
not, for the first time in history, going to turn out to be a bad
thing?
And especially one where the money is just paper and computer blips
that
they can create on a whim? Of course, I sigh wearily as I note that the
banks themselves are in on the scam, and they bought up another $13
billion in government debt [the week before last]. Foreign central
banks
continue to soak up government debt, and they swallowed another $7.6
billion [that] week, too. The government sells debt to get money to
spend on its deficits, and the bank creates the money to buy the debt.
Debt and money supply both expand, and it expands to create a bigger
and
more expensive government! And higher prices. This is economic
suicide!"
Indeed, it truly is "economic suicide", but it's even worse than that.
It's also monetary homicide. The dollar as we know it is being killed,
poisoned by debt from the hand of the federal government with its
accomplices in the Federal Reserve and the banking system. So far it's
been a slow death, with few people watching, but that's about to
change.
With the horrific new amounts of debt being injected into the dollar's
weary remains, its death is not far off.
Published by GoldMoney
.
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