“Government is the great fiction by which everybody seeks to live at the expense of everybody else.” Frederic Bastiat (1848), a man of few words yet much wisdom, offers up his definition of government and sums up our circumstances well.
We have watched this way of thinking playing out across Europe and the United States. Decades in the making, the promises made by our ‘benevolent’ governments can no longer be kept. The unholy alliance between men who desire to consume more than they produce (at the expense of others), and the politicos who promise to fulfill that dream in exchange for votes, is nearing its contemporary endpoint.
Many of us have tagged along for the ride – and it has been a good ride. We have lived well beyond our means for more than a generation, enjoying the borrowed fruits of the labors of the more recently born and yet to be born. It’s been a game of winks and nods. We wink, the politicos nod. And we dig ourselves deeper and deeper into the abyss. Consider that if we had a balanced budget at 2011 spending levels, all personal income taxes would have to be double what they are today.
Truth is, there isn’t enough wealth in the world to pay off the debt that has been accumulated by sovereign nations. Actually, there isn’t even enough wealth in the world just to pay off the debt and unfunded liabilities of the U.S. government.
Let’s look at a few numbers to illustrate our current condition. Our public debt is roughly 15 trillion dollars. For 2011, our interest payments on that debt totals about 230 billion dollars, meaning we are financing that debt at an average rate of around 1.5%. Wish I could get that deal. But what happens if that rate moves up? If our rate moved to 2.5%, our interest payments would increase to $380 billion. At 3.5%, they go to $530 billion. You get the general idea. And, lest we forget, we are adding a trillion plus each year in additional debt (deficit spending).
Now, let’s look at Europe. Many Eurozone nations have spent and borrowed like we have. The Greek crisis is well known. A massive welfare state and bloated, powerful public sector unions enjoying early retirements and big payouts have bankrupted Greece. And even the most recent EU bailout plans (including writing down 50% of their public debt) won’t be enough to save Greece. No big story here, Greece has spent most of its modern history in some form of default or another.
Italy, Ireland, Portugal and Spain round out the “PIIGS” of Europe – those countries facing the financial abyss. Spain has 70% public debt to GDP, while the other three are all over 100% to GDP (U.S. is currently at 75%). In recent weeks, we have seen the bonds of Italy and Spain hit the 6 and 7% levels (Portugal is over 12%). To put some perspective on that, if we (the U.S.) were paying 6.5% on our debt, our interest payments in 2011 would amount to $980 billion dollars. Put another way, our interest payments alone would eat up more than five times what the government collects in corporate taxes, or about 80% of what it collects in individual taxes. The interest payment would be our single largest budget category, a larger expenditure than even defense and two wars. But this is what Spain and Italy are facing with their bond rates now. And unlike Greece, their economies are large. Bailing them out isn’t a two or three hundred billion Euro fix. Expanding the field beyond the PIIGS, France is now also feeling the heat – and as of last week, even the more fiscally conservative Germany. French 10-year bonds auctioned at about a 3.7 rate and Germany wasn’t finding buyers at 2.25, a quarter percent higher than the week before. In short, Europe is imploding. And growth in those economies can’t be found, ranging anywhere from -5% to a high of maybe 2%.
Europe’s only answer, other than default, is for the European Central Bank (ECB) to step in, print trillions of Euros, and buy up the individual nation’s debt. But the bank’s charter expressly prohibits it from doing so. And, to date, Angela Merkel (Germany) has vowed they won’t do that. Germany’s collective memory knows what happens when the printing presses are turned on – they remember Weimar (when hyperinflation translated to a wheelbarrow full of currency to buy a loaf of bread). I wish our Federal Reserve Bank had a similar memory.
Should Germany (and thus the ECB) remain steadfast in their resolve to not meaningfully intervene, the capital markets in Europe will lock up soon, much as ours did in 2008 following the Lehman collapse. And without a lender of last resort infusing capital like our Fed did (to the tune of trillions), the great banks of Europe will fall (or be nationalized) one by one as the contagion spreads. Europe’s 500 million people will slide into a depression.
Strangely, because of all this turmoil in Europe, the Dollar, and U.S. Treasuries, have been the safe haven assets investors have been flocking to – further holding down our interest rates. The U.S. has the distinct honor of being the prettiest house on a very ugly block, for now.
But we, too, are nearing that tipping point, despite our reserve currency status and our printing presses running full steam. Collectively, our local, state and federal governments are spending $7 trillion a year; our federal government is running a 10% to GDP deficit ($4 billion a day), and our population is aging and retiring. With 11,800 Boomers retiring each day, they are moving from productive workers and savers to Medicare and Social Security recipients, and sellers of assets (stocks, bonds, 401Ks), rather than buyers. Additionally, we have an anemic economy with 25 million unemployed or under-employed existing on food stamps and unemployment payments, despite $1.3 trillion in deficit spending. And a significant portion of a generation has emerged from, or is soon to emerge from college with few job prospects and massive student loans. Due to these circumstances, most graduates are not forming new households. They are the boomerang generation, returning to their parents’ homes. So while Boomers are retiring and downsizing, the Boomerangs are returning to the nest to lick their wounds and whittle away at their debt. So much for an imminent housing rebound leading us out of ‘recession’.
Further eroding our prospects for growth at home are two additional factors, 1) tight lending by the banks and 2) strangling anti-business policies and attitudes emanating from Washington, D.C.
So where are we today? Housing prices and the Dow stand at their 1999 levels, while food and energy prices have risen substantially, wages have remained flat, and the dollar’s value (buying power) has fallen. Yes, most of us (the 99%?) are regressing economically.
Through this summer we witnessed the failure of Congress to pass a budget deal (we’re in our third year without a Federal budget), and just this week we saw the utter failure of the Super Committee to address our deficits, once again punting on taking any responsible action to right our course. And the Super Committee was only charged with reducing the rate of increase in debt by 10% against the baseline (current trajectory is an increase of about 11 trillion in additional debt over ten years).
Right now the bond vigilantes are focused on the European sovereign debt crisis. Europe is the raging, out of control fire. But once contained (or post-implosion) the attention will turn to the United States. Be prepared for more debt monetization by the Fed and Treasury – QE3 (quantitative easing).
The meltdown at both sides of the Atlantic is imminent. Like a major fault line, the pressure builds and builds until finally it is overwhelmed and the result is a catastrophic earthquake. Should that occur in Europe, the resulting tsunami will reach our shores.
The central bank zombies and politicos may well find and implement another stopgap measure to delay the inevitable recognition of bankruptcy – we have since 2008. But the day of reckoning cannot be denied forever. Frederic Bastiat’s ‘great fiction’ will be exposed to the light of day. We will have to eventually live within our means and dispose of our accumulated debt either by overt default or stealth default the Weimer way (hyperinflation). Standards of living will fall precipitously throughout the western democracies. Draconian budgetary cuts will be made of necessity at every level of government and the impacts will be deeply felt. Taxes will skyrocket.
As I have written before, we still have a small window to affect a more controlled landing. But even beginning that process will take a very different Congress than we have today and a strong President willing to take very bold action. That work was begun in 2010 and must be followed through with similar results in 2012. Should we fail to elect conservative, responsible leadership in both houses of Congress and the Presidency in 2012, the bond vigilantes will surely visit our shores and we will be forced to pay debt service rates that more accurately reflect our risky financial condition.
I cannot predict the fallout of such a scenario. What I do know, though, is that if annual debt service is eating up a trillion dollars (the interest payments at a rate of 6.5%), something will have to give. Consider again that we are talking about extracting $750 billion from other areas of our Federal spending. To put that number in perspective, consider that we currently spend about $700 billion on defense and $800 billion on Medicare and Medicaid. Added together, these three categories would exhaust every payroll and income tax dollar currently collected. That would mean that there would be no funding for federal income supports (earned income tax credits, supplemental security income, food stamps, unemployment insurance, child care and child tax credits, child nutrition, foster care), education, housing, Social Security and more.
Think about the looting, property destruction and violence in London when the British government proposed college tuition increases and other moderate austerity measures. How would our citizens react to the elimination of the safety net expenditures listed above? My guess is it wouldn’t be pretty.
To date, demonstrators here at home (like OWS or the OneNation crowd) seem content to lobby government zombies to do the dirty work and take more from the producers to feed their needs and bellies. But government, under this scenario (more normalized interest rates), will be unable to extract enough from the “haves” to meet the demands of the “have-nots”. Will they (the have-nots) then choose to take it themselves? Will civil unrest, roaming gangs, and flash mobs become the new norm? And if such ugly possibilities begin to surface (as they have in countless societies in the past), how will our government react? What extreme measures might our leaders take?
I offer all this up only to encourage some heavy thinking about our future, about what may befall our country, and how all this may impact our individual lives and our family’s security. Might the government choose to confiscate all 401Ks and IRAs and replace them with a National Annuity Payment program? Such a plan was floated in the Clinton era. Or perhaps they would enact a one-time wealth tax to stem the bleeding?
Again, I cannot envision what further devastation our government is capable of or willing to do. Your guess is as good as mine. But one way or another our lives will change dramatically within the next few years, or next month, and it seems to me only prudent to plan for and prepare for a different American landscape.
As a final note, I will say I remain very cautiously optimistic that the American people feel and see the impending doom facing us, and may react responsibly and in sufficient numbers at their polling places in 2012. I pray we do. Perhaps with enough honest, constitutionally constrained and literate representatives in government, and a true leader in the White House, we can begin to restore some sanity to governance and fiscal policy – and avoid a total collapse of our system. For now, it is still up to us.