Cut Their Throats

The Gross Federal Debt ^₪ is now over 100% of GDP. This has only happened once before, during WWII. We outgrew it after WWII because we were the only game in town. Now we’re in peacetime.

Federal tax revenues in the U.S. have stayed at an amazingly constant 18% of GDP ^₪ in good times and bad, war and peace, low and high inflation; under Republicans, Democrats, tax reforms, tax cuts and tax increases. For 70 years.

It’s not unreasonable to believe that attempts to raise taxes above 20% of GDP will be counter-productive. Tax revenues drop instead of rise.

That’s the limit to the Federal rolling debt scam (i.e., issuing new debt to pay the interest on the old). When interest payments on the Federal debt exceed ~20% of GDP we enter into an unstoppable debt escalation: one that can never be paid down. Mathematically. Default or inflation are the only options.

Today we’re at 2.6%. Whew!

Cut Their Throats
Not So Fast!
Default
Inflation
Avoidance
Contingency
Commentary

Not So Fast!

We’re not paying down the debt. That 2.6% rises each year. In 2014 it’s 2.9%, in 2015 it’s 3.8%, etc.

Keep the math simple. GDP now equals debt. All new tax revenues from GDP growth will get eaten up by the growth in interest payments on the existing debt. There is no plausible scenario where we can outgrow today’s debt burden.^[1]

Add $3-4 trillion in further debt each year for the 80 million baby boomers coming into retirement. At 5% this adds $150‑200 billion each year to interest payments, compounded. These interest payments get added to the debt.

Oh, and we’re currently running an annual deficit over $1 trillion per year.

We reach unstoppable debt escalation in about 15 years. May seem like a long way off. But the financial markets will not tolerate anything near this point of no return. Foreign creditors will precipitously draw down their dollar holdings to speed up the timeline. Ten years? Five Years?

You can’t borrow your way out of this mess. You can’t pay your way out. Default or Inflation?

Default

Can’t happen. There’s no one to bail us out. It would plunge the world into a financial devastation like none ever seen. The world economy would essentially come to a standstill perhaps leading to global war.

Inflation

The most likely scenario. As long as the markets stay calm nothing happens. But everyone’s nervous. Any little bruit starts a stampede.

We’ll see rolling crises where the Fed has to inject $1 trillion from time to time to stop the stampedes. Each new crisis happens overnight with little or no warning. They come sporadically at first and then accelerate.

We’re looking at very uncertain times. Interest rates and inflation skyrocket; GDP plummets; economic crises multiply; job-crushing hidden taxes proliferate; more government debt is issued to cushion the burgeoning poor; unemployment easily tops 20-25%. The middle class finally learns to stop trusting their savings to Wall Street, leading to a collapse in capital formation and investments. Hoarding and barter become the norm.

Not pretty but perhaps not the end of the world.

Avoidance

Insist everyone take a bath now before it’s too late. Beneficiaries, creditors, taxpayers.^[2]

Beneficiaries because they didn’t pay enough taxes to cover expected benefits.
Creditors because they weren’t careful enough as to the long term risks of lending to the Feds.
Taxpayers because they didn’t pay enough to cover annual deficits, or push hard enough on politicians to stop their spending.

First the Feds have to cut up the credit cards to make sure this doesn’t happen again. Then we deliberately engineer a (semi-) controlled financial crisis. Raise taxes to 20% of GDP. Renege on 20% of debt principle. Reduce benefits by 20%. We must take this medicine now, in the midst of a recession.

There’s not enough political leadership in all of Washington DC combined to make this happen.

It’s already too late. Last one holding dollars please turn out the lights.^[3]

Contingency

Set up an alternate industrial currency similar to the WIR currency in Switzerland. When the crash comes at least industry can continue unabated. This currency must be completely divorced from all Federal involvement and from the dollar. Perhaps the Swiss will let us join their bank.

Commentary

You can feel sorry for honest, patriotic Americans who worked hard, kept a tight budget, saved and sacrificed for their kids’ future. The Feds stole their credit card and went on a spending spree. And now the bill’s coming due.

I feel no sympathy. I repeat, I feel no sympathy! The German people chose their fate. That may surprise some people. Don’t fool yourself. We didn’t force the German people. They gave us a mandate, and now their little throats are being cut! – Goebbels ^₪

The warnings on debt have been sounded for over a decade. The American people chose their fate. They listened to those who told them what they wanted to hear.

Now the knife is at their throats.^[4]

1. GDP growth was sustainably above 10% in the decade after WWII which allowed us to outgrow that debt burden. Since 1985 GDP growth has rarely and only slightly exceeded 5%. My math assumes interest rates will track with GDP growth, both rising to about 5%. GDP growth in 2013 was 1.9% ^₪ versus 2.6% for interest rates. The complexity comes from divining how the Fed and Treasury could meddle in the economy to keep today’s historically low interest rates low (2.6%) while growing GDP even higher. For further economic statistics see: Historicals ^₪

2. Since tax revenues have always been near the maximum 20% of GDP this points to a spending problem rather than a tax revenue problem. We’re not getting the returns (i.e., GDP growth) on tax investments that justify recent levels of Federal spend. Since all parties benefited in the past from over-extravagant spending all must pay back for that extravagance.

3. I know a very elegant alternative but it only works when it’s not public knowledge. Hint: as a nation do we really need that piece of real estate we call Manhattan?

4. The smart money will bulk up on cheap long-term debt (with inflated dollars it’ll cost almost nothing to repay) and buy commodities for the coming barter economy.