How deep are we?

I was listening to the news yesterday when they mentioned the congressional debt commission had at least broached the subject of eliminating the mortgage deduction for home purchasers--an astonishing shift in political tides. I mean, that the topic was even mentioned as a possibility to bring government revenues slightly more in line with expenses.

After all, "It's a lot of money and we [i.e., the government] have an enormous deficit."

Yeah.

Except I was astonished at how much money the entire country's mortgage interest deductions equal. Something like $103 billion or $105 billion. Total.

That's over 7.7% (close to one thirteenth) of the current deficit--deficit! we're not talking debt, here! deficit. The government needs to find thirteen changes of this magnitude to puts its house in order.

But think of the impact on the U.S. economy that this one tiny change would make.

If the U.S. economy is in the tank right now while the federal government is "stimulating" it to the tune of $105 billion per year in income tax deductions on mortgage interest alone, where do you think it will be if and when they eliminate the deductions?

• If you are purchasing your home, would you be able to afford your mortgage if the income tax deduction were eliminated?
   
• If you could make your payments, do you think the price of your home would remain stable? Would it go up (so you could borrow equity) or would it go down (so if you are still "right side up" on your mortgage debt, you might find yourself "upside down"--owing more than your house is worth)?

I bring this up not to make a political statement either in favor of or against the proposal. Rather, I bring it up to point out that federal deficit spending is not without cost, it is not without pain.

I think, for many, the federal government's spending and tax collection has no impact on the economy. So what if they raise the debt ceiling? So what if they aren't collecting enough taxes to cover their expenses?

Well, the so what's are getting ready to come home to roost.

At some point, the debt really does have to be repaid. Somehow. Those who loan the money want it back. The Chinese will say, "No, no. You've borrowed enough. We're not sure you can pay back what you owe us already, so we're not going to loan you more. We're not going to buy any more of your bonds. You'll have to find someone else to loan you more money."

"But, but, but!!! There is no one else to lend us money!"

"Tough."

"Okay. Then we'll buy our own bonds, by creating more dollars. We'll engage in quantitative easing."

"Good luck!"

When we put it into these kinds of terms; when we see how only one thirteenth of the federal deficit (not debt!) is equal to the entire home mortgage interest deduction; when we realize how devastating it would be to eliminate the interest deduction: it should be obvious that federal deficits do have an impact on the economy.

Of course, that should have been clear, anyway.

So here's the question.

We see the riots occurring in France and Britain, in Greece and elsewhere around the world as people say, "No, no, no! You can't take my benefits, my expected retirement at 62 [or whatever]. You owe it to me." Do you think we will escape similar social dislocations here in the United States?

If we are afraid of the impact of reining in the deficit now, when our national debt is still officially less than $14 trillion (let us not speak of the unfunded liabilities!): do we seriously think there will be fewer or less significant social dislocations later on if we continue to dig ourselves further into the hole?

********

A few additional items of interest.

• According to USDebtClock.org, which keeps running tabs on all kinds of numbers like these I have been talking about, total interest per year per citizen of the U.S.--on all debts, both governmental and personal--is $10,541. That hit me. That's saying our economy faces a headwind of $10,541 in interest every year per person: before we can move forward one inch; before we can pay for anything new; before we can repair what we already own . . . we have to pay $10,541 per person in interest.
  
  That's quite a headwind!
  
  What could we do if we did not have that headwind working against us?
   
• The Dagong Global Credit Rating agency, what I understand is the official Chinese government credit rating agency, has downgraded U.S. debt. I.e., it has said it believes that purchasing U.S. bonds is more risky now than it was in the past. Moreover, it has also said the outlook for the future is "negative"--meaning that, unless something changes, the risks are only going to get worse . . . which means, in turn, that we can expect further downgrades in the future.
  
  And all of this means? Expect the U.S. government will have to pay higher interest rates on its debts. It will have to pay higher rates. It is the supplicant. It is the beggar. Beggars can't be choosers.
  
  See World Currency Watch for more.

I thought he was "green." So what's with the sudden move to open oil fields?

Perhaps you were as surprised as I was when President Obama announced his intentions to open huge new oil fields off the coast of the United States.

You can be sure of this, writes Keith Fitz-Gerald of Money Morning, it "has nothing to do with oil. It's all about the U.S. dollar."

Fitz-Gerald reminds us of a little British history from the early 1900s--when Britain was the world's most powerful country--to 1939--at which point "England had spent itself into oblivion and the pound sterling was being abandoned en masse by the international banking community - not to mention by the Crown's own subjects. To prevent a complete breakdown in global markets, the government made it an act of treason to use anything but the pound sterling to settle debts, while simultaneously implementing strict exchange-rate controls designed to prevent an all-out currency collapse"--to the present:

By the start of the 1970s, Britain was all but bankrupt and unable to sell long-term government bonds. . . .

So what saved Great Britain from oblivion? Many historians attribute this rebirth to the leadership of the dynamic Margaret Thatcher, and the proliferation of "Thatcherism." But the truth is that the catalyst for the United Kingdom's turnabout was the North Sea oil fields, which began pumping in earnest in the latter part of the 1970s - producing a trade surplus that helped engender new support for the pound in international markets.

By the way, in case you didn't see my post of February 21, or haven't been following the story since that time:

• Government bond auctions have continued weak and weaker and, as a result, interest rates continue to rise. Not yet front-page news, but don't be surprised when it gets there.
   
• Then there's the story of the national debt.
  
  Some commentators keep pointing out that the U.S. debt is relatively small compared to several other countries' debts as a percentage of GDP. And that is true.
  
  However, we have to look not only at total quantity of debt, but when the debt is due. And a large portion of the U.S.' debt is due very soon. As Porter Stansberry points out, the federal government has about $7 trillion of debt it needs to sell in the next 30 months. It's nice that the government is so eager to "supply" all that debt. The question is, is there enough demand from the market in order to swallow it all? At what price? (After all, when there is too much supply and too little demand, prices inevitably fall . . . which, in the bond markets, means interest rates rise.)
  
  I think it's time to say goodbye to low interest rates!
   
• And then, finally, what about exchange controls? (Did you note Keith Fitz-Gerald's comment about Great Britain in the early '70s?)
  
  Did you see this item in your local paper? Yep. The United States government is tightening the noose on freedom of commerce. As Tyler Durden suggests, the $17.5 billion Hiring Incentives to Restore Employment Act (H.R. 2487) ought really to have been called the Capital Controls Act. Durden concludes,
  

  [V]ery soon the only option US citizens have when it comes to investing their money, will be in government mandated retirement annuities, which will likely be the next step in the capital control escalation, which will culminate with every single free dollar required to be reinvested into the US, likely in the form of purchasing US Treasury emissions such as Treasuries, TIPS and other worthless pieces of paper.
  
  Congratulations bankrupt America - you are now one step closer to a thoroughly non-free market.

Who pays for what?

I caught this in World magazine (March 13 issue, p. 68) concerning the Greek debt crisis:

The most likely scenario is a bailout led by the Germans, but such a move is extremely unpopular in Germany. Greece's early retirement age is a big sticking point for Germans, who recently raised their own retirement age from 65 to 67. "The Greeks go onto the streets to protest against the increase of the pension age from 61 to 63," said the Frankfurter Allgemeine Zeitung newspaper in an editorial. "Does that mean that the Germans should in the future extend the working age from 67 to 69, so that the Greeks can enjoy their retirement?"

I think a similar question could be asked about U.S. debt.

Are the thrifty and self-denying Chinese and Indians (for example) supposed to permit Americans to renege on their impossible promises to repay--in good, uninflated money--the trillions of dollars of debt they (our government; we!) have already contracted? Are we Americans supposed to enjoy our "free" health care and Social Security retirement benefits and Medicare while the Chinese and Indians continue to labor for wages worth a fraction of what Americans receive?

Financial storms on the horizon?

Image by Voetmann via Flickr
I receive Gary North's Reality Check every weekday but read it only once every extreme once-in-a-while. And today was one of those once-in-a-whiles. Or, I should say, today I read Friday's "Reality Check." North said Storms on the Horizon by Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, is the scariest speech he has ever read, and "I have been reading speeches for a living for over 40 years."

Things are worse than I had imagined, and my scenario has been bad. This dwarfs my scenario. Coming from the person who delivered it, you had better take it seriously.

I have no further comments. Click. Print. Read.

Coming from Gary North--a guy known as "Scary Gary" for his rampant pessimism and doomsday scenarios--his comments are probably a bit of hyperbole. But maybe not.

Mr. Fisher's comments, certainly, merit attention. I think North is correct: "Coming from the person who delivered [them], you had better take [them] seriously."

Fisher, speaking on May 28th this year, said,

Eight years ago, our federal budget, crafted by a Democratic president and enacted by a Republican Congress, produced a fiscal surplus of $236 billion, the first surplus in almost 40 years and the highest nominal-dollar surplus in American history. While the Fed is scrupulously nonpartisan and nonpolitical, I mention this to emphasize that the deficit/debt issue knows no party and can be solved only by both parties working together. For a brief time, with surpluses projected into the future as far as the eye could see, economists and policymakers alike began to contemplate a bucolic future in which interest payments would form an ever-declining share of federal outlays, a future where Treasury bonds and debt-ceiling legislation would become dusty relics of a long-forgotten past. The Fed even had concerns about how open market operations would be conducted in a marketplace short of Treasury debt.

That utopian scenario did not last for long. Over the next seven years, federal spending grew at a 6.2 percent nominal annual rate while receipts grew at only 3.5 percent. Of course, certain areas of government, like national defense, had to spend more in the wake of 9/11. But nondefense discretionary spending actually rose 6.4 percent annually during this timeframe, outpacing the growth in total expenditures. Deficits soon returned, reaching an expected $410 billion for 2008—a $600 billion swing from where we were just eight years ago. This $410 billion estimate, by the way, was made before the recently passed farm bill and supplemental defense appropriation and without considering a proposed patch for the Alternative Minimum Tax—all measures that will lead to a further ballooning of government deficits.

In keeping with the tradition of rosy scenarios, official budget projections suggest this deficit will be relatively short-lived. They almost always do. According to the official calculus, following a second $400-billion-plus deficit in 2009, the red ink should fall to $160 billion in 2010 and $95 billion in 2011, and then the budget swings to a $48 billion surplus in 2012.

If you do the math, however, you might be forgiven for sensing that these felicitous projections look a tad dodgy. To reach the projected 2012 surplus, outlays are assumed to rise at a 2.4 percent nominal annual rate over the next four years—less than half as fast as they rose the previous seven years. Revenue is assumed to rise at a 6.7 percent nominal annual rate over the next four years—almost double the rate of the past seven years. Using spending and revenue growth rates that have actually prevailed in recent years, the 2012 surplus quickly evaporates and becomes a deficit, potentially of several hundred billion dollars.

He goes on to outline how pessimists have usually fingered the unfunded liabilities of the Social Security system as one of the key factors we need to beware of in the not-so-distant future. But "Social Security is the lesser of our entitlement worries. It is but the tip of the unfunded liability iceberg. The much bigger concern is Medicare," he says.

The amount of money the Social Security system would need today to cover all unfunded liabilities from now on—what fiscal economists call the “infinite horizon discounted value” of what has already been promised recipients but has no funding mechanism currently in place—is $13.6 trillion, an amount slightly less than the annual gross domestic product of the United States. . . .

The infinite-horizon present discounted value of the unfunded liability for Medicare A [what covers hospital stays] is $34.4 trillion. The unfunded liability of Medicare B [which covers visits to the doctor] is an additional $34 trillion. The shortfall for Medicare D [the drug benefit that went into effect not quite three years ago, under the pressure of our current president] adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy.

Add Medicare to Social Security, and, between those items alone, you have a total unfunded liability of $99.2 trillion.

Let’s say you and I and Bruce Ericson and every U.S. citizen who is alive today decided to fully address this unfunded liability through lump-sum payments from our own pocketbooks, so that all of us and all future generations could be secure in the knowledge that we and they would receive promised benefits in perpetuity. How much would we have to pay if we split the tab? Again, the math is painful. With a total population of 304 million, from infants to the elderly, the per-person payment to the federal treasury would come to $330,000. This comes to $1.3 million per family of four—over 25 times the average household’s income.

Obviously, that's not going to happen.

So what else can we do?

[A] permanent 68 percent increase in federal income tax revenue—from individual and corporate taxpayers—would suffice to fully fund our entitlement programs. Or we could instead divert 68 percent of current income-tax revenues from their intended uses to the entitlement system, which would accomplish the same thing.

Wouldn't that be great? Maybe!

Suppose we decided to tackle the issue solely on the spending side. It turns out that total discretionary spending in the federal budget, if maintained at its current share of GDP in perpetuity, is 3 percent larger than the entitlement shortfall. So all we would have to do to fully fund our nation’s entitlement programs would be to cut discretionary spending by 97 percent. But . . . discretionary spending includes defense and national security, education, the environment and many other areas, not just those controversial earmarks that make the evening news. All of them would have to be cut--almost eliminated, really--to tackle this problem through discretionary spending. . . .

[J]ust to drive an important point home, these spending cuts or tax increases would need to be made immediately and maintained in perpetuity to solve the entitlement deficit problem. Discretionary spending would have to be reduced by 97 percent not only for our generation, but for our children and their children and every generation of children to come. And similarly on the taxation side, income tax revenue would have to rise 68 percent and remain that high forever. . . .

No combination of tax hikes and spending cuts, though, will change the total burden borne by current and future generations. For the existing unfunded liabilities to be covered, . . . someone must pay $99.2 trillion. , , , This is a cold, hard fact. The decision we must make is whether to shoulder a substantial portion of that burden today or compel future generations to bear its full weight. . . .

[L]et me come back to monetary policy and the Fed.

It is only natural to cast about for a solution--any solution--to avoid the fiscal pain we know is necessary because we succumbed to complacency and put off dealing with this looming fiscal disaster. Throughout history, many nations, when confronted by sizable debts they were unable or unwilling to repay, have seized upon an apparently painless solution to this dilemma: monetization. Just have the monetary authority run cash off the printing presses until the debt is repaid, the story goes, then promise to be responsible from that point on and hope your sins will be forgiven by God and Milton Friedman and everyone else.

We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid.

So what should we do?

I found it interesting that Fisher never mentioned a "solution" that I've been scared our government will choose: attempt to extort concessions--"forgiveness of debt"--from other nations through war. How awful would that be?

Fisher concludes,

Purging rampant inflation and a debased currency requires administering a harsh medicine. . . .

Failing to face up to our responsibility will produce the mother of all financial storms. The warning signals have been flashing for years, but we find it easier to ignore them than to take action. Will we take the painful fiscal steps necessary to prevent the storm by reducing and eventually eliminating our fiscal imbalances? That depends on you.

I mean “you” literally. . . . When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them. You are the ones who let them get away with burdening your children and grandchildren rather than yourselves with the bill for your entitlement programs. . . .

When George Shultz, one of San Francisco’s greatest Republican public servants, was director of President Nixon’s Office of Management and Budget, he became worried about the amount of money Congress was proposing to spend. After some nights of tossing and turning, he called legendary staffer Sam Cohen into his office. Cohen had a long memory of budget matters and knew every zig and zag of budget history. “Sam,” Shultz asked, “tell me something just between you and me. Is there any difference between Republicans and Democrats when it comes to spending money?” Cohen looked at him, furrowed his brow and, after thinking about it, replied, “Mr. Shultz, there is only one difference: Democrats enjoy it more.”

Yet no one, Democrat or Republican, . . . wants to see the frightful storm of unfunded long-term liabilities destroy our economy or threaten the independence and authority of our central bank or tear our currency asunder.

Of late, we have heard many complaints about the weakness of the dollar against the euro and other currencies. It was recently argued in the op-ed pages of the Financial Times that one reason for the demise of the British pound was the need to liquidate England’s international reserves to pay off the costs of the Great Wars. In the end, the pound, it was essentially argued, was sunk by the kaiser’s army and Hitler’s bombs. Right now, we--you and I--are launching fiscal bombs against ourselves. You have it in your power as the electors of our fiscal authorities to prevent this destruction. Please do so.

Are you ready to do your civic duty and say no to any candidate who is unwilling to say no to further deficit spending and who is unwilling to say yes to massive cuts in federal entitlements?

If not, who do you expect to to bring the federal deficit under control and the debt back to a level that can actually be managed? And by what means do you think the deficit is to be cut and the debt to be retired?

Debt, Purpose, Joy and Giving

Back to my conversation with Jim.

At one point we were talking about a class our church was about to sponsor intended to help members handle their finances more wisely.

Jim said something like, "John, you are in a unique position in the church in your ability to give. Most people don't have funds that they can set aside for giving. They are so far in debt . . . "

"Why are they in debt?" I asked.

There are lots of reasons people fall into debt. Many are beyond their control.

Yet I think one great reason is because they have never thought of their purpose. They can't think beyond themselves: "What's in it for me?" "What will please me?" . . . So every time they see something that they think will give them pleasure [see, for example, my post on the Tesla car], they go out and buy it. Then they get into debt.

I wish people were challenged with the bigger picture of what God is doing around the world! Kind of like the way St. Paul talks about stealing. We normally contrast stealing and not stealing. He actually contrasts stealing and giving--you're either involved in positive contributions to the world around you, or you're involved, it seems, in taking from the world. But you're never neutral. Apparently.

Let him who steals steal no longer; but rather let him labor, performing with his own hands what is good, in order that he may have something to share with him who has need. (Ephesians 4:28; NASB)

--It is so striking to me: all the subjects I have been writing about recently are so intimately intertwined: purpose, joy, giving, our ability to give . . .