Why The Government and The Economy Will Collapse (+3K Views)

Lorimer Wilson August 26, 2012 Comments Off on Why The Government and The Economy Will Collapse (+3K Views) 4,004 Views

Most people don’t understand the unsolvable problem the US government has created for itself and its citizens. Sovereign default is beyond a likelihood; it is inevitable. When and which (possibly all) obligations are defaulted on are to be determined. Panicked political decisions, likely in the near future, will produce a complete financial and economic collapse. Hopefully that is the worst that will occur.

Official Government Debt

The official federal debt is $16 Trillion. This debt represents 100% of current GDP. Ken Rogoff and Carmen Reinhart studied countries with high levels of government debt. This Time Is Different: Eight Centuries of Financial Folly, their well-acclaimed book, contains their findings. The authors concluded:

In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth. Our results are based on a data set of public debt covering 44 countries for up to 200 years. The annual data set incorporates more than 3,700 observations spanning a wide range of political and historical circumstances, legal structures and monetary regimes.

Elsewhere, the authors state:

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP.

The US has passed their danger point and recent US GDP experience conforms to their findings. The economy is growing at subnormal rates, despite unprecedented stimulus efforts. A recent Rasmussen survey found that only 27% believe the economy is improving.

Actual Government Liabilities

Debt problems in the US are worse than stated, much worse. Three areas shed light on the problem:

The Glide Path
Treasury Obligations
Unfunded Liabilities

Each is discussed below.

1. The Glide Path

The glide path of expected spending and revenues indicates that the debt problem will get worse. While forecasting may be a fool’s errand, especially when extended ten years out into the future, the CBO estimates (under their alternative budget):

Under that alternative fiscal scenario, far larger deficits and much greater debt would result than are shown in CBO’s baseline. Deficits would average 5.4 percent of GDP over the 2013–2022 period, rather than the 1.5 percent reflected in CBO’s baseline projections.

The assumptions supporting these numbers are suspect meaning the estimate could be off either way, possibly by large amounts. Assumed interest rates (a very important variable with regard to government expenditures), employment rates, the resolution of the European crisis, resolution of existing banking problems, etc. etc. are difficult to accurately forecast. So too are political biases and future economic policies which may alter outcomes.

If deficits do average 5.4% of GDP over the ten year period, the debt to GDP ratio will worsen because GDP growth typically averages much less over a long period.

The Paul Ryan Budget Plan is every bit as subject to assumption risks as the CBO forecast. It may be more susceptible to political risk according to David Stockman (obviously not a fan of the plan):

Mr. Ryan’s plan is devoid of credible math or hard policy choices. And it couldn’t pass even if Republicans were to take the presidency and both houses of Congress. Mr. Romney and Mr. Ryan have no plan to take on Wall Street, the Fed, the military-industrial complex, social insurance or the nation’s fiscal calamity and no plan to revive capitalist prosperity — just empty sermons.

The Ryan budget, if achieved, would not stop the rise in government debt, although it would slow the rate of increase. Under his plan debt rises by $3 Trillion. That compares favorably with other plans, e.g., Obama’s plan increases debt by almost $7 Trillion and the size of government even more, covering higher spending with increased taxes. The Ryan Plan does not end deficits but could result in GDP growing at a faster rate than debt, lowering somewhat the ratio of debt to GDP.

2. Treasury Obligations

In addition to the debt of $16 Trillion, the Treasury has explicitly guaranteed the debts of certain government agencies. Furthermore, it undoubtedly would underwrite the failure of certain other agencies or private entities as demonstrated by bank and auto bailouts. How much this could add to the Federal debt over the next several years is a function of what happens in the economy.

The Treasury nationalized Fannie Mae and Freddie Mac, effectively guaranteeing $6 Trillion of debt not yet recognized on government’s balance sheet. A host of other government agencies probably would be backed by Treasury as necessary. These include the Postal Service, Amtrak, the Federal Deposit Insurance Agency, the Pension Benefit Guaranty Corporation and others. Arguably every one of these entities is bankrupt and will need assistance before the economic crisis terminates.

The pension problem in this country is enormous. For example, General Motors and Chrysler are estimated to have a potential $42 billion liability for the PBGC. At the end of 2009, the exposure of this agency was estimated to be $168 billion. A recent estimate suggests that private pension plans are underfunded by $435 billion, a number that could worsen dramatically if financial markets do not improve. Public sector pensions are estimated to be over a Trillion dollars underfunded.

The FDIC has virtually no funds to bail out depositors in the event of bank failures.

These shortfalls are likely to be covered by the federal government, although none are recognized as potential government debt. Furthermore, in a world where everything is collapsing, government attempts to keep the system going may be unbounded, including involvement in European bailouts.

3. Unfunded Liabilities

The unfunded liabilities of the federal government are enormous, dwarfing everything else. They arise from promises made to citizens, primarily with respect to Social Security and Medicare. The government maintains it has no legal liability to honor these promises, hence does not recognize these obligations as debt. For seniors or near-to-be seniors that attitude should not be comforting.

It is unlikely that these programs will be cancelled, although they will eventually be altered.

Estimates of the present value of these obligations range from lows of $50 Trillion to over $200 Trillion, depending upon the actuarial and return assumptions made. Gary North uses Laurence Kotlifkoff’s figures and explains the calculation (my emboldening):

The total obligation of the federal government to voters that is not funded at the present time is now $222 trillion. This does not mean that, over the entire life of the program, the government will be short $220 trillion. It means that the present value of the unfunded liability is $220 trillion. This means that the government would have to set aside $220 trillion immediately, invest this money in non-government projects that will pay a positive rate of return, and will therefore fund the amortization of this debt. I have written about the estimate here.

This estimate is 14 times what government reports as debt ($16 Trillion). The number itself is unfathomable. To put it into perspective, the entire net worth of the US is estimated to be only about $60 Trillion, as shown in this chart:

According to Kotlikoff’s calculations, the US government has promised its citizens almost four times the entire net worth of the nation. If the government confiscated everyone’s net worth, people would be left penniless and the government would still be unable to fund these promises.

At the risk of confusing readers, the annual government deficit using Generally Accepted Accounting Principles (GAAP) is $11 Trillion per year, not the $1.3 Trillion that will be reported. Kotlikoff’s calculations of the unfunded liabilities may be high. Other estimates are lower, but not enough to alter the conclusion that the US is hopelessly broke. Gary North comments on lower estimates:

Even if Kotlikoff is wrong by a hundred trillion dollars, it becomes clear that Congress is completely incapable of dealing politically with this problem. It could not possibly raise the funds to balance the budget if the budget really is increasing by, say, $5 trillion per year [GAAP calculation].

Conclusion

The claimed debt of the Federal Government of $16 Trillion is enough to threaten its viability and that of the US economy. The current glide path of spending and revenues ensures that debt will increase. Explicit and implicit Treasury guarantees will be required to bail out failing public and private agencies. The situation becomes hopeless when the unfunded liabilities are taken into account.

Buckle up for a very scary ride.

A version of this article originally appeared on American Thinker earlier today.