Charlatan Exposed: Spiraling to Bankruptcy
NOTE: Originally published at www.metalaugmentor.com on December 2, 2009 at 7:30AM EST.
I am starting a new series of commentaries focused on the idiocy that passes for “market intelligence” and “informed thought” these days when it comes to the Internet. I believe this idiocy is quite dangerous to unsuspecting investors and thus it deserves to be exposed, and even ridiculed, when warranted. I will not be spending a lot of time on this stuff so the writing isn’t going to be very polished or formal. I will, however, consider requests so if you’d like to see a future Charlatan Exposed cover a particular topic please just leave a comment.
The first Charlatan Exposed goes to the blog “Monty Pelerin’s World”, which purports to examine “Economics, Finance and Politics through the Prism of Classical Liberalism”. Unfortunately, the blogger appears to be using a fact checker that consists of a “Prism of Obsidian Glass” in explaining how the United States is Spiraling to Bankruptcy.
Before getting to a few of the rotten details, let’s be clear that the general premise of this Monty Pelerin commentary is essentially correct in concluding that the debt level of the United States government, much less of U.S. consumers and businesses, is unsustainable. If these debts were called by creditors today, the United States would indeed be bankrupt. But that’s a big “if” and essentially an impractical way of looking at it. More relevant than the possibility of having debt called is the ability to service the debt according to its contractual terms. While projected debt levels in the U.S. certainly cannot be serviced in the long run, it is not a foregone conclusion that debt levels cannot return to serviceable levels without sovereign bankruptcy. For one, there are going to be a lot more individual (consumer and corporate) bankruptcies before things are over and done with and such bankruptcies will reduce debt levels. For two, private credit is going to be constrained, and consumer attitudes about credit have changed, for a long time into the future. For three, interest rate structures are going to remain under pressure for a while. For four, a certain amount of reflation has already been built into some asset prices (most notably gold) and this reflation will eventually transfer to some extent into other asset prices (most notably real estate). I’m not saying home prices will recover anytime soon to their crazy 2005-2007 peak, only that they will eventually recover to the point where most homeowners are back in the black in terms of equity.
In any case, the critical thing to consider is the ability to service debt, not absolute debt levels. But Monty Perelin unfortunately gets even the absolute debt levels wrong so there is no point to following his math to its logical conclusion.
Consider the following:
The Federal Government admits to over $12 Trillion dollars in debt. In reality, its obligations are multiples of that figure. The unfunded promises from Social Security and Medicare total around $100 trillion. That is, to properly fund the forecasted future deficits in Social Security and Medicare, $100 trillion would have to be put in the fund today. This liability is growing at the rate of about $5 trillion per year! The Government has promised benefits that they cannot honor. These programs are Ponzi schemes that make Bernie Madoff look like Mother Teresa. As evidence, the total net worth of the country (the country’s total assets less liabilities) is slightly above $50 trillion. If the Government confiscated everything, the programs would still be $50 trillion short and the Government would still be bankrupt. Furthermore, no company or individual would be left with anything.
Now, you should easily recognize how preposterous the above argument is on the face of it. Supposedly the United States has $100 trillion in unfunded promises but only $50 trillion in assets. But, those unfunded promises by definition are not liabilities payable today and they are not going to be paid from the sale of assets but rather from past, current and future employee contributions. This is no different from the idea that a business pays interest on debt not from selling its productive assets but rather by placing those assets into service for profit. Yes, there are major demographic and other issues that make it impossible for Social Security and Medicare to sustain current funding levels beyond another few years but minor reductions in benefits and/or minor increases in withholding rates would keep these programs solvent for a few years more. The looming entitlement situation is certainly a big problem that should have been resolved a long time ago but it is definitely not going to be the cause of the United States “spiraling to bankruptcy”.
In any case, those “unfunded promises” actually include past employee contributions amounting to approximately $2.5 trillion in U.S. Treasury securities that are being held by the Social Security Trust Funds as of October 2009. So, $2.5 trillion of the $12 trillion in U.S. government debt is essentially a wash. In fact, another $1.9 trillion in U.S. government debt is held by other government agencies such that the actual public debt is closer to $7.7 trillion as of November 30, 2009. Now that’s still a lot but it ain’t no $12 trillion.
Moreover, if we are going to talk about bankruptcy of an entire country then obviously we need to look at who actually holds the debt. If, for example, Tom owes Dick $100 and the debt is not repaid, then we don’t have an international U.S. dollar issue or a sovereign debt issue but rather the netting of an asset and a liability. Similarly, if Tom Corp. owes Dick Investor $100 in corporate bonds and the debt is not repaid, there are no international currency implications. In other words, what matters from a sovereign standpoint isn’t gross debt level but rather the amount of debt held externally by foreigners.
In the case of U.S. government debt, the foreign holdings are approximately $3.5 trillion as of September 2009. This is a lot, but it ain’t no $12 trillion. In sum total, the gross amount of U.S. debt held by foreigners including private U.S. debt and bank deposits is around $13.5 trillion as of June 2009. That is definitely a lot and obviously more than $12 trillion but it includes everything including the kitchen sink (or at least the loan on the kitchen sink). And while it’s true that $13.5 trillion is huge in absolute terms, it is a little less shocking when compared to the size of the U.S. economy. At under 100% of GDP, it turns out that U.S. external debt held by foreigners is by no means the largest in the world. For example, Germany has an external debt to GDP of 140% and Switzerland has 261%. Meanwhile, the UK comes in with an absolutely dismal 337%. You can get the most recent external debt figures here and GDP figures here. Obviously the reason to measure external debt in relation to GDP is that GDP is a pretty good proxy (though not perfect) of the size of an economy and therefore the potential ability to service debt.
Interestingly, the external debt ratios of many countries have actually been falling recently despite the financial crisis. In particular, the external debt of the United States fell from $13.7 trillion in March 2008 to $13.5 trillion in June 2009. I’m not sure this is what “spiraling” is supposed to look like. In any case, if the United States is on the verge of bankruptcy, what about Germany or Switzerland, much less the United Kingdom, France (174%) or even Hong Kong (300%)?
In conclusion, Monty Pelerin uses bad debt figures and a completely bogus measurement (that includes gross internally-held debt which is essentially a wash) to make the case for an impending United States sovereign bankruptcy. Yet what matters isn’t gross debt levels, much of which consist of internal assets and liabilities, but external debt owed to foreigners. And even then, the relevant measure is the percentage of foreign-held debt to GDP, which provides a reasonably accurate measure of ability to service debt. According to the external debt to GDP ratio, the United States is not even close to being in trouble compared to many other countries including most of Europe, Hong Kong and a smattering of other countries. Yes, if the United States continues to binge on debt as it did the past few years (although external debt has actually shrunk recently), it will certainly be a very big problem somewhere down the road, but to say — “Is the country heading for bankruptcy? Yes. Is there anyway to avoid this end? No! Not unless you repeal the laws of mathematics!” — is nothing more or less than the words of a charlatan.
One quibble. You said:
“In any case, those “unfunded promises” actually include past employee contributions amounting to approximately $2.5 trillion in U.S. Treasury securities that are being held by the Social Security Trust Funds as of October 2009. So, $2.5 trillion of the $12 trillion in U.S. government debt is essentially a wash.”
How is it a wash? The Trust fund will start needing to pay out (as soon as next year possibly), and the only way they can do it is by cashing in the IOUs from the Treasury, which in turn has to borrow that money in the market. Just because the debt is owed by one govt agency to another one (which in turn has obligations to retirees), doesn’t make it a wash. Rather it’s been a way of kicking the can down the road, but the obligations (and debt) are still there, unless Social Security defaults on its promises.
It’s a wash because the public debt held by the Trust funds is simply an accounting entry to recognize the fact that contributions do not sit in the fund as dollars waiting to be disbursed. To the extent the Trust funds are drawn down you would be right that we would need to count the debt but contrary to your claim that the fund assets will need to be paid out “as soon as next year possibly”, the truth is that even under negative scenarios the funds would be solvent for a couple of decades and thus any “pay out” would be gradual. At the moment the $2.5 trillion is a wash and certainly such amount is not part of an imminent “spiraling to bankruptcy” equation. There is some time left to deal with the problem and default is not contingent on repealing the “laws of mathematics”.
http://brucekrasting.blogspot.com/2009/11/oct-sstf-report.html
Social Security Trust Fund is in its 5th month of DEFICITS. Oct had a $4.2 Billion Deficit and Nov has been forecasted to be about $10 Billion. In the 5 months the SSTF has been running Deficits, it has racked up a total of $15 Billion in shortfalls.
Tom, you must remember, the IOU’s of pension plans, 401K’s, retirement plans, social security and all the rest are a source of REVENUE that allows the LEECH and SPEND ECONOMY to continue. 36 million people now get food stamps. Without this, we would have SOUP LINES just like during the DEPRESSION.
The only way the US ECONOMY can continue its LEECH AND SPEND SOCIETY is by increasing the PONZI SCHEME ad infinitum…..and we all know, that can only occur if the FED HYPERINFLATES. Without all these people getting their PAYCHECKS from the GOVT, the economy would disintegrate.
There are no bubbles left to BLOW SMOKE UP THE US ECONOMY’s AZZ. Time to wake up and smell the overpriced STARBUCKS coffee. The UNITED STATES wasted it post war wealth on spreading the SUBURBAN ECONOMY. Very similar to the GERMAN WAR MACHINE when it ran out of resources in WW2. German may have taken a great deal of land, but as all PONZI SCHEMES go, it never lasts.
The US ECONOMY has reached its peak. A FALLING EROI, PONZI FINANCE, DECLINING BENEFIS FROM COMPLEXITY, and CRIMINAL SYNDICATES RUNNING THE GOVT will take down the US EMPIRE. We of course can debate all day long about details that are in fact a FRUSTRATING SIDESHOW.
Time to get RELIGION and be in GOLD-SILVER BULLION, GUNS, BUTTER and LBJ - LAND-BULLETS-JESUS….HAHAHA….or whatever religious label makes you feel good.
The absolute debt is only part of the equation. What matters is how much comes due, when it comes due and what the lenders do.
In 2010, the USA will likely have $3+ Trillion of new debt to issue.
A 2 trillion 2010 deficit.
1.0 trillion from 2009 - almost all debt was short term.
0.5 trillion from previous years.
Can they refinance next year? Probably.
If interest rates rise, the burden will get greater and greater. I would not be surprized if the interest on the debt consumes almost 50% of the non SSI and medicare budget in 2011.
The USA can never pay back its debt. The question is: can it even pay the yearly interest in 2011+ ???
@eddy881
I don’t disagree with the premise that the USA can never pay back its debt. But it is true of almost every other country as well and in many cases even more so (most of Europe, Japan, etc). Much more difficult than managing massive debt is what China must face in order to bring its speculative economy to developed status. The odds that China has a soft landing are very low I’m afraid.
In any case, the 2010 U.S. deficit is likely to be lower than preliminary estimates ($1.5 trillion), not higher. The vast majority of debt issued in 2009 was 2, 5 and 10 year so most of what is coming due for reissuance in 2010 is not short term but rather older debt typically bearing higher interest rates. As long as rates stay low, refinancing maturing debt should be a net positive to the budget.
The trap that most people fall into, including myself on many occasions, is to believe that events will play out on a regular, terse time line toward some extreme or denouement along the current trend. Unfortunately (or fortunately as the case might be) things rarely turn out that way. Meanwhile, we all ignore black swan possibilities like climate destabilization that could lead to global famine as early as next decade. Debt levels would matter little when the priority of every person, every company and every government is how to produce enough food for the population to survive. In a country like China where about 60% of the population (750 million people) not only rely on agriculture for their livelihood but for personal food supply as well (they have no other source of income), the implications are staggering. It could be even worse for India.
In conclusion, the U.S. looks awful right now but it might turn out to be awfully pretty in comparison to the rest of the world. Especially if we get an ecological black swan in which case a country like China may have to use its $2 trillion of reserves just to keep its 70 million communist party members from starving to death or being beaten to death (few party members are farmers and the farmers are likely to engage in open rebellion against the Politburo).
I am new to this site. A friend referred me to it to rebut the very article you address. However, a close reading makes me skeptical of your refutation.
First, that you think climate destabilization leading to global famine is probable enough to make US bankruptcy pale in comparison makes you look like you are reaching. If anything, the next ten years are likely to be cooler than the past decade. And the climate change crowd has certainly lost their credibility.
Second, you seem to take comfort with the idea that although the US is in great trouble, many other countries are in even worse shape. This is supposed to make us feel better? How does Germany’s or Switzerland’s or UK’s worse situation do us any good? It seems that you are pointing to a global collapse rather than to a “no problem, what me worry?” scenario for the US.
Third, you don’t disagree that the US can never pay back its debt. Is that supposed to comfort us? Eventually all debts are liquidated, either by the debtor, the creditor, or the debasement of the currency. You did not merely say that the US, out of an economic choice, WOULD not pay back its debt. You said that it CAN NOT ever pay back its debt.
I am not sophisticated enough in economics to critique all your observations and comments about Perelin’s contentions. And I tend to believe that reports of the end of the world are highly exaggerated (to borrow from Mark Twain). But my simple minded common sense and my effort to make a close reading of both articles does not make me feel better.
Holy good points, Batman! Even with your skepticism of my refutation, you seem to agree that “reports of the end of the world are highly exaggerated”, which is precisely my point here. If it isn’t the end of the world, many gold and silver bug arguments go out the window, don’t they?
In any case, to address your three points:
(1) With whom has the climate change crowd lost its credibility? Certainly not the right wing and libertarians, with whom they never had any. Or is it with the public? If so, that is irrelevant as the public frankly cannot understand the science or statistics and therefore is going to be easily misled (by either side). Right now everybody is asking, where is the global warming?, as they freeze their asses off in North America and Europe. But, this regional cold is actually consistent with the climate models — many other regions are actually warmer than normal, including the Arctic, and there is some regional drought (see northern Amazon where Venezuela is being forced to curtail electricity due to reduced hydro utilization). Also, note that there are some strange happenings with the Gulf Stream and pressure over Greenland the past few weeks which appears to be in large part responsible for the cold spell. So, let’s not rush to a conclusion about climate change yet, okay?
(2) I don’t take “comfort” with the idea that the U.S. has big debt problems, I am simply stating that the U.S. is not in as big trouble as the “pro-gold, anti-dollar” crowd seems to think. As for the global collapse, it has already happened to a large extent although the next few years are going to be more painful for some countries than others. I argue elsewhere that the countries seeing more pain than less will be those which still have a huge amount of leverage, speculation and bubble economies, to include China.
(3) I am not trying to comfort anybody. Yes, “eventually” all debts are liquidated but there are always options along the way. The Pelerin guy says U.S. sovereign bankruptcy is a mathematical certainty, which is simply not true.
In conclusion, I think you are trying to read too much into my commentary here as I was only disputing a very narrow ideology, that the U.S. is “spiraling toward bankruptcy” based on the simple math of adding (and in many cases double-counting) the various public and private debts.