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Jan. 15 2010 - 10:30 am | 14,031 views | 3 recommendations | 15 comments

U.S. government, on its way to bankruptcy, Part 1

The U.S. government is quite literally out of control.

I’m not talking about a government which shows an almost total disregard for the U.S. Constitution.  I’m not talking about elitist politicians in Congress who think they know what’s best for you, who think it’s their job to take care of you from cradle to grave, whether you like it or not.  I’m not even talking about an administration whose policies sometimes appear to have more in common with the command and control societies of Benito Mussolini or Karl Marx than they do with the freedom loving societies of Thomas Jefferson and James Madison.

No, what I’m talking about is a government whose fiscal finances are a mess.  I’m talking about a government that, because of these policies, thinks nothing of spending what it does not have, of committing to obligations that it can not possibly keep, and then trying to stick someone else with the bill.

One of the basic tenets of Austrian Economics is that actions have consequences.  And when the government spends money, someone has to pick up the bill.

The fact is if you believe the U.S. government should be policing the world, that’s going to cost you.  If you believe the U.S. government should be providing unemployment insurance to the jobless, social security to the elderly, money for your kid’s education or medical care to everyone, that’s going to cost you too.  And if you believe the U.S. government had no other choice then to bail out AIG, Fannie Mae or General Motors, to supposedly save the economy, that’s fine.  But someone still has to pay the tab.

Over the next few posts, I will attempt to lay bare the facts of a government that is going to have a lot of trouble meeting its obligations.  In fact, these obligations, years in the making, are so big, that unless policies change, and fast, the tab the U.S. government is running will be so big that national bankruptcy is a certainty.  Not today.  Not tomorrow.  But it’s coming, and it’s as sure as death and taxes.

If you are an American taxpayer, a holder of U.S. government debt, or simply a holder of U.S. dollars take heed.  This is your bill.

Part 1.  Peter doesn’t know the half of it

Let’s start with some facts about U.S. government spending.

For the fiscal year ending September 2009, U.S. government spending, representing budget, off-budget and supplemental appropriations, was about $3.7 trillion dollars.  At 26% of GDP, excluding the World War II years 1942-1945, that’s the highest share of government spending relative to GDP on record.  For all the talk about the government not doing enough during this economic crisis, it’s instructive to note that this is 2.3 times the peak rate reached during the Great Depression and 3.3 times the average rate seen for the whole of the 1930s.

Quite simply, the U.S. government is spending itself silly. And by the looks of it, the Obama administration and this Congress, with their endless spending plans, are set to put this spending machine into overdrive.

So then, how will the U.S. government pay for all this spending?  Can the government foot the bill?

To answer these questions, it will be helpful to first understand how U.S. government spending got so big, and in so doing, set the stage for understanding why it will be impossible, unless policies change, for the government to foot that bill.

The U.S. government has NO money.  It takes money from Peter to spend it on Paul.  It takes money from Peter, whether Peter likes it or not, whether Peter receives something of value from the exchange or not.  It’s called a tax.  And the simple fact is government spending ALWAYS means government taxes.

Tell me something I don’t know, you say.  Well, yes and no, for here’s where it gets a bit tricky.

Besides the ever constant cry for more government spending in support of Paul, it’s the way in which the government taxes Peter that allows the government to spend so much on Paul.  Lay the bill bare and its likely Peter throws a fit.  But mask Paul’s true cost and maybe Peter will be, shall we say, more willing to support the government’s desire to spend money on Paul.

The U.S. government taxes Peter in 3 different ways:

- Tax Peter now

- Tax Peter later

- Tax Peter don’t tell him

Tax Peter now. This is the easy one for Peter to figure out.  These are the kind of taxes that are taken right out of Peter’s pocket, right in front of his eyes – taxes like income and capital gains taxes, social security and medicare taxes – the ones on his IRS forms.  The government has a more soothing name for these taxes.  They call them receipts.  Peter knows better.  And so do politicians.  They know that if they abuse this tax venue it will likely get them thrown out of office.

Tax Peter later.  This one is a bit harder for Peter to figure out, and as a result, a tax venue the politicians really like.  This is the U.S. treasury entering the capital markets and borrowing from the savers of the world, to fund the government’s spending.  This is treasury bills, notes and bonds.  Problem is this is nothing more than taxes deferred, and to add insult to injury, taxes with interest.  Peter’s kids will have to pay these taxes.  So maybe, the politicians think, Peter won’t notice, or at least they hope he won’t notice, until they’re out of office.  The government has a soft sounding name for these taxes too.  They call it borrowing.

And finally, every politician’s favorite tax, Tax Peter don’t tell him.  This is the hardest tax venue for Peter to figure out, and a subset of Tax Peter later, I mean borrowing.  This is the Federal Reserve entering the capital markets and buying those treasury bills, notes and bonds with money printed out of thin air, through a check the Federal Reserve writes on itself, so that the U.S. government can in turn take that money and spend it on Paul.  The government doesn’t have a name for these taxes, because they don’t want to talk about them.  We Austrians, we call these taxes the inflation tax.

Why, you ask, is printing money a tax on Peter?  How is this taking money from Peter to spend it on Paul?

Here’s why and how.

As the first recipient of this newly printed money, it appears that Paul is getting something for nothing. He gets unemployment benefits to buy food and clothes, subsidized medical care for his wife and free college educations for his kids.  Paul gets all this without having to do a thing in return, without having to produce anything.  He gets all this solely because he’s on the receiving end of the Federal Reserve’s printing press.  And the best part about it – it appears he’s getting all this without a dime from Peter.

And that’s exactly what our politician friends are hoping you think.  This, however, is only part one of the story.

Before long, because of Paul’s spending, this newly printed money makes it way into the hands of Peter.  Armed with this new purchasing power, Peter is now in a position to bid for these goods and services, right along with Paul.  The effect of this competitive bidding is to drive the prices of all these goods and services up – the prices of food, clothing, medical care and college educations.  The rise in the prices of these goods and services is slow at first, but as the newly printed money makes its way into the hands of more and more Peters, the prices of these goods and services rise to the full extent of the newly printed money.

For sure, in the end, everyone gets the same goods and services at the higher prices.  But as the first recipient of the newly printed money, Paul, for as long as it takes for the newly printed money to make its way into the hands of Peter, gets to buy these goods and services at the lower prices, in exchange for nothing.  Peter, on the other hand, gets nothing but higher prices.

Thus, Paul gets to steal purchasing power from Peter.  And it occurs without Peter even knowing it.  That’s why politicians love the inflation tax.  They get to hand out candy to Paul, all the while telling Peter, as well as Paul that the candy is free.

We Austrians can’t think of a more sinister tax.  Not only does printing money steal purchasing power from Peter for the benefit of Paul and produce higher prices, but when pursued without limit, it will eventually reduce the value of that money to zero, and with it, the hard earned savings of anyone holding that money.

You see, a government cannot print money, as a matter of policy, year after year, and expect people to want to hold that money forever, without question.  As the money printing policy proceeds, seeing prices rise and the value of that money fall, they will want to hold less of it.  The increased supply of money now combines with a decline in the demand for it causing the value of that money to fall further and for prices to rise even higher. And if this money printing policy is pushed to the extreme, when people come to realize that it is a deliberate policy with no end in sight, as they watch prices continue to rise and the value of that money continue to fall, they will come to want no part of that money.  They will exit that money en masse, with the inevitable result being its complete destruction.

This inflation tax is very nasty stuff, something that our politician friends obviously can’t depend on forever; that is, if they care about the value of the U.S. dollar, not to mention Peter, and even Paul’s hard earned savings.

Let’s now bring these concepts to life with a look at the U.S. government’s fiscal 2009 financials:

Spending                                                                              $3.7 trillion

Reciepts (Tax Peter now)                                               $2.1 trillion

Fiscal Surplus / Deficit                                                – $1.6 trillion

Borrowing $1.6 trillion, via

Capital Markets (Tax Peter later)                               $1.3 trillion

Federal Reserve (Tax Peter don’t tell him)            $0.3 trillion

Exactly as we would have surmised.  Not only do we have a boat load of spending, but it’s being financed by a lot of those hard to figure out taxes too.  At $1.6 trillion, about 45% of fiscal 2009’s spending was financed this way, with a dose of those nasty inflation taxes to boot.

No wonder why the U.S. government can spend so much money on Paul.  No wonder why spending was 26% of GDP in 2009 and both the Obama administration and Congress are still talking about more.  Peter literally doesn’t know the half of it.

Now, if all this was just a one year event, even this contrarian wouldn’t be too alarmed.  Unfortunately, this kind of stuff has been going on in Washington for years.  Because the government has been able to mask the cost of all this spending, deferring and hiding these costs through its borrowing and inflation tax venues, the U.S. government has taken on obligations that it likely can not keep.

How big are these obligations?

The U.S. government has gross debt outstanding, meaning years of Tax Peter later, of $12 trillion.   And depending on the source and calculation methodology, the U.S. government is on the hook for an additional $50 to $100 trillion more in unfunded liabilities.  Using $75 trillion as the proxy for unfunded liabilities, that’s debt plus unfunded liabilities of 6 times GDP and an eye-popping 41 times 2009 receipts.

And the trends are going from bad to worse.

How is the U.S. government going to honor these obligations? Can it even do it?  Is Peter able, willing and ready to pay higher taxes?  Will Paul be willing to do with less?  Or will the answer be the Federal Reserve’s printing press, and quite possibly the destruction of the U.S. dollar?

More on these trends, and answers to these questions beginning with my next post…

———-

I would like to thank Robert Pergament for his very helpful comments

Comments

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7 T/S Member Comments Called Out, 15 Total Comments
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  1. collapse expand

    Very well written article. You have a talent for explaining the issue. And I really like that shirt.

  2. collapse expand

    Speaking of Paul, read Ron Paul’s book “End the Fed” where he makes a case for many of your points in calling for an end to the Fed who got us into this mess.Great analysis,Michael!!

  3. collapse expand

    Federal workers pay has skyrocketed in this recession….rising from 14% to 19% of federal workers who get $100,000 salary’s plus overtime and benefits

    • collapse expand

      Yeah, it’s all the fault of federal workers and those studies of fruitfly mutations and cow flatulence. It’s never the fault of the really big ticket items, like wars, our lillypad military bases the stretch worldwide, weaponry R&D for things like Reagan’s Star Wars laser gizmos, and those minor splurges like Vietnam, Iraq, and Af/Pak.

      Look, I don’t mind people complaining about the pay and benefits packages for federal workers, but anyone who won’t look at our military and CIA expenditures is just being dishonest.

      In response to another comment. See in context »
      • collapse expand

        Our military expenditure is about equal to that obama stimulus package…where over $700 billion was completely wasted and not one private sector job created….the obama stimulus went to buy off local and state governments

        In response to another comment. See in context »
        • collapse expand

          Andy,

          Let’s try to stick to the facts and clarify your position. First the stimulus package does not spend $700 million yearly, nor does it expand by millions when generals casually ask for additional soldiers at one million apiece without finding the money in their already bloated budget. Second Obama has not spent but a fraction of the stimulus to date.

          If the military is off the table for cuts and if corportate welfare is off the table is off the table can we have an honest debate about cutting the budget?

          I have heard a great deal of nonsense about the Mommy party that coddles us from cradle to grave. Really, we get a large bill for that cradle, we get crappy under funded schools, mommy and daddy have to work and still can’t make ends meet, mommy and daddy’s jobs are being sent overseas, mommy and daddy voted in someone who will cut taxes and spend lots and lots of money. The adult Daddy Party feels it is responsible for the twin promotion of America as Savior and Protector of the World and Protector of Free Trade and China’s Prosperity.

          So if we were to cut spending without raising funds, ending all that is the Mommy party and its welfare state what are we left with? A military based economy that protects industry and banks. That sounds like something tried in the 1930s.

          In response to another comment. See in context »
  4. collapse expand

    Michael’s article is a great lesson presentation! It should be required reading for every civics and economics class in the Nation! Unfortunately though, I doubt that will happen within the Public School System…..only the home-schooled would ever see it.
    (I’m making copies and handing them out!)

  5. collapse expand

    Yes this writer is right
    I try to talk to libertarians about spending and they keep screaming back about taxes
    It seems they are okay with spending, but not taxes
    Supporters of the health bill counter with ‘we need compassion’
    The gov’t is planning to make us pay VAT or GST which is sales tax of about 15% in Europe&Canada..so we’ll then have Europes taxes without their benefits..

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    About Me

    I am a retired Investment Banking professional, most recently Chief Operating Officer for the Bank's Cash Equity Trading Division. I am a passionate free market economist in the Austrian School tradition, a great admirer of the US founding fathers Thomas Jefferson and James Madison and a private investor.

    See my profile »
    Followers: 33
    Contributor Since: January 2010
    Location:New York