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Jan. 22 2010 - 10:12 am | 10,503 views | 2 recommendations | 10 comments

U.S. government, on its way to bankruptcy, Part 2

In Part 1 of this series, I made the case for a U.S. government that is quite literally out of control, a government that has committed to obligations so big, that unless policies change, it’s a government that’s on its way to bankruptcy.

Starting with the simple fact that the U.S. government has NO money, that it must tax Peter to spend it on Paul, I posited that in addition to the ever constant cry for more government spending in support of Paul, it’s the way the government taxes Peter that allows the government to spend so much on Paul.  Lay the bill bare and it’s likely Peter throws a fit.  But mask Paul’s true cost and it empowers the government to commit to obligations far beyond the ability of Peter to ever pay the bill.

I then introduced the 3 kinds of government tax forms – Tax Peter now, Tax Peter later and Tax Peter don’t tell him – and further posited that it is the latter two, Tax Peter later, better known as borrowing, and Tax Peter don’t tell him, namely the inflation tax, which have been instrumental in masking the true cost of Paul and putting the U.S. government and therefore Peter in a deep financial hole.

In Part 2 of this series, I will expand this discussion with facts, figures and charts.  I will demonstrate that the tab being run by the U.S. government is years in the making, regardless of which political party is in charge, and it’s going from bad to worse.  I will further demonstrate that the policy of deferring the costs of all this spending largesse, by Taxing Peter later via borrowing instead of Taxing Peter now, has helped create obligations so huge, a bill so big, that it may never be paid.  And finally, I will make the case that as a result of all this the U.S. government is on its way to bankruptcy, more than likely through a stealth default on those obligations via the Tax Peter don’t tell him policy of inflation.  In other words, by devaluing those obligations by printing money.

With that as an intro, if you have not yet read Part 1 of this series, I would encourage you to do so now.  You can find Part 1 of the series here.

———–

Part 2.  Peter’s bill, going from bad to worse to No Can Pay

Let’s begin this discussion with where it all starts, with government spending.

As we saw in Part 1 of this series, the U.S. government is spending itself silly.  The 50 year spending record is shown below:

RGovFin ESSAY_4314_image001

Official government spending for fiscal 2009, representing budget and off-budget appropriations, was $3.5 trillion.  That’s about 25% of GDP, the highest share of government spending relative to GDP in this 50 year study.  Yes it’s been with ups and downs, but it’s been a steady rise throughout this 50 year study, from a low of 17% in 1965 to today’s 25%.  And if you include the supplemental appropriations for the Iraq and Afghanistan wars and various other off-off-budget items, government spending clocks in even higher, at about $3.7 trillion or 26% of GDP.

If that’s not enough to give you pause, the recent acceleration in government spending will.  Take a look:

RGovFin ESSAY_4314_image002

In fiscal 2009, the year over year growth rate in official U.S. government spending was 18.2%, second only to the 23.4% year over year rate recorded in 1975.  And if you add in those off-off budget appropriations, that growth rate rises to 24%, the high for this 50 year study.

For sure, 2009 is not just a one year spike.  Rather, it’s indicative of a worsening trend that had it’s genesis at the turn of the century.  It began with a George W. Bush led government that decided that a few big stimulus packages, a war on Iraq and Afghanistan and a generally more gentle conservatism (meaning mega new safety nets like prescription drugs), not to mention a bailout of the financial industry, were must haves; and it was put into hyper-drive by an Obama administration and a supportive Congress that seem to think that every economic and social issue can be solved by the government.  Indeed, since 2000, government spending has been growing at an annual rate of about 8.5%, more than double the rate seen in the 1990s, and a trend that has taken government spending from about 18% of GDP in 2000 to today’s 26%, an increase of 44%.

The government cannot continue to grow at rates faster than the economy, forever.  Said more pointedly, the government can not continue to take from Peter, the producer, to spend on Paul, the consumer, at ever higher amounts, in perpetuity.  One must produce before one can consume, lest there is nothing left to consume.  Continue down this spend-now-ask-questions-later path and you eventually run out of Peters.  You eventually end up with a basket economy, with no one left to pay ANY bills.

With this in mind, let’s now move to the taxing side of this equation; i.e., how has the U.S. government been paying for all this spending.

First up, Tax Peter now taxes, more politely known as government receipts.  Here’s the 50 year record of government receipts against government spending:

RGovFin ESSAY_4314_image003

To say that receipts have tanked would be an understatement.  In fact, at a minus 16.6%, 2009 marks the biggest year over year decline in this 50 year study by a country mile.  Granted, receipts always weaken in a recession as unemployment grows and business profits shrink, but the fact is, except for a brief period around the turn of the century, when a Tech Bubble put a temporary charge in receipts , receipts have been lagging government spending throughout this 50 year study. And since 2000, those trends have picked up some real steam, witness the deteriorating deficit:

RGovFin ESSAY_4314_image004

To solidify the point, if one takes the ratio of receipts to spending, again putting aside the Tech Bubble spike, the long term trend is blatantly clear – receipts have not been keeping up with spending, with the last couple of years being a site to behold:

RGovFin ESSAY_4314_image005

At a ratio of 0.60 we have by far the lowest ratio of receipts to spending in this 50 year study.  And not to belabor the point, but if you include those off-off-budget appropriations, the ratio drops to 0.57.

As an individual, such a trend would likely give you reason to worry.  It would likely lead you into making some adjustments to your spending patterns.  Not so if you are a politician.  If you are a politician you keep spending, fund the excess of spending over receipts in the capital markets and then brag about all the wonderful things you’re doing for Paul.

Here’s the 50 year record of government borrowing versus government receipts:

RGovFin ESSAY_4314_image006

The fact is, when politicians deem it’s time to step up spending, it’s time to Tax Peter later.

Now, years of opting for the Tax Peter later venue has created quite a tab for Peter.  In Part 1, I touched on just how big a tab that was.  Now for the details, and with it the real meat of this discussion.

The cumulative impact of the Tax Peter later policy is embodied in what the U.S. government calls gross debt.  Here’s the 50 year record:

RGovFin ESSAY_4314_image007

And here’s the year over year growth rates:

RGovFin ESSAY_4314_image008

And finally here’s the 50 year trend versus GDP:

RGovFin ESSAY_4314_image009

Gross debt is growing right along with government spending.  At $12 trillion, it’s up 18.8% from 2008 and zipping along at an annual rate of about 8.5% since 2000.  At 84%, the ratio of gross debt to GDP is the highest in this 50 year study, and to underscore the acceleration since 2000, up 47% from the 57% of GDP seen in 2000.

To repeat, these trends are not sustainable.  The government can not continue to take from Peter, the producer, to spend on Paul, the consumer, at ever higher amounts, in perpetuity.  Eventually you run out of Peters.  Eventually there is no one left to pay the bills.

How close are we to running out of bill-paying Peters, you ask?  It’s hard to say, but the trends are anything but encouraging.  In fact, they are downright scary.

To see why, let’s have a look at the ratio of the U.S. government’s gross debt to receipts, in essence a measure of the amount of years it will take Peter to pay all those Tax Peter later taxes:

RGovFin ESSAY_4314_image010

Does this look like a healthy trend to you?  Peter is currently looking at a bill that based on 2009 receipts will take him close to 6 years to pay.  That’s a double from 2000 and by far the biggest burden in this 50 year study.

If 6 years doesn’t scare you then buckle up, because this is only the tip of the iceberg.  And I do mean tip.

Enter the U.S. government’s unfunded liabilities for social security, medicare and prescription drugs.  This is government spending to come, locked in by virtue of the commitments the U.S. government has made to Paul.  Despite what the politicians would have you believe, there is NO money anywhere in the government coffers for these commitments.  They are taxes yet to be, but taxes sure to come.  And whether they come in the form of a Tax Peter now, Tax Peter later or Tax Peter don’t tell him venue, they are coming, and they are coming in size.

As I discussed briefly in Part 1, depending on the source and calculation methodology, these unfunded liabilities are estimated to be anywhere from $50 trillion to $100 trillion.  Below is an itemized accounting, under representative best and worst case scenarios:

slide0001_image002

The representative best case scenario is sourced from the U.S. government’s latest 2008 Financial Report of the United States, roughly guesstimated by yours truly for 2009 exposures based on the increase in unfunded liabilities in 2008. The representative worst case scenario comes via US Debt Clock.org, a site dedicated to spreading the facts about the U.S. government’s financial status. Given that there are a number of other credible sources that track closer to US Debt Clock.org calculations than to the U.S. government’s calculations, you can probably guess which scenario I think is a more accurate representation of the cost of those unfunded liabilities.

With that in mind, adding unfunded liabilities to gross debt, we get the full picture of the U.S. government’s obligations and in turn Peter’s future bill:

slide0002_image004

Under the best case scenario, Peter’s in the hole for $65 trillion, 4.6 times GDP and 31 times 2009 government receipts.  Under the worst case scenario those obligations are a staggering $119 trillion, 8.4 times GDP and 57 times 2009 receipts.  That’s right, it will take Peter any where from 31 to 57 years to pay all the U.S. government’s obligations based on current tax receipts.

These obligation totals are surreal and they are growing at about $5 trillion best case, and at about $8 trillion worst case, per year.  That’s somewhere between a 35% to a 65% take of GDP.

This size of an obligation, one that’s growing at this kind of pace, can not be covered simply by upping Peter’s tax rate.  If tried, it wouldn’t be long before the economy simply collapsed under the tax burden.  And the claims by one politician after another that the U.S. can grow its way out of this financial hole are quite frankly bunk, especially if the government decides to take taxes rates higher.  The math simply does not work.

In a word, this bill is a burgeoning disaster.

Although political opinion is not the purview of The Contrarian Take, please allow me one short digression…

Perhaps, if our politicians had come clean long ago, and not tried to mask the true cost of Paul, perhaps then America would not be in this hole.  Perhaps Peter would not be stuck with such a huge bill, a bill he likely can never pay.  And even more importantly, perhaps Paul would not now be so dependent on Peter for a life style, indeed a level of security that he can not possibly keep.  But alas, that was not the case.  And it is a moral tragedy.

With that out of the way, let’s proceed.

As you know, there is a third option for the U.S. government, to make good on all these obligations.  It’s the Tax Peter don’t tell him venue, the inflation tax.  This venue is of course the politicians’ favorite taxing venue, and already in active use.  And with what the U.S. government now faces, it’s probably looking more and more attractive to those same politicians with each passing day.  In fact, short of reneging on the government’s obligations; namely, through outright default – by cutting spending or simply by defaulting on the government’s debt – those politicians, with the help of their accomplice, the Federal Reserve, could very well view the inflation tax as the ONLY way out of this mess.

In the meantime, before we reach this point, I anticipate a lot more borrowing, higher tax rates too and of course increasingly more inflation.  If you will, a delaying of the inevitable while the bill becomes even larger.  But the inflation tax as THE tax, the ONLY tax, I don’t think we are there quite yet.

In Part 3 of this series, the prospects for an acceleration in the inflation tax and what might need to happen first…


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  1. collapse expand

    Michael, thanks for another excellent column! When you have completed this series, I believe you should consider doing one on the “Federal” Reserve and/or “Central Banks” worldwide.
    There seems to me to be an incredible lack of awareness of the role ours and others play in the world economy. On the cautionary side, however, you would probably be wise to merely present information without actually advocating their elimination. (I remember how long President Kennedy lasted after having done so.)

  2. collapse expand

    Excellent column.

    I’m unclear though whether you see the current predicament as an inherited problem, or more recently having to do with strategic use of that problem.

    I mean, in the later case, are some planners within the Democratic Party employing something akin to the Cloward–Piven strategy?

    • collapse expand

      Hi octa,

      I’m not a political commentator. An economist/financial geek is what you get with me. Having said that…

      I think the “debt” problem the U.S. faces is one that’s year’s in the making, based on a belief that the free market is flawed and requires the government to step in and set it right. That sets the stage for politicians of both parties, supported by their special interests, to use the government’s power of coercion to do their bidding, well intentioned or not. And what bidding that is, where these politicians/special interests wish to spend money, doesn’t matter. It’s still taking money from the unsuspecting and giving it to the politically favored.

      Now, each intrusion into the economy by the government makes matters worse, economically, calling for yet more intervention, more spending. For sure, what seems common place now was seen as extreme 10 years ago, which is why it keeps getting worse and worse

      Some say that the recent anti Obama, anti Bernanke activity, in response to their extreme actions, is proof positive that things are about to change for the better. What I wonder is how much of this response is simply people saying – stop spending money on them, spend it on me instead. What I think we need to do is stop spending period, then figure out how we make the best of a terrible situation, clean up the mess, get the government out of the way and move forward from a solid base

      My sense is that things will continue to get worse and worse with each intervention until government/Fed policy finally ushers in some kind of U.S funding / currency crisis. My sense is we have reached the point of no return too – there will be some kind of crisis. The only thing in question is when and how big, with the longer it is delayed the worse it will be.

      What happens in response to this is anyone’s guess

      I will touch on some of these points in future posts

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

    I am glad you brought in Social Security and Medicare A,B & D into your analysis this time because they are only getting worse with the rising unemployment and dropping FICA tax receipts. I hope the current effort to keep helicopter Ben from another term will result in “No one” being his replacement and an end to the Fed and their printing press. I am hopeful people are finally starting to pay attention to these problems as evidenced by the number of views of your outstanding posts on these issues. Thank You.

  4. collapse expand

    Michael Pollaro,

    Let us take you proposition at face value, the US government is rapidly heading toward a financial meltdown. The question for me is how did this happen? I think that there a bunch of really smart and well trained economist and scholars, many whom who are well connected and powerful, who are well aware of the nature of the debt, deficit, taxation, &c and can do the math as well as you can. I do not believe that all of these folks suddenly got stupid. So why would people allow something like this to happen. More to the point, why aren’t these same same people not doing something to change this situation?

    The answer has to be that someone is making a lot of profits at it and that others are gaining politically.

    • collapse expand

      David,

      First, I did not say rapidly with respect to a meltdown. What I am saying is a bankruptcy is inevitable on the current course

      I agree, their are lots of Pauls and lots of politicians gaining at the expense of unsuspecting Peters. Politicians and their special interest Pauls are using the power of government coercion to do their bidding. And do these people know what they are doing and want to keep it going? Of course

      And there are also some well intentioned politicians and special interest groups who believe in managed economies, even socialism, and think you should just let them take care of you, because the government can do it better. They have no faith in the fact that the free market can always do it better and cheaper, if it is truly free

      Regarding the intelligence of economists. I’ll simply say that its not a matter of how smart you are but how educated you are. Most of these people just don’t get it. The mainstream economists are very bad economists because they went to the wrong classes, learned Keynesian and Monetarist economics and are now hopelessly lost in fallacies galore. Look no further then Bernanke ( I wrote an essay on him, my first post, listing some of the bigger fallacies he sees as facts). There are thousands like him, really smart, but just flat lost. Bernanke and his ilk had NO idea what was coming in 2007-08. witness the fact that they are advocating the same polices now as remedies. And they now have no idea what’s coming next

      Now, if the so called expert economists are out their validating the policy actions of politicians and special interest groups to Peter (which I agree are often cited by politicians to justify their positions), while at the same time deferring/hiding the costs from Peter, you have a recipe for a mess

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

        Mr. Pollaro,

        I do not think that this is literally a matter of personal corruption of politicians per se (although that of course happens). Rather I think that there is a much bigger set of problems. At the political end of things, “conservative” politicians have been since 1981 been running up huge deficits and cutting taxes while giving billions of dollars to their friends. This ties the hands of future administrations since they cannot then take any actions because of crippling debt and deficits.

        The other side are the investors. The US economy in 1981 was based mostly on industry and manufacturing. Now almost all of that is gone with most manufacturing having been “off shored” to other countries, most notably China. How can wealth be created in the US with only limited places to invest profitably? Stock manipulations, Ponzi schemes, and financial bubbles are the only “growth” industries left in the US.

        This is a very convenient convergence of interests. Conservative politicians are interested in creating crippling debt and deficits and Wall Street is looking for profits from financial shell games in lieu of actual investments. There really are not a lot of other options. It is not like an investor could get rich investing in a steel mill in this country. This is all that is left. At least they can make the rich richer, if no one else.

        So this is why we have a new liberal administration following the same disastrous policies of its conservative predecessors, it is the only game in town.

        In response to another comment. See in context »
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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.

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    Contributor Since: January 2010
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