David

Karki

Read David's bio and previous columns here

December 31, 2008

Happy New Debt!

It's customary at New Year's to look back at the year that's wrapping up, and especially forward to the year that's about to begin. Many of these predictions seem designed to elicit fear, and proffer doom and gloom. And more often than not, most of them turn out to be wrong.

In that spirit, what I present here will – I hope – not be based on fear, but rather factually demonstrate the scale of the problem we face.

The United States currently sits on more than $10 trillion in public debt, per official reports. This is due to decades of borrowing by Congress in order to spend like mad. And it has gotten significantly worse under President Bush and (up through 2006, at least) a Republican Congress that doubled it from $5 trillion to the current $10 trillion-plus figure.

But the problem doesn't stop there – the Federal government holds far more in obligations than what is officially reported. There are, in no particular order:

• The Medicare Part D prescription drug coverage entitlement, cost projections for which run as high as $11 trillion.

• The Fannie Mae/Freddie Mac credit market bailout, which comes to just over $5 trillion. Thanks to Sen. Chris Dodd (D-CT) and Rep. Barney Frank (D-MA) orchestrating the issuing of mortgages by lenders to borrowers who never should have received them, the taxpayer now holds all that worthless paper. The de facto nationalization of the credit industry that this represents, and the moral hazard it necessarily entails, is a subject for another column. Suffice it to say, $5 trillion would be merely the tip of the cost iceberg if we don't put a stop to what put us in this situation, rather than doing a whole lot more of it.

• Social Security and Medicare, which were already tens of trillions overdrawn. And that likely worthless paper will come due sooner rather than later, as the Social Security trust fund – which Congress has long since looted and spent – will be needed to start paying benefits when the Baby Boomer cohort starts retiring en masse. As the IOUs there will be of no intrinsic value without the cash to back them up, Congress will have to stop diverting these monies and either cut the programs that are funded by them or massively raise taxes to pay for both them and Social Security benefits.

By the time you add it all up, and get over the incomprehensibility of the monstrous enormity of the numbers involved (only distances between objects in outer space use figures as large), a plain reality is clear to see:  There isn't enough money in the universe to pay all this off legitimately. Taxes couldn't be raised high enough nor spending cut enough, and even if they could, entitlement transfers would be all the government would do as that cost swamped all other functions.

Nor would starting the printing presses at the U.S. Mint and letting them run 24/7, 365 days a year be enough. And doing so would spark a devaluation of the dollar that would wipe out people's life savings. What you thought would be enough to retire on would instead buy only a loaf of bread.

No, there is only one way this is going to end and the government to finally clear all this debt off its books once and for all. To some extent, perhaps a very large extent, much of this paper and many of these obligations are simply going to be defaulted upon as insolvency is reached. What you thought you were going to get – payment from a T-bill, note, bond or security; a retirement entitlement – you're simply not.

Consider it a macro version of a bankruptcy filing that allows past contracts to be re-done. In this case, the company being reorganized so it can survive is Uncle Sam. And its creditors, to whom it owes money, are all those who hold the paper it has issued. A good portion of this is held by foreign entities, with China, Japan and the United Kingdom the three largest holders. Who knows if they'll simply chalk up a lesson learned and accept the admittedly enormous write-off, or if their reaction will be more severe?

It may depend on the likelihood of repayment over time, just as a mortgage lender allows a borrower to re-finance at a lower interest rate. Better for them to accept incrementally smaller and slower re-payment from the homeowner than foreclose and get nothing at all. (Especially when the home has not much re-sale value.) By the same token, these countries could accept a similar arrangement.

We do have time to avoid much of this potential cataclysm. Retirement entitlements can and must be reformed, the credit markets taken off the fed's books, and Congress needs to stop spending like mad when they're already so far in the hole. But even if, by some miracle, all this happens, we are already $10 trillion-plus down this road. We aren't going to escape the consequences of having driven where we never should have. The only question is will we turn around, or stomp on the gas pedal?

With that, I bid you a Happy New Year.

© 2008 North Star Writers Group. May not be republished without permission.

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