Are We Broke? It Couldn’t Happen Here. Could It? (Part 4 of a Series)

April 7, 2010
By John

(This is another in a series of postings about the size of US liabilities, their implications for our economy and personal wealth, and a path out of the mess we are in.)

In prior postings of the “Are We Broke?” series, we discussed the impact the recession has had on household wealth, the rapid growth of our indebtedness and the simultaneous reduction of our debt service capacity, signs that the financial markets are reassessing the riskiness of US debt, the financial and political/moral costs of nationalized healthcare in the US – and what it really means to be broke and/or bankrupt.

In this post, we’ll consider the practical question of whether it is actually possible for America to be broke – and even go bankrupt.  And we will make the case that we are already broke, and that an American bankruptcy is not only possible – it is likely and will be enabled by the same factors that made us a dominant economic power in the first place.  In subsequent posts, we’ll ask how much collateral we have to forestall a potential bankruptcy, how much we actually owe, and propose a plan to restore our economic vitality and fiscal balance before it is too late.

America Is Too Big to Fail.  Until We Fail.

Let’s face it, it is hard to imagine America going broke (when your current bills exceed your current income, you’re broke).  We hear pundits and politicians tell us it just can’t happen here – ‘we’re just too rich.’, ‘we can always print the money we need’, and ‘we’re too important to the trading system’ to fail.  But the truth is we are running a national deficit of about a trillion and a half dollars per year (over 10% of GDP in 2009 and 2010, at least) and our incomes aren’t growing enough to pay it back within our lifetimes, or those of our children or grandchildren for that matter.  Federal budget deficits are expected to exceed a trillion dollars per year for decades to come, and our leaders tell us that unemployment and slow growth will persist for an extended period.   And that doesn’t count the tens of trillions of unfunded, off-balance-sheet liabilities that are hidden from public view, or the dead weight loss we are experiencing in our retirement funds and other investments.

Yes, we are broke.  It isn’t really a question any more – it’s a fact.

Note:  The Federal Reserve Bank of St. Louis published a paper by Laurence J. Kotlikoff, an Economics Professor at BU and a researcher at the NBER, in 2006 that confirms we were already broke back then – and that was over $4-trillion in public debt ago….

Ok.  So we’re broke.  So what?  We can keep borrowing until things turn around, right?

Party Like It's the End of the World?

It isn’t possible that America could actually go bankrupt, is it? (You’re bankrupt s when your bills exceed your current income plus your expected future income growth plus your savings plus your borrowing capacity).   We just have too many assets and too much wealth to actually default on our debts, don’t we?  We have a printing press, don’t we?  We could just print the money we owe and they’d take it, right?  Or we could tax and liquidate our assets, couldn’t we?

It is really hard for ‘ordinary’ nations to go bankrupt because there are so many forces that prevent them from doing so.  Creditors will tighten the reins by raising rates and reducing lending.  International agencies will step in with loans and force spending restraint.  Some countries can print money for a while – but traders and business people normally have the option of using other currencies to transact – and thereby force nations to behave more responsibly.  Taken together, such forces make over-leveraged, over-spending nations either reduce their largesse, or raise taxes, or both, to get control of their balance sheet and protect their debt service capacity.

But it is hard to see who could force such conditions upon the United States.  There just isn’t anybody strong enough, large enough, independent enough, and gutsy enough to call our bluff.  So we need to ask a question – could America escape normal market disciplines, and keep spending and borrowing trillions more than would normally be possible?  Could our very strength and size prevent market forces from stopping the madness before we pass a point of no return?  Could we and our ‘partners’ be sucked into a maelstrom of bad paper and failed currencies?  Is global – not just US – bankruptcy on the horizon?

US and World Locked in Fatal Debt Embrace

It is Rough Truths’ view that America could indeed be allowed to go too far – and that we are in fact likely to go bankrupt if we do not change course.  We can sell our assets , increase taxes on a stagnant economy and print even more money (we have already printed over $2-trillion in cash in the last decade) to fund our debt service costs for a while.  But the laws of physics – and their corollaries in economics – still apply, and at some point it will become obvious we cannot purchase something with nothing.  But we could overwhelm the world’s financial system by the time we reach that epiphany, and drag everyone down with us.

One World in Debt

The reasons we can go too far are simple – and the implications are horrific.  The primary reason is that the dollar is the world’s only reserve currency.  While this is usually cited as a key reason we cannot fail, it is also a double-edged sword that could topple us and those dependent upon it.  And every nation and business in the world depends – directly or indirectly – upon the dollar.  The simple fact is that the world is so vested in the dollar’s survival (and US spending) that other nations must buy our debt or risk the collapse of their own balance sheets and economies.   And the more US debt they buy and dollars they use, the more entwined our fates become.

  • The dollar is the primary trading and settlement vehicle for all commodities around the globe – including oil – and most financial instruments.  The dollar is understood, liquid and reliable.  Well, it always has been.
  • Ours is the currency that multi-national companies – and other nations – most often use to when contracting across borders.  Its stability and liquidity have offered tremendous utility to everyone for many decades – and now they cannot escape its fate.
  • The dollar is the currency of both lawful and unlawful commerce – and most dollars in circulation operate beyond our borders.  There is no refuge available to those who hold them.
  • It also the currency of the international super-rich, who hold over $10-trillion in ‘offshore’ dollars that are not subject to taxation or scrutiny.   These people cannot escape a dollar collapse – and need to keep the dollar afloat to sustain themselves.
  • And now our leading trading partners in China, Japan, the UK and elsewhere own trillions of dollars of our once golden federal debt – and these same countries need our huge (debt-funded) spending to keep their economies afloat.   So they cannot sell their dollars or old US debt, and they cannot stop buying new debt without sinking their own economies.

And so we are all locked in a choking embrace from which there is no escape.   Indeed, government debt and spending are the next bubble.  And its potential magnitude dwarfs all the other bubbles of the last few decades taken together.

Toxic Debt Soup Feeds American Addiction to Spending

Rough Truths believes this toxic dependency soup will enable us to borrow more and at lower rates for much longer than would otherwise be possible – and to continue spending at a rate which is unsustainable.  And that could be our undoing, because there will come a point where our printed currency will not be credible and our expenses and debt service will exceed our ability to tax (irrespective of Paul Volcker’s faint call for a VAT yesterday).

Tea Party Message is Clear to All

The world is well aware of our collective peril – and it explains why we are so frequently chided by friend and foe alike for our continuing profligacy.  But the Rough Truth is there is no one who can stop us from continuing to borrow and spend – except for Americans themselves.  This insight is at the root of the Tea Party movement – and why so many on both sides of the political spectrum fear its power.  Because American Tea Partiers see what is coming very clearly and want to stop it – while most politicians just want to kick our problems down the road.  But it’s too late for that.

The Rough Truth is America is now ‘too big to fail’.  And we already know where that leads.

Tags: , , , , , , , ,

3 Responses to “ Are We Broke? It Couldn’t Happen Here. Could It? (Part 4 of a Series) ”

  1. momof3 on April 8, 2010 at 10:05 am

    John –

    Although your arguments are persuasive, I wonder if you are incorrect. I don’t think America is ‘too big to fail.’

    We are, after all, individuals who make up this great country. When the majority of the parts are failing, usually this indicates a larger system failure. No, America is behaving more like an Ostrich with its head in the sand. America (The Elected Officials) are refusing to see the problem and therefore take any form of corrective action.

    After all, what would happen if a spending freeze were to be implemented in DC? Now that would be interesting to watch….

  2. John on April 8, 2010 at 12:15 pm

    I meant too big to fail by way of analogy to the Fed’s strategy with respect to the largest banks. It was US policy that they were ‘too big to fail’ in 2008 (and still is – though that may change). And in many ways, it was true. Hence we had the bailouts.

    The point I tried to make – perhaps poorly (?) – is that US creditors are looking at us in the same way we looked at those large banks in 2008. And it is in that sense that America is ‘too big to fail’. Our creditors are now in a position where they cannot stop lending to us lest they sink themselves – and hence I believe they are being forced to lend and lend and lend until we all go down together. We are not too big to fail as a nation – but we are too big to fail alone. We have created our own hurricane-level headwind, and no one is strong enough to steer into the teeth of that storm. All anyone can do is try to ride it out until we stop feed the wind.

    As to your point about individuals driving the nation’s success, I concur. But I think we are waking up – faster than I’d hoped, frankly. The reason is that our leaders have shoved our heads under water and are now offering us the use of a snorkel that they provide so we can continue to breathe. And we’re not happy about it.

    But we only have a little while to respond. The reason is that when newly you’re dependent on that kind of apparatus, you are panicked and it’s natural to struggle for a while. But if you don’t find a way to get out of the water, you discover that by fighting, you get a bunch of water up your nose and are likely to knock the snorkel of your mouth. Then you realize that if you would just relax and use the snorkel they’re holding, you can breathe again (although the weight of the water makes it harder to breathe than it was before). Worse, you realize they are still holding you under water, and you are at risk of having your snorkel given to somebody else if you object too much. So you lie there and get slowly weaker – grateful for those moments when they let you rise a couple of inches closer to the surface of the water.

    I think a spending freeze is a great idea, and something to run on this fall …. Heritage suggests a spending freeze until 2012 would balance the nominal budget without tax increases (it wouldn’t solve our entitlements problems – but would stop the bleeding). Frankly, I’d like to go further and erase every spending bill we’ve passed since and including Medicare Part D in 2003 (basically every program started under Obama and Bush), and try again. There’s very little that the government is buying that is helping our families, or our businesses.

    Our financial troubles are of our own making – and the bulk of them are related to baby boomers making promises to ourselves that we cannot keep. We can fix it, but we need to stop using government as a tool to steal from our kids so we can spend on ourselves, and create a stable and sane tax/regulatory environment that businesses can bet on for years to come. Those are the only paths away from decay and collapse – for the world. And they will be the topic in a couple of posts……

    Thanks…

  3. momof3 on April 8, 2010 at 2:35 pm

    All very good points…

    Something to run on this fall…

    Are you registering or endorsing?

Leave a Reply

Get Adobe Flash playerPlugin by wpburn.com wordpress themes
ga.js