Currently, the US federal debt stands at more than $100 trillion. According to the recent US stock market rally, the fact that the US government is not only bankrupt but has put every four-person family in America on the hook for more than $1.45 million does not merit concern. Of course, in reality, the US economy and the US stock market are two entirely different creatures. Perhaps, if the Plunge Protection Team took a prolonged vacation, US stock market behavior would begin to reflect the fundamentals of the US economy again.
However, it is important for an investor to understand that due to the not-so-invisible hands of Goldman Sachs (NYSE:GS), JP Morgan (NYSE:JPM) and the Plunge Protection Team, quite often, the US market can move higher for sustained periods of time even when the fundamentals of the US economy at large are atrocious. This is the fiat money-induced phenomena otherwise known as irrational exuberance. In the long run, the fundamentals of the economy at large will catch up and drive US stock market behavior once again.
Despite the recent stock market rally, the fundamentals of the US economy are downright scary. According to the figures released by the US government, as of May 25, 2009, the US federal debt stood at $11.3 trillion, about $37,000 for every man, woman and child in the US (we’ll get to the real federal debt figure soon). To accommodate this growing debt, the US government merely raises its debt ceiling every so often to avoid default in the US Treasury market. Currently this debt ceiling stands at $12.104 trillion.
Recently foreign appetite for Treasury auctions has dried up and the US Federal Reserve has resorted to buying US Treasuries in the absence of foreign demand to keep the US Treasury market from collapsing. However, what if the largest foreign holders of US Treasuries realized that the current US federal debt already exceeded the national debt ceiling by $98 trillion? How would they feel about keeping the US Treasuries they currently hold?
According to Richard W. Fisher, the president and CEO of the Federal Reserve Bank of Dallas, the unfunded liabilities of the US Social Security and Medicare system stand at $99.2 trillion today. That figure is not a misprint. If the US government plans to keep operating the Social Security system and the Medicare system, then the official federal debt really is $11.3 trillion plus $99.2 trillion, or $110.5 trillion. Why does our government state that its federal deficit is only slightly north of $11 trillion (with the term “only” a relative term, given that the true US deficit is about ten times greater than the “official” government figure)? Over the years, the US government has stated several reasons why they don’t include unfunded obligations in their official debt figures, with one of the most common reasons being that these programs are optional and can be cut at any time.
However, this practice is tantamount to a corporation omitting the cost of its health benefits program from its operational expenses even though it has promised its employees health care benefits. If the government is omitting the expense of the nationwide Social Security and Medicare programs from its budget, is this an admission that these programs will soon be history? Given the fact that a $110.5 trillion deficit puts every American family of four on the hook for more than $1.45 million, it seems unlikely that those of us that have paid a lifetime of Social Security taxes but are still many years away from eligibility will actually live to see the benefits of doing so.
Or maybe I am being too hasty. Richard Fisher explains that mechanisms that can fund the currently unfunded obligations of the Social Security system ($13.6 trillion) and the Medicare system ($85.6 trillion) do exist. For example, “a permanent 68 percent increase in federal income tax revenue, from individual and corporate taxpayers, would suffice to fully fund our entitlement programs.”
Other than that, the only other mechanism to keep the nationwide Social Security and Medicare programs afloat in the future, according to Fisher, would be to cut discretionary spending by 97%, thus eliminating the majority portions of the national budget for defense, security, education, and the environment. Of course, this solution is not viable, so we are left to explore the alternative permanent 68% increase in taxes. Or perhaps the solution is to devalue the dollar until it takes $1 trillion to purchase a single loaf of bread. Then, the sale of 100 loaves of bread could solve this nasty shortfall. Sarcasm aside, I make this point to illustrate the severity of this problem.
The government may attempt to implement the tax solution but it is probably more likely that when push comes to shove in the political arena, they will have to axe either the Social Security and Medicare programs, or maybe even both. If you think this outcome is unfathomable, consider that for these two programs and their associate benefits to survive, $99.2 trillion either has to be raised through taxation or cut from programs that have already promised funds. There is no other solution to this problem, other than to attempt to inflate the $110 trillion deficit away.
Furthermore, when debating the realm of discretionary spending cuts to refill the government’s coffers, this avenue, in reality, is not viable either, simply because cuts from any other programs other than from those of national defense and national security won’t be large enough to make an impact. In the end, it seems as though most of us still believe that a bankrupt government can provide the backbone for an economic recovery.