Obama Says We're Out of Money 21 comments
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Last week, Standard and Poor's released a statement suggesting that the United Kingdom's sovereign credit rating was being reviewed. The statement was made on expectations that the UK's debt would approach or even exceed 100% of its annual GDP during 2009. Scary. Traders the world over saw this as a sign to evaluate the credit ratings of other sovereign nations and the US was hit hard. US equities markets began to plummet and the dollar was beat to the ground. US Bond yields almost instantaneously jumped 30 basis points driving prices to the floor and sparking discussions of an impending debt downgrade. So is there any merit to the fear of a US debt downgrade? Or worse yet...gulp...even fears of a default?
"We're Out Of Money" said Barack Obama (go to second 0:29) on CSPAN last week and indeed "we" are. The President goes on to say (paraphrased) that we have a "short term problem" and a "long term problem". He suggests that our fiscal issues and the current economic crisis are short term issues while the looming crisis is Medicaid and Medicare. However, facts from Mr. Obama's administration tell a different story.
According to the United States Congressional Budget Office, if Barack Obama would have changed nothing after coming into office, by 2019, the US debt obligation would have amounted to 42% of annual GDP. How much is 42% of annual GDP? Roughly 5,991.13 Billion dollars, this (shockingly) is in-line with historic norms. However, the CBO goes on to say that after the past 6 months of spending, and the inclusion of Barack Obama's proposed budget, by 2019 the US will need roughly 82% of GDP to service its debt load.
Does this sound like it is a short term problem to you? Not that the US's health care issues are not problems, but this level of debt is more than just a short term thing. The amount that the US has borrowed from the world is simply staggering and is well beyond normal. This level of debt will take decades to pay back and will cost multiple generations a tremendous amount. So to the first question, is a US debt downgrade possible? Absolutely. In that case, if a downgrade is possible, what does it mean for America's outstanding obligations?
Quantitative Easing
Throughout the great recession the Federal Reserve, Treasury, and President's office have been spending money like it's going out of style. As illustrated above, in order to spend the US is borrowing money at an alarming rate. As it incurs more and more debt, naturally, it is required to pay interest on that borrowed money. Knowing this, the American government has been doing everything in its power to reduce interest obligations.
In December the Fed announced for the first time in 28 years that they would begin to actively buy T-Bonds in the open market (with money printed from the Treasury). They also made a similar announcement in March to purchase up to $300 Billion in "mixed duration" Treasury instruments. By purchasing long term T-Bonds (with treasury printed dollars) the government has been working to drive debt durations down. Why is lowering debt duration important? Low durations are required to ensure that overall borrowing costs remain as low as possible on any new debt issued. This is where quantitative easing comes into play.
Until recently the strategy of quantitative easing has been fairly successful (in relative terms; it can't work in the long term) as the world has flocked to United States debt as a safe haven investment. Evidence of this can be found in the fact that the average duration on all outstanding US debt is currently at about 4 years; the shortest in history. It can also be seen in US Treasury Yields which have been at their lowest levels in decades. The only problem with this exercise is that in order for it to continue to work, one of two things must eventually happen:
1. Spending has to come to a halt, tax receipts need to climb dramatically, and the US government needs to act in a fiscally responsible manner in order to properly service existing debt obligations.
Or...
2. Interest Rates have to stay low indefinitely so that debt service payments remain manageable.
If these two things are the only way that quantitative easing can continue, what will the result be for the bond markets?
Option 1
It does not appear that the government will take or can take option one in the short term. However, in the long term it is all but inevitable that this trail must be blazed. The only problem with the "stop spending and raise taxes" option is that the US's 8.9% (and rising at an alarming clip) unemployment, coupled with a lack of "real" economic gains, continues to erode the nations already shrinking tax base. Plain and simple, at some point, in order to stop deficit spending and properly service debt the US will need more cash in the treasury. The only way to get that cash is through increased tax revenue, fiscal responsibility, and sustainable long term interest rates on US obligations. As this is not currently happening its relationship to the bond markets is all but irrelevant at this time.
Option 2
This week the US Treasury will be selling or has sold $40 Billion in 2 year notes, $35 Billion in 5 year bonds, and $25 billion in 7 year bonds. This whopping one week total of $100 Billion in US debt is unusual, and also incredibly important. For starters, this week's auctions clearly show that the government is still foolishly pursuing quantitative easing. A quick look at the maturity of the debt offered is evidence of this enough; no maturity longer than 7 years. Additionally, according to the Wall Street Journal:
Market participants noted investors, including foreign central banks, have cut long-dated Treasury holdings and parked cash in two-year notes and Treasury bills, a trend that may create a challenge for the U.S government at a time when it needs to sell a record amount of debt.
Thus, based on the happenings above, it should be increasingly clear that option #2, over the long term, is not sustainable. Yesterday's debt auction results and the climb of the yield curve, across all mid to long term maturities, (note the trend since March when quantitative easing was announced) is an indication that the market won't allow nearly interest free US spending to continue indefinitely. This also begins to beg the question, "What will the US do when its short term debt matures and needs to be refinanced? What will be the interest cost in 4 years at this spend rate? This is called rollover risk and I wonder how many are considering it.
Out of fears that loans may not get paid back, the market will demand more interest on its money when it is loaned to the US government. After this, the market will then try to reduce the duration of loans to the United States to the shortest possible period of time to reduce exposure risks. Then risks of inflation will also come into the picture as the market lends to the government. Each debt issuance will lead to more premiums being demanded to compensate for a loss of purchasing power in US dollars over the duration of the loan. All in all this will ultimately drive bond yields higher, drop bond prices continuously lower, and eventually dislocate the US debt markets.
Can The US Go Bust?
Does that mean the US can go bust then? It certainly does, but that is highly unlikely to happen. The US is not a developing country and it has the ability to print money to meet interest and principal obligations. At the risk of sounding arrogant, if the US were to go bust, the world would go bust. I sincerely don't intend to deliver that from an American elitist point of view; I think I'm anything but. However, based on the size of the US economy alone, if there was a US default much of the global financial system would all but collapse.
Assuming the US does not collapse, will the printing of new money greatly devalue the US Dollar and increase inflation? Certainly, but this is not likely to happen in the near term. More deleveraging in the financial system is needed, and this event is unlikely while deflationary pressures remain strong. So, again, what does that mean for US debt? It means that while the Federal Reserve and Treasury continue pursuing quantitative easing, (option 2) the markets are likely to become increasingly dislocated. It means yields will continue to rise, prices will continue to fall, and debt service costs in the United States will become unmanagable. At this time, consumer borrowing rates will then also start to climb and will add further pressure to the US government's problems. (Did anyone see what mortgage rates did after yesterday's debt auction?). When debt service costs will finally grow to an unsustainable level is anyone's guess. However, if what is happening with treasury yield curves over the last 3 months is any indication, that time is coming soon.
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He's chosen the path of trying to jump-start the economy, which should provide some of the resources to address the longer-term problems.
This strategy may not work, though I'm not sure there are any more appealing choices. In fact, our political and economic systems have demonstrated precious little appetite for long-term, productive investments. I expect the likeliest outcome will be for the USA to inflate its way out of its debt obligations and for the real average standard of living to decline. Less access to quality health care, more stress on families trying to keep their homes, less educational opportunities for people of moderate means, more expensive staples like food and clothing. Sounds like what we've been experiencing for decades.
On May 28 10:53 AM DONE_SONZ wrote:
> Plan [A] inflate and debase.Plan [B] raise the roof on gold and pay down debt.
Saffron wrote: Plan [B] should read: confiscate gold and revalue the dollar at 1/3500 per oz. of gold.
The gold then offsets the debt, which won't actually be paid down. But the ledger is balanced. Obama is Roosevelt II.
On May 28 12:01 PM old boat guy wrote:
> Your article is good, but you need to factor in devaluing the dollar.
> This is a third course of action the government could take, and one
> probably eminent in the next year or two.
Nik
> Well at least we spend more on our military budget than all other
> nations on earth combined, so if anybody objects to our QE-market
> manipulating-dollar-de... policies, they can go pound sand. 'Cause
> that's what all our nukes can turn them into if they don't like it
> :-P
>
> Nik
The Jist of your statement is why most have put up with the "Current Chicanery" that the "Children In Government" have been implementing.
"Fill The Money Hole" and "Distract The Populous" Is The Current Agenda.
buy some gold and silver too. miners are good to trade lately. confiscation seems remote but i would never discount the quest for command and control power seeking of govt.. it is harder to make all equally poor and dependent if some have metals and staples. compliance is often mandatory when the game is rigged.
speaking of distraction--has anybody got info on the new vat? value added tax? i caught a snippet on the radio last night. apparently it is one of europe's slide into socialism taxes and is being kept quiet? i did not get enough ti know what it was.
On May 29 09:31 AM fireball wrote:
> speaking of distraction--has anybody got info on the new vat? value
> added tax? i caught a snippet on the radio last night. apparently
> it is one of europe's slide into socialism taxes and is being kept
> quiet? i did not get enough ti know what it was.
I'll clarify, I'm a small manufacturer. All the goofy tax laws and regulations we have now require me to have a full time book keeper and a good (read: expensive) accountant to keep track of everything. I need to hire Professionals that do NOT add value to my end product to maintain compliance with what we got now.
The VAT is essentially a transfer tax applied in EVERY step of production, from raw materials through the labor of the clerk ringing out the retail purchase. Great. More stuff to track and comply with. Judging by our 70,000 page tax code in the US, I can't imagine this turning out to be a simple thing.
To clarify even more:
I'd cheerfully make a bargain with the loons in DC (both parties!): You can have your VAT - which is intrinsically Much Harder To Evade - if and ONLY if you get rid of the existing 70,000 page bundle of loopholes (and the blasted personal income tax)...FIRST!
My $.02...
No, they cant raise taxes to fix the problem, they must cut spending!!
You say how? Start with across the board cuts of gov jobs, elimenate 10% of all gov jobs, cut salary's by 10%, 20% for all gov workers making over 50K, cancel defined benefit pensions and replace them with 401K's, freeze all compensation packages until half of current borrowing is paid off.
At that point, we should cut income tax on workers and employers, and maybe then we will get the un-employment rate back under 10%.
Thanks for your article, it reminds me to continue beating on our State gov of CA.
thank you.
So Obama's analysis is correct, but not necessarily astute. Where he is astute is in exploiting the anxieties created by these issues. What is troublesome is that, when faced with a gargantuan debt problem, he quadrupled down. It is the most fiscally irresponsible act since FDR made gold ownership illegal.
If Americans are suffering such a dearth of health care, then why are typical Americans so healthy? Why are death rates from cancer and heart disease, and other killers of Americans, declining? Even if these good health outcomes are due to something other than sufficient access to health care, then access to health care is not as important as claimed. OTOH, if access is essential, then the good outcomes demonstrate that people are typically getting enough of it.
Besides which, the problem for most people is not that they cannot get health care. That is a problem for very few people. The problem (if it is one) is that health care is more expensive than people would like. Guess what? Gasoline is more expensive than people like. Food is more expensive. Health care is not prohibitively expensive for most people (although it is for an unfortunate few, and some of those are not covered by Medicaid, which is awful). Americans like to moan about the high cost of medical care, but typically they are getting a very good product for that cost.
Regardless of one's perspective on the cost, this should not be distorted into an untruth that people cannot get health care, since most can. They can even usually get health care insurance (not the same thing as health care itself) if they are willing to forgo other things and bear the financial pain. Bad health can cause financial ruin. That is sad, but so are fatal car accidents. Stuff happens.
It is unfortunate that some politicians are using the anxiety over this issue to seize control of the health care industry.
I also challenge the notion that Americans are getting "less (sic) educational opportunities". The number of children in school has increased monotonically. The number of people in higher education has increased monotonically. The cost is higher, but that simply determines which school one gets into and perhaps the quality of the education. It might also force people to forgo expensive liberal arts education, but is such an education necessary and worthwhile? Also, not everybody who is qualified to be a doctor gets to be a doctor. It has ever been thus. It ever shall be. Life is not fair.
Again, it is unfortunate that some politicians have exploited anxiety over this issue in order to solidify their power and secure the devotion of teacher unions. The result is more tax money sent to schools -- it's a shame if all that extra money is not getting the job done. Makes me wonder if the money is well spent, or if the problems with education are not only or even primarily a lack of funding.
We do agree however that the American standard of living will decline if the currency is debased. That, however, is not an inevitability. There are elections in 2010. There are protest rallies in the streets. There will be hundreds of thousands of people in DC on September 12 protesting the current expansion of Federal power and debt. This is as unprecedented as Obama's deficits.
On May 28 11:05 AM Larrysyr wrote:
> Obama has analyzed the situation correctly in that there is an immediate
> fiancial/economic crisis to deal with AND a long-term structural
> mess with Medicare, Social Security, and infrastructure deterioration,
> among other forces.
>
> He's chosen the path of trying to jump-start the economy, which should
> provide some of the resources to address the longer-term problems.
>
>
> This strategy may not work, though I'm not sure there are any more
> appealing choices. In fact, our political and economic systems have
> demonstrated precious little appetite for long-term, productive investments.
> I expect the likeliest outcome will be for the USA to inflate its
> way out of its debt obligations and for the real average standard
> of living to decline. Less access to quality health care, more stress
> on families trying to keep their homes, less educational opportunities
> for people of moderate means, more expensive staples like food and
> clothing. Sounds like what we've been experiencing for decades.
PUT America (not China) back to work at living wage jobs. The income taxes alone would pay the debt off rapidly.
Of course, our New World Order, is not going to allow this.
Yes , I have read on several sites that a VAT , federal sales tax , in addition to the income tax , is presently gaining momentum in congress . Rates from 10% - to as high as 25 % have been discussed .