Starve the Economic Beast, Part 2

Includes: DIA, SPY
by: James Quinn

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Money is Power

“Money is power, and in that government which pays all the public officers of the states will all political power be substantially concentrated.”

-- Andrew Jackson

The chart below shows that after 182 years as a country we had accumulated a National Debt of $389 billion. Then in 1971, President Nixon closed the gold window. The Federal Reserve was free to print dollars with no constraints. And print they did. Politicians used the printed dollars to spend on any costly initiative that would help them get re-elected. From 1970 to 1980, the National Debt went up by 2.4 times. From 1980 until 1990, the National Debt went up by 3.5 times. From 1990 until 2000, the National Debt went up by 1.8 times. From 2000 until today, the National Debt has gone up 2.0 times. Based on the spending implemented and proposed over the next few years, it will go up 1.5 times during Obama’s 1st term. It will have gone from 33.3% of GDP in 1980 to 100% of GDP by the end of Obama’s 1st term. At that point we will have entered the Argentina – Weimer Republic zone.

End of
Fiscal Year
US Gross Debt
USD billions
US Gross Debt as % of GDP
1910 2.6
1920 25.9
1930 16.2
1940 43.0 52.4
1950 257.4 94.1
1960 290.2 56.1
1970 389.2 37.6
1980 930.2 33.3
1990 3,233 55.9
2000 5,674 58
2005 7,933 64.6
2007 9,008 65.5
2008 10,699 74.6
3rd Quarter of 2009 11,383 82.5

“Debt is the fatal disease of republics, the first thing and the mightiest to undermine governments and corrupt the people.”

-- Wendell Phillips

When looking at a graph of government revenues and outlays since 1962 a few things stand out. The government was able to keep revenues in line with outlays until about 1982. Even while fighting the Vietnam War, the budget deficit was kept relatively under control. Since then we have had cooperation between the Republican and Democratic parties for the majority of the last 27 years. The Democrats allowed the Republicans to reduce taxes and increase military spending, therefore decreasing revenues. The Republicans allowed the Democrats to increase spending on social welfare programs. The only time revenues exceeded expenditures was when gridlock reigned during the Clinton administration. New spending slowed down and capital gains taxes from the era provided a one-time boost to revenues. The CBO projects a $1.8 trillion budget deficit in 2009. This equals our entire National Debt in 1985.

“Blessed are the young for they shall inherit the national debt.”

-- Herbert Hoover

As can be expected when politicians make projections, the likelihood of them being within $10 trillion is nil. It is fascinating that individual income tax revenue will jump by 32% and corporate income taxes by 30% in 2011 from 2009 levels. The inconvenient fact that you need a job to pay taxes and corporations need to have profits to pay taxes is brushed aside. I presume they also are counting on a windfall when the Bush tax cuts expire. The largest tax increase in history will surely lead to 4.7% GDP growth in 2011 and 6.0% GDP growth in 2012. Maybe the Cap & Trade tax and the additional $1 or $2 trillion for government takeover of the healthcare system will lead to a boom in our economy. These projections are at best pure fantasy and at worst a bold faced lie. The scary part is that even with the pie in the sky numbers, they still project the National Debt to grow by $4 trillion between 2009 and 2014. The likely number will be $8 trillion.

“In general, the art of government consists of taking as much money as possible from one class of citizens to give to another.”

-- Voltaire

The single biggest risk to the Obama rosy scenarios is interest rates. The CBO assumes interest rates will stay below 5% through 2019. This is a ridiculous assumption. The Federal Reserve is printing trillions of dollars, we are fighting two wars, we have just committed $787 billion in pork spending, we’ve committed billions to our banks and auto companies, and now we are about to commit at least a trillion dollars to national healthcare. The countries lending us this money will absolutely require higher interest rates to account for their risk. If interest rates don’t approach double digits in the next five years, all economic reason will be out the window. As Bud Conrad from Casey Research points out, just a 1% increase per year over the assumption in the budget will double the debt. The government has pushed this country to the limit of debt induced growth and we are no longer in control.

Any good corporate Treasurer worth their salt would have been taking advantage of the lowest long term Treasury rates in decades by locking in their debt for 20 to 30 years. Not our brilliant chieftains of finance at the Treasury Department. 40% of all U.S. debt rolls over in less than one year. Less than 5% of all U.S. debt is locked in for 20 years or more. The average maturity is 50 months, a three decade low. The extremely short duration of this debt leaves the country susceptible to a spike in interest rates. A spike in interest rates could drive annual interest expense from $250 billion to $500 billion virtually overnight. The worst part is that a large portion of this interest expense is flowing out of the country to foreigners.

Foreigner Invasion

Warren Buffett described the problem the U.S. was getting itself into a few years ago:

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce—that’s the trade deficit—we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

Warren was right. We’ve now sold off more than half the farm and the mortgage owed to foreigners threatens to force us into foreclosure. Foreigners currently hold 30% of all U.S. debt and have been buyers of more than 50% of new issuance in recent years. The U.S. will need to issue $2 trillion of new debt in the next year. Who is going to buy this debt? What pension manager or foreign treasury official would buy long term U.S. Treasury bonds paying 4.3%. The chart below shows that foreigners were purchasing hundreds of billions in U.S. debt between 2004 and 2007. Even a Treasury bureaucrat can look at the chart and realize they have a problem. Foreigners are now selling U.S. long term debt. They will not be the buyers of the $2 trillion coming to the market unless rates rise to 6% or higher. The Fed will not allow that to happen, so the buyer of the $2 trillion will be the Fed. They will monetize the debt and push the country closer to default. The coming crash in the dollar will ruin Ben Bernanke’s academic textbook plan.

Continue to Part 3 >>

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