My Two Cents - "The New Humpty Dumpty"

01/28/2011

Irony is a wonderful thing sometimes. It has a habit of framing things exactly the way they need to be framed. Unfortunately, this is a knife that cuts both ways and irony sometimes points out awful realities. I am not a political animal per se, but I find it incredibly ironic how the avalanche of bad news on the deficit, Social Security, and essentially most of the things wrong with our economy was saved until after Tuesday’s SOTU speech. Make no mistake, this has happened before, and each time I find the timing to be absolutely incredible. It is very clear at least at this point that our leaders prefer to pay lip service to the idea of reducing the deficit rather than actually trying to rectify the situation. I say this because, with very few exceptions, the rhetoric centers around a silver bullet solution that will allow programs and spending to remain pretty much on the same path as what got us here, but at the same time, ‘fixing’ things.

We are learning a very hard lesson that it isn’t always about what you make, but what you spend. For all the talk about decreased Federal tax revenues, one would think that alone would command lower spending. Not so as we once again flirt with the statutory debt limit on the largest credit card in the world. For many years we depended on the world to absorb these excesses, selling trillions in Treasury bonds to the four corners of the Earth. Now that engine is stalling (quickly) and the Federal Reserve has stepped in to pick up the slack and even their overt monetization has not changed the tone in Washington with regard to debt. It certainly gives credence to the argument made by many non-mainstream economists that the problem of debt is already too big to be fixed. We are sitting on the world’s biggest Humpty Dumpty. Let’s take a look for a few minutes at some of the updates on the worsening fiscal front.

Social Security in the Red

This wasn’t supposed to happen until 2016. And I remember when that prediction came out that it was considered a ‘worst case’ date. Amazingly, the early descent into insolvency is now being blamed on the economy rather than horrible actuarial prognostications and the lack of political will to remedy the situation when something still could have been done.

“The massive retirement program has been suffering from the effects of the struggling economy for several years. It first went into deficit last year but had been projected to post surpluses for a few more years before permanently slipping into the red in 2016.” - AP

This gargantuan program will be $45 billion in the hole during 2011, but we should rest assured. Congress has pledged to replace revenues lost from the recently passed tax cuts. This stance alone is prima facie evidence that our leaders are clueless. IF Congress had a piggy bank of savings, then we could at least only be forced to ask how long it would take to eat up the savings. But Humpty Dumpty has no savings. Humpty is flat broke. So to read this correctly, what it means is that Congress will have the Federal Reserve monetize whatever revenue shortfalls occur from the tax cuts and then plug the borrowed dollars back into Social Security and everything will be fine. This is the type of ridiculous nonsense that passes for leadership today – from BOTH parties. And we wonder why no one wants to buy our bonds?

The Irresistible Force versus the Immovable Object

In what has been called a game of chicken recently, the Treasury is once again running out of room with regard to the statutory debt limit. Each time it gets about 6 months from hitting the ceiling the Treasury Secy. goes hat in hand to Congress, usually in the form of a letter, explaining that yes, they need to up the limit on the national credit card. No, we can’t stop spending because if we do, GDP will collapse.. Yes, you’ll need to raise this ceiling again in the near future because you won’t raise it enough this time.. No, Dr. Paul, you can’t fire me.. And that is about how it goes. Generally after a good deal of political posturing, Congress raises the limit saying they have no choice and that the world will end if the limit is not raised. But we are going to tackle spending now that the debt ceiling has been raised and this time we mean it (with thumping of fists).

Normally this wouldn’t even be worth writing about because it is so commonplace, however, this time things are a tad different. A whole bunch of new Congressfolks have been sworn in and some of them are having their feet held to the fire on spending and are balking at granting another increase. They’re demanding specific and defined spending cuts before another increase in the ceiling is given. I have no doubt that they will in fact increase the ceiling before the deadline, but it is kind of humorous to watch the Treasury scramble to re-arrange its deck chairs.

However, there is a very interesting tidbit in here. I’ve asked Martin Crutsinger, the AP author of this piece for clarification, but have not gotten and don’t expect an answer. Note the following:

“Treasury officials said that starting next week they will gradually decrease the $200 billion the government has borrowed in a special program conducted for the Federal Reserve, lowering that amount to around $5 billion. That will provide the government with an extra $195 billion that it can devote to its regular borrowing needs.”

What I’d like to know is what ‘special program’ the Treasury is running for the Fed at a $200 Billion cost to the taxpayer? I would say the Fed has plenty of its own money. It certainly has plenty when it is time to buy FFF- bonds from Wall Street. It certainly has plenty of money when it is time to setup emergency facilities to bail out its owners. Yes you read that right – its owners. I’d love to know why the US taxpayer is having another $200 Billion borrowed on its behalf to do ANYTHING for the Fed.

Japan – Where Debt Matters?

I have often joked with clients and subscribers about the ratings agencies here in the US. Whether it was taking ridiculous subprime mortgage tranches and slapping an AAA rating on them for resale, the same type of occurrence in the commercial RE market, or the constant, but never delivered upon threats to downgrade the USGoverment’s credit rating, S&P and Moody’s have earned themselves quite a distinction of being ratings agencies for hire.

However, when it comes to Japan, the rating cut was swift and decisive. S&P cut Japan to 4 notches below that of the US this week making the island nation government’s credit rating the same as China’s. This is laughable in and of itself considering that China is the lender to the world. What is even more hilarious is the fact that S&P still assigns the US Government a pristine AAA rating. It gets better.

The stated reason for the cut of Japan’s rating was its debt load. Its budget deficit is roughly 200% of GDP, which essentially means that Japan borrows $2 for every $1 of economic activity. Obviously, this is an awful situation and has been persistently blamed on deflation, which has had the country firmly in its grip for over a decade now. Japan’s total debt load is roughly $11 Trillion.

A sane person would properly ask how the US can maintain a AAA rating given that our national debt is $14 Trillion and that using Generally Accepted Accounting Principles, our fiscal gap is well over $200 Trillion. S&P would have you believe that it is because America’s budget deficit at $1.5 Trillion is only a tad over 10% of GDP. That isn’t entirely accurate. When GDP is calculated (and yes, we’ve done this before), it includes all government spending – even the borrowed dollars. So FY2011’s total GDP will count the $1.5 trillion that was borrowed and spent, plus whatever else was spent. When we hold the budget to the GAAP standard, the actual deficit gets much larger due to the accrued unfunded liabilities. That is also not counted in the deficit/GDP ratio. FY2010’s deficit was somewhere in the neighborhood of 40-45% of GDP when the numbers are looked at honestly. Granted this is not Japan’s 200%, but one would think that given our larger total stated debt and massive fiscal gap, this would be good for at least a single tier cut. Nope. The rating agencies have lost all credibility because it is obvious that their ratings in many cases are geopolitically driven.

When we take a look at these factors and ask whether we are closer to the beginning than to the end of the debt crisis, the answer can only be that we haven’t even started. The vast majority in leadership positions and the media are still trying to convince the American people that we need to cut the deficit, but can do so without laying even a finger on the sacrosanct welfare state programs namely Social Security and it’s insolvent cousin Medicare. We have recently been told that the only way to cut the deficit is to spend more money. If we were going to spend that on building a productive economic base, I would be in agreement. But we aren’t planning on doing that at all. We appear to only be interested in kicking the can down the road.

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.