US Debt Crisis: What NOT to Do When Your Country is Broke

Another month gone by. Another month closer to bankruptcy.

Not you, dear reader.

We’re talking about the US government.

But hold that thought…

Let’s turn to the markets. Hmmm… Not much action. The Dow rose a piddly 4 points on Friday. Gold went up $15. Not much to talk about there…

Investors are waiting to see what happens next week. They’re sitting on the edge of their chairs. Will Ben Bernanke play it cool? Or will he want to do something really big, bold, and bumbling?

We’re not as curious as most investors. We doubt that he will want to go too far in either direction. Most likely, he’ll do what investors expect…announcing more quantitative easing – money printing, in other words – but being a little cagey about how much, and when.

So, let’s turn back to the biggest bankruptcy of all time.

Many are the ways the facts are interpreted, distorted and bearded. But the numbers keep going up.

The red numbers, that is.

The US press barely reports the story. They know Americans aren’t interested. In the US, people figure we’ll muddle through…we’ll work our way out of debt…

Or, hey, maybe there will be a miracle! In the US, we believe in all sorts of things that are miraculous…unbelievable…and preposterous.

Got too much debt? We’ll fix it by giving you more debt!

People short of real money? We’ll fix that by giving them make-believe money.

Did the authorities miss the biggest financial blow up of all time? Did they fail to stop the biggest Ponzi schemer in history – even after they were tipped off? Did they completely “blow it” when it came to controlling the bubble and the damage it caused?

Yes? Well, let’s give them $10 trillion of the taxpayers’ cash and credit and see if they can do better the next time!

Fantasies, hallucinations, delusions – and don’t forget the “war on terror”…the first war on nobody in particular in history.

But let’s get back to who owes what to whom. We’re talking about the US government. And Canada’s Globe and Mail has the story:

The scary actual US government debt

Boston University economist Laurence Kotlikoff says US government debt is not $13.5-trillion (US), which is 60 per cent of current gross domestic product, as global investors and American taxpayers think, but rather 14-fold higher: $200-trillion – 840 per cent of current GDP. “Let’s get real,” Prof. Kotlikoff says. “The US is bankrupt.”

Writing in the September issue of Finance and Development, a journal of the International Monetary Fund, Prof. Kotlikoff says the IMF itself has quietly confirmed that the US is in terrible fiscal trouble – far worse than the Washington-based lender of last resort has previously acknowledged. “The US fiscal gap is huge,” the IMF asserted in a June report. “Closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 per cent of US GDP.”

This sum is equal to all current US federal taxes combined. The consequences of the IMF’s fiscal fix, a doubling of federal taxes in perpetuity, would be appalling – and possibly worse than appalling.

Prof. Kotlikoff says: “The IMF is saying that, to close this fiscal gap [by taxation], would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.

“America’s fiscal gap is enormous – so massive that closing it appears impossible without immediate and radical reforms to its health care, tax and Social Security systems – as well as military and other discretionary spending cuts.”

He cites earlier calculations by the Congressional Budget Office (CBO) that concluded that the United States would need to increase tax revenue by 12 percentage points of GDP to bring revenue into line with spending commitments. But the CBO calculations assumed that the growth of government programs (including Medicare) would be cut by one-third in the short term and by two-thirds in the long term. This assumption, Prof. Kotlikoff notes, is politically implausible – if not politically impossible.

One way or another, the fiscal gap must be closed. If not, the country’s spending will forever exceed its revenue growth, and no one’s real debt can increase faster than his real income forever.

Prof. Kotlikoff uses “fiscal gap,” not the accumulation of deficits, to define public debt. The fiscal gap is the difference between a government’s projected revenue (expressed in today’s dollar value) and its projected spending (also expressed in today’s dollar value). By this measure, the United States is in worse shape than Greece.

Prof. Kotlikoff is a noted economist. He is a research associate at the US National Bureau of Economic Research. He is a former senior economist with then-president Ronald Reagan’s Council of Economic Advisers.

He says the US cannot end its fiscal crisis by increasing taxes. He opposes further stimulus spending because it will simply increase the debt. But he does suggest reforms that would help – most of which would require a significant withering away of the state. He proposes that the government give every person an annual voucher for health care, provided that the total cost not exceed 10 per cent of GDP. (US health care now consumes 16 per cent of GDP.) He suggests the replacement of all current federal taxes with a single consumption tax of 18 per cent. He calls for government-sponsored personal retirement accounts, with the government making contributions only for the poor, the unemployed and people with disabilities.

Without drastic reform, Prof. Kotlikoff says, the only alternative would be a massive printing of money by the US Treasury – and hyperinflation.

Wait a minute, says our old friend Jim Davidson. Professor Kotlikoff is wrong. He “unaccountably overstates the solvency of the US,” he says.

Jim makes a good point. It’s not total GDP output that supports the government. It’s just the private sector part. The government part is a cost…not a source of financing. The total fiscal gap – unfunded government obligations – is over $200 trillion. It’s about 14 times GDP. But compared to the real output of the private sector, it’s 20 times as great.

If this were a more traditional debt burden, it would have to be financed. Interest rates are at a 60-year low. But they could easily be back up at 5% in short order. At that rate, it would take 100% of private sector output just to keep up with it.

Professor Kotlikoff is right. The US is already broke. Busted. Bankrupt. It cannot possibly honor its commitments. One way or another, it must default on them.

But how? That’s what we’re going to find out.

Bill Bonner
for The Daily Reckoning