August 4, 2008 – In my article on January 7th, I analyzed the federal government’s financial position using its consolidated financial statements, dubbed the Fiscal Year 2007 Financial Report of the United States Government. That article was posted on FinancialSense.com and is still available at the following link: www.financialsense.com
The picture I painted was not a pretty one. I noted that”that the US government has accumulated $53 trillion of direct and indirect debt“. I then went on to show that”these debts are overwhelming by any measure” by comparing the federal government’s financial condition to that of financial basket-case General Motors. “GM’s 2006 audited accounts indicate that its debts totaled $190.4 billion, which is a daunting 91.8% of the $207.4 billion of revenue GM generated that year. In contrast, not only is the $53 trillion US government debt greater than its annual revenue, it is in fact 20-times greater than the $2.6 trillion of revenue it received last year. The US government’s debt load by comparison makes GM look like a paragon of financial prudence.”
Well, I just learned that my analysis actually sugarcoated the federal government’s true financial position. Things are actually a lot worst because the government’s consolidated accounts do not include all of the unfunded liabilities for Medicare.
According to Dallas Federal Reserve president Richard Fisher, when these Medicare liabilities are added in with those for Social Security, the unfunded liabilities grow to $99.2 trillion. After adding in the direct debt obligations from its borrowings, the total government debt is $110 trillion, which is twice the amount reported in the government’s annual consolidated accounts. Here are some insightful excerpts from a speech given by Mr. Fisher in May. (www.dallasfed.org)
- “Let me give you the unvarnished facts of our nation’s fiscal predicament.
- [in the seven years ending in 2007], federal spending grew at a 6.2 percent nominal annual rate while receipts grew at only 3.5 percent.
- the mathematics of the long-term outlook for entitlements, left unchanged, is nothing short of catastrophic.
- critics…begin by wringing their collective hands over the unfunded liabilities of Social Security.
- The bad news is that Social Security is the lesser of our entitlement worries. It is but the tip of the unfunded liability iceberg. The much bigger concern is Medicare.
- If you wanted to cover the unfunded liability of all[Medicare] programs today, you would be stuck with an $85.6 trillion bill.
- For the existing unfunded liabilities to be covered in the end, someone must pay $99.2 trillion more or receive $99.2 trillion less than they have been currently promised.
- We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid.“
It is noteworthy that Mr. Fisher mentions the experience of”countless economies, from ancient Rome to today’s Zimbabwe.“Though he doesn’t actually say it, the United States is headed for hyperinflation. Its debt obligations make that outcome certain, just like it did for those other countries with fiat currency.
The federal government will not cut back on spending. There is no political will to do that, and in any case there is no need for politicians to cut back in today’s monetary system. Because there is no external discipline imposed on the currency creation process as there was, for example, under the classical gold standard, its captive central bank, the Federal Reserve, will make certain that sufficient dollars will be created to meet every penny the federal government intends to spend. That is why the Federal Reserve exists – the Federal Reserve is there to make sure that the federal government’s budget deficits get funded just like the central bank funded the deficits of Weimar Germany in the 1920s or today’s government budget deficits in Zimbabwe are being funded by that country’s central bank.
The underlying causes of the hyperinflation in both of these countries are identical. There are two – a declining demand for the currency, and uncontrolled, essentially unlimited government spending. Both of these factors are today impacting the dollar.
First, the demand for the dollar has been falling for years. For example, sophisticated investors like Buffett/Templeton, sovereign wealth funds and central banks around the world have been diversifying out of the dollar. Second, the feds are on a path of uncontrolled, essentially unlimited government spending.
Regarding this second cause of hyperinflation, the federal government’s budget deficits are not being funded in the same way as Weimar Germany in the 1920s or today in Zimbabwe. In both Weimar and Zimbabwe the fiat currency was spent into the economy by those governments by means of paper currency. Neither country had a developed banking system, with checkable deposits and a means of making deposit transfers (checks, plastic cards, online payments, etc.). In those countries the central bank just printed more paper currency. The financial markets in the United States are different.
In contrast to Weimar Germany and Zimbabwe, the feds are now beginning to hyperinflate through the banking system. The feds are not spending fiat”paper currency” into the system – they are spending fiat”deposit currency” into the system. Deposit currency is the money on deposit within the banking system. What we are witnessing is the beginnings of the first ever hyperinflation of a fiat deposit currency monetary system.
There have been comments that the financial system in the US is deep and sophisticated, and contrasts to those of Weimar Germany and Zimbabwe, which is true. But I don’t see how a deep financial market can stop the feds from spending in a monetary system without any discipline on the currency creation process. In fact, as I see it a deep financial market will feed the hyperinflation regardless whether or not it is “sophisticated”.
The principal tool of participants in a so-called sophisticated financial market is interest rates. If risks increase, they sell their paper and interest rates rise. Eventually higher interest rates (and we are starting to see those now on longer term paper) worsens the federal government’s interest expense burden, further worsening the federal budget deficit, causing further monetization by the Fed Reserve and the banking system to give the feds the dollars they are spending, whether on interest expense, welfare, wars or whatever.
The banking system is needed to hyperinflate fiat deposit currency. But will the banking system help hyperinflate?
Of course. The banks will continue buying so-called’safe, no-risk’ federal government debt that they fund with short-term borrowings with an interest rate lower than the yield on the federal government paper they own. Thus, banks will earn the spread, and they will repeat this process to excess. They will be all too happy to create earnings to handle all the charge-offs still to come as the economy weakens. In fact, banks are ready to welcome the coming onslaught of federal government debt. Earning the spread on federal government debt is one thing they relied upon to re-build their balance sheets back in the early 1990s. Also, buying federal government debt will be seen as a way of improving the quality of bank assets.
The reasons the feds will’print’ its way to hyperinflation (it is actually more accurate to say’bookkeep’ its way to hyperinflation) will be the same as those for Weimar Germany, Zimbabwe and other fiat currency countries. Amid a falling demand for currency, the mechanism for hyperinflation will be purchasing an ever greater amount of federal government debt that will be borrowed to fund a federal government that is out of control and spending money like crazy. I used to say the feds were spending money like drunken sailors, but a friend corrected me by saying that it gave drunken sailors a bad name.
Meanwhile Reuters reported on July 28th that “The Bush administration on Monday plans to project the U.S. budget deficit will soar to a new record…because of the slowing economy and an economic stimulus plan approved this year.” Reuters goes on to report:”The budget has been sapped by the prolonged wars in Iraq and Afghanistan and experts have been warning about an expected rise in health care spending as the baby boom generation’s retirement looms and other entitlements are likely to expand.”
The time-bomb is ticking. The federal government is liquid because as its consolidated accounts state, it has”the power to print additional currency.“ And print it will for one simple reason. The federal government is insolvent. Its debt obligations far exceed its financial capacity to repay those debts without debasing the dollar. At least, that is how I see it, which explains in part why I expect a dollar crisis now.