What raising the debt ceiling means

Copyright 2011 by John T. Reed

Below is an email I sent to my customers. It drew a spirited response some of which caused me to add several new items to my list of intellectually-dishonest debate tactics. A couple of minor errors were also pointed out to me. I have improved this version of the article from the original.

There must be huge cuts in federal spending right now. We’re not going to get them.
You have to protect yourself.

What raising the debt ceiling means
The U.S. national debt ceiling was set at $14.29 trillion in February, 2010. It looks like we are going to hit that ceiling in the next few months.

Politicians are starting to agitate about which way to vote. As usual, many are lying about it.

Debt ceiling is better than a balanced budget amendment

Not passing a law to increase that ceiling is tantamount to enacting a balanced budget amendment. Actually, not raising the debt ceiling is better than a balanced budget amendment—much better.

How so? The debt limit is a hard number. It says to the U.S. Treasury, “You can never have more than this amount of U.S. bonds outstanding.” That is unambiguous.

Budgets, on the other hand, are a joke. Every state in America has a constitution that requires them to balance the budget. Yet numerous states have spent too much like California, New York, New Jersey, and so on. If they are required to balance the budget, how did that happen? Gimmicks, projections of revenue that were too high, projections of expenses that were too low, overly optimistic assumptions about returns to be earned on investments. Whatever. The bottom line is that the bottom line is frequently negative when you enact a balanced budget amendment saying it must never be negative.

What ‘living within or means’ means

Not raising the national debt ceiling means deficit spending ends immediately. It means the U.S. government would henceforth have to live within its means.

The means of the U.S. government are the $2.2 trillion it collects each year in taxes. Current federal spending is $3.7 trillion.

That means the U.S. government has to borrow the difference—$3.7 trillion – $2.2 trillion = $1.5 trillion. (That $1.5 trillion deficit number came out from the Congressional Budget Office the day after I sent the original email which said $1.3 trillion. Www.usdebtclock.org still says $1.3 trillion.) That difference is called the deficit. The U.S. government borrows by selling U.S. Treasury bonds.

One reader demanded to know the source of my numbers. Generally, various U.S. government web sites. Also, www.usdebtclock.org. if you want to check out any number in this article, Google it. There generally seems to be someone somewhere bitching about the accuracy of every number but only the terminally cynical would take the position that no numbers are accurate. If there is another source than those, I will cite it.

If Congress refuses to raise the debt ceiling, the U.S. government is not allowed to sell any new bonds except to refinance old ones.

Risking the ‘full faith and credit’ of the United States

Some politicians are saying that not raising the ceiling risks the “full faith and credit” of the United States.

Not really. As I just said, we can still sell bonds for the purpose of paying off existing bonds.

The average term of U.S. bonds is 49 months. Originally, I said that means about 1/4 of the bonds come due each year. A reader pointed out, correctly, that U.S. bonds mature at various dates from less than one year to thirty years. So the first 49 months from now is only about half of the bonds. My bad. So the amount of bonds coming due each year is apparently somewhere in the one to three trillion range. It varies according to how the government outlays and inflows went in past years.

So if we do not raise the debt ceiling, we would only be able to sell $1-3 trillion of refinancing bonds this year and something similar in future years. The politicians want to sell an additional $1.5 trillion of new bonds to finance the new deficit.

We would not have to default on any existing U.S. bonds if we do not raise the debt ceiling. So the “full faith and credit” of the U.S. government would not be in jeopardy if the debt ceiling was not raised.

Plus, you gotta be kidding me that a 41% cut in federal spending would be risking the “full faith and credit.” The full faith and credit of the United State is already being risked, if not destroyed, by the politicians who have been deficit spending since the 1960s. Continuing the deficit spending is the true threat to the full faith and credit, not stopping it.

Would not raising the debt ceiling have any other effect then?

Hyperinflation and Depression

Oh, yeah.

We have to cut federal spending 41% now, or more later

It would mean we would have to gradually cut federal spending by the amount of the deficit over the next twelve months. That’s $1.5 trillion which is $1.5 trillion ÷ $3.7 trillion = 41%.

So we would have to cut federal spending 41% by the end of the twelve months after the ceiling was reached.

If you applied that percentage across the board equally to every category of spending, it would mean that Social Security and federal retired pensions recipients would see their monthly checks go down by 41%. 41% of federal employees would have to be fired or have to accept a 41% pay cut including military, FBI, Border Patrol, and so on. Medicare would be cut 41% presumably meaning patients would have to pay that much because doctors and hospital probably would not accept such a cut and would refuse to treat the patients unless the patient or some other person paid the difference.

Congresspersons and the president would have to take immediate 41% pay cuts—so would their staffs.

Of course, you do not have to do it equally across the board. You could do as John Stossel advocates and cut out entire cabinet departments 100% like Agriculture, Commerce, Education, Energy, HUD, and so on. Bravo. That would reduce the amount you would have cut social security and Medicare and such below 41%, but not by much. Social Security and Medicare are really big numbers. Agriculture, Commerce, etc. are small numbers relatively speaking.

Reneging on politicians’ promises

Opponents of not raising the ceiling say the world would lose faith in U.S. government promises if the government reneged on Social Security, etc.

They should. Those bogus promises were made by politicians playing Santa Claus with taxpayers’ money.

Don’t feel too bad for the current politicians having to renege on promises made by former politicians. Politicians renege on their promises all the time. For example, every president starting with Nixon promised energy independence. In fact, we have become more dependent on foreign energy every single year. They are used to getting crap about reneging. They just shrug it off.

Not enough money in the world—literally

There is literally not enough money in the world to pay Social Security, federal pensions, medical care benefits and so forth that have been promised by federal politicians.

The net worth of the world is minus $38 trillion. The gross domestic product of the entire world is $70 trillion. (Google those two numbers to find multiple sources.) The unfunded liability (money we should have put in the bank but did not) for Social Security and Medicare alone was $107 trillion in 2008. There is no hope that we can ever pay that.

A reader demanded to know where that $107 figure came from. I suggested he Google it. He sent back a blizzard of alphabet soup sources like OASDI and NCPA. He denounced some and said the others proved the $107 trillion overstated the unfunded liability by 20 times.

NCPA, which the reader dismissed, is the National Center for Policy Analysis, a conservative group. They say the $107 trillion figure came from the trustee reports of Social Security and Medicare—U.S. government sources. Democrat reader says those reports do not say that. If you want to read them, be my guest. They are on the Internet.

I suggested he try the Dallas Federal Reserve. He made no mention of that in his response.

OK. Here’s the link. YOU look at the speech made by Richard W. Fisher, the head of the Dallas Federal Reserve Bank, on May 28, 2008 to the Commonwealth Club in San Francisco. In the transcript of that speech you will see that he says the Social Security has a $13.6 trillion unfunded liability and Medicare is $85.6 trillion, the sum of which is $99.2 trillion. And remember that speech was made in the first half of 2008!

Those calculations are done using a method economists call “infinite horizon.” My Democrat reader does not like that method. Google it if you are excited about it.

Baby Boomers retiring, Obamacare not in the $107 trillion, etc.

Let me give you a couple of non-numerical facts. The first Baby Boomers become eligible for Medicare in 2011 and they become eligible for Social Security with no restriction on income in 2013. Obamacare, are not included in the Social Security/Medicare numbers, nor are federal employee pensions and other benefits in the $99.2 trillion figure. The number of workers per retired social security recipient has gone down, down, down since the inception of Social Security and will get worse as the Baby Boomers age.

You can nit pick the exact number endlessly because it includes actuarial assumptions and all that. But no one can say the number is not enormous.

Recovery won’t help

Would a recovery and unemployment going down to 5% solve the problem? Not even close. That would only increase annual tax revenues by about $150 billion. (Do the math yourself. About 18% of GDP becomes tax revenue each year—been true for 70 years—no matter what the maximum rates are.)

Tax increases are not enough

Would tax increases solve the problem? Not even close. Numerous experts like Former Fed Chairman Alan Greenspan have said that. If you could increase taxes 25%, which is probably impossible unless you broadened the base (made the 50% of Americans who no longer pay any tax other than Social Security tax start paying income tax), you would still only get about $500 billion more revenue. Not enough.

Selling all federal property not enough

Selling all the national parks and federal buildings like the Smithsonian? Not even a dent. (See the book The Coming Generational Storm)

If the U.S. continued to make on-time payments to existing bond owners, the “full faith and credit” of the U.S. would not be adversely affected. Indeed, I suspect the world bond market would feel relieved that the U.S. government was finally getting serious about living within its means and behaving in a way that will likely result in bond holders being paid back as promised.

Seniors take precedence over bond holders?

No doubt, liberal politicians will say that seniors and the sick should take precedence over bond holders.

Okay. Go with that. But understand it takes you to the same place very rapidly. If the U.S. government defaults on the bonds instead of the Social Security and other federal entitlements, the world bond market will instantaneously impose their own debt ceiling. That is, they will refuse to buy any more U.S. bonds. In other words, defaulting on the bond payments would change the U.S. government’s credit from AAA to defaulted. To put it in laymen’s terms, the credit card of the Congress and the President would be cut to pieces and canceled.

The “full faith and credit” of the U.S. government would, in that case, indeed, be destroyed. That’s actually not the end of the world. See my article on that. But that would NOT happen if we cut spending instead of screwing bond holders.

If and when the world bond market, which mainly consists of U.S. citizens and institutions, stops buying U.S. bonds, those same cuts I described above will have to take place immediately. Basically, there are two entities that can shut down the U.S. government selling bonds and engaging thereby in deficit spending:

• Congress and the President voluntarily
• the world bond market involuntarily

Same result no matter who initiates it.

Many think China is financing us. Partly. Foreign citizens or entities own about 27% of U.S. bonds. Japan owns the second most after the U.S.. China is behind Japan. Almost every country owns some of the U.S. bonds, incliuding our enemies. But about 3/4 of the holders of U.S. bonds are U.S. citizens and entities.

Both parties have been creating this mess since 1930 (Hoover)

This is a hell of a mess, isn’t it? Your elected officials have been building this mess since 1930—both parties albeit more the Democrats.

So what is probably going to happen?

Nothing significant will be done

On January 25th, Obama, Paul Ryan, and Michelle Bachman all delivered State of the Union addresses. Obama promised more of the same, calling spending on Democrat pet projects like green jobs “investment.” His concessions—five-year freeze on non-defense, discretionary spending except where union contracts exist, cutting back on the requirement to issue tons of 1099s, vetoing earmarks, were all symbolic trivia, no substance.

Ryan said the right things, but almost in Federal Reserve code that only an expert on fiscal and monetary policy would truly understand. See my article on translating Federal Reserve Code. Bachman gave the best of the three talks with a more militant Tea Party list of plans,. Like Ryan, she was truthful, but failed to tell audiences exactly what it all meant because if she had there would be demonstrations in the streets today.

Surprisingly, the best State of the Union Speech on the 25th was made by John Stossel on Fox Business. He even had a little presidential podium only it said Stossel instead of The President of the United States. He also entered the room shaking everyone’s hand and had lots of flags. But after a pause, he began his speech with, “We’re in DEEP trouble.”

Stossel said almost exactly what I am saying about what has to be done. But it’s not going to happen.

Ryan and Stossel have long been two of the 20 people on my list of living national treasures.

Token measures

They will probably vote to raise the ceiling. Republicans will probably demand some token spending cuts from the Democrats. They will probably refuse most of them. That will result in the debt ceiling arriving and the government not being able to sell bonds because refusing to vote on the ceiling is the same as voting against it.

During that post-hitting-the-ceiling period, Democrats will probably try to reprise the Clinton-era trick of saying the “Republicans shut down the government.” It worked for them back then. I doubt it would work again. If two sides do not agree, you cannot logically blame the lack of agreement to either side. Each side can explain their position and the public can decide which is more reasonable.

Both parties are guilty of succumbing to forgetting their campaign promises and going along with business as usual when they get to Washington. Republican House Speaker John Boehner called voting for the debt-ceiling increase “being adults” and Republican “strategist” David Winston called voting to increase the debt ceiling “governing.”

Call it what it is: kicking the can down the road—again, stealing from our children and grandchildren, and making sure we have to do “nine” when a “stitch in time” would have saved them. Criminal careerism is probably the most accurate thing to call it. “Careerism” is placing your personal career advancement above all other considerations.

Ultimately, they will all get together and raise the ceiling with some meaninglessly small cuts. If it’s not a trillion or more this year, not spread over ten years as one Republican plan calls for, that means the situation is still deteriorating.

We are stopping the bleeding when the deficit is zero and making progress toward healing when the national debt starts going down. No plan, other than those by guys like John Stossel and me, would reduce the national debt. But it has to be reduced. It has been alarming levels for years and skyrocketing up to unimaginable levels.

One of the few developed countries whose national-debt-to-GDP ratio is worse than ours is Japan. Around January 27, 2011, their “full faith and credit” rating was cut from AA to AA- by Standard & Poors (S&P). The United States has been warned that the same thing is going to happen to us by Moody’s and S&P if we do not cut spending.

After we vote to raise it this time, the media will start discussing when we will hit our next debt ceiling. Once again, everything I said above will apply only the cuts required to match outlays with tax revenues will be bigger.

In other words, the choice is not 41% cuts now or more borrowing. It is 41% cuts now or bigger cuts next year or even bigger cuts the year after that, etc. etc.

41% is the best offer the American people are ever going to get. And they will almost certainly haughtily reject it.

Congress and the president will not vote to cut federal spending 41%. When they have to choose between personal political suicide or national financial suicide, they will choose national financial suicide. That means we will be hit with bigger cuts in the future. “It could happen tomorrow” is the first sentence in my book How to Protect Your Life Savings from Hyperinflation & Depression.

The back cover of that book says,

There is no grown-up in Washington or on Wall Street looking out for you. You have to be your own grown-up.

Hyperinflation and Depression

But the vast majority of Americans are behaving exactly as if they believed some Washington/Wall Street grown-up were taking care of them.

What can/should you do? Implement the “Action Plan to Protect You” in chapter 27 of How to Protect Your Life Savings from Hyperinflation & Depression.

John T. Reed

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