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US dollar death spiral or vicious circle? Either way, we are about to hit a wall.

Posted by John Reed on

I recently wrote here that the increases in interest rates now going on will soon consume prohibitive amounts of the US budget. In Today’s WSJ, Red Jahncke, head of Townsend Group LLC says what I said in more detail.
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I used the phrase “death spiral” of the USD. Jahncke uses the phrase “vicious circle.”
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If you look at the pie chart of the budget, the biggest slices are health care, pensions, and defense, in that order—all over a trillion each. Then comes interest at a paltry $357B. Not for long.
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Jahncke says with the new higher interest rates, the US government’s annual interest expense will rise to a trillion dollars.
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So where will we get the additional $1T - $357B = $643B?
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A century ago, we would have to raise taxes. That would be about a $2,000 annual tax increase per adult. Not gonna happen. Nowadays, we do not even tax half the country,
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Next, the US government can borrow to pay the interest on the former borrowing. First, that is considered a debtor death spiral. If a borrower is doing NEW BORROWING TO PAY INTEREST ON OLD BORROWING, they are headed for bankruptcy.
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Second, the Fed said it is not going to do “quantitative easing” anymore. That mean buying US government bonds with money that the Fed conjures out of thin air. The more accurate name for it is “printing” dollars. They say they are not going to do that any more. And if they do return to “printing”, that will INCREASE inflation. If you are fighting inflation, “printing” money is aiming a gasoline hose at a fire.
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That is simply out of the question.
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Third, they can do like in WW II—the last time time our debt to GDP ration was so high—and sell US bonds not to the Fed but to the American people and the people of the world.
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But how is the US government going to do that? They will have to pay high interest to attract bond buyers and they must convince the borrowers that the bonds will not default. But when you are borrowing new money just to pay interest on the old money you borrowed, you look like you ARE going to default.
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In other words, after initially buying the new interest-on-interest, high-interest rate bonds, the American people and the people of the world will refuse to buy them.
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I often describe this as going off a cliff. Hitting a wall is more like it. The US government would have tax revenue of about $4.3T and spending for the year of about $7T. If you cannot borrow the $2.7T difference and you cannot raise taxes to cover it, you have to cut the spending other than interest on the debt.
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And what would that be? The US government would have to eliminate all civilian federal government employees and cut health care and pensions (social security) by something like 50% to 75%. The biggest slice in the national budget pie chart would become interest.
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Like I said, that would mean we would slam into a wall of massive entitlement and government cutting. The entitlement-receiving and fired federal employee voters would scream to the heavens.
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A third party along the lines of the Nazis or Communists might claim to be the solution and might win. Certainly, the Democrats and Republicans would have no hope or proving THEY were the solution. They are the CAUSE of this situation—more the Dems than the GOP, but the GOP is not innocent.
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The short term “solution” would be to default on the national debt. That would avoid most cuts in entitlements. But America would be hated world wide. How that would affect our economy? I am not sure. It would NOT be good for international trade. So the resulting shrinkage in tax revenue would force MORE cuts.
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We are about to hit the wall caused by the collision between the increasing interest rates and vote-buying entitlements which we could never afford.
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It would meant going back to the government size of the 1960s in percentage terms. I lived through the 1960s. Great time for me. But taking today’s thoroughly spoiled pension kings and welfare queens back to the pensions and health care of the 1960s will cause a political cataclysm.
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