Thursday, July 14, 2011

The Debt Crises



The recent book by David M. Walker entitled “Comeback America: Turning the Country Around and Restoring Fiscal Responsibility” has made us consider the national debt in relationship to the current market.  Recent statistics show that current, as of 2011, the national IOU is ten times our current individual annual income or approximately $670,000 per household[1]. 


To give you an idea of how serious the debt crises is, the U.S. Federal Government in 2008 revenue from tax year 2007 was $2.52 trillion while spending for fiscal year 2008 was $2.98 trillion. Remember 2007 was a good “employment” year with high tax revenue from individuals and corporations paying taxes.  The federal budget has only increased while the tax base has diminished with the current economic downturn.


However, federal budget deficit is not the only problem.  Public debt is a looming problem as well.  Public debt is obligations the U.S. Federal Government owes to individuals, institutions and intergovernmental holdings (intergovernmental holdings are Treasury Securities held in various government trust accounts such as OASI Trust Fund administered by Social Security.  (More on this below). These obligations make up the public debt. The Total Public Debt is $14.38 trillion or 98% of our national GDP. Our GDP for 2011 is $14.66 trillion[2]! Let’s look at each for a moment:



1)      U.S. Federal Government owes Individuals:


a)      Social Security


The U.S. Government has no control over this spending as these programs are “mandated” by Congress.  These mandated programs make up 60 percent of our federal budget.  Social Security is the only program that has revenue, FICA taxes paid by the citizens. However, there is a large unspoken “off the books” liability in Social Security.  The money placed in Social Security was spent a few years ago beginning in the Johnson Administration. Currently $2.4 trillion was spent and in its place the U.S. Government issued special securities backed by the full faith and credit of the U.S. to be paid back when needed with interest.  These securities are held in a locked file cabinet in West Virginia not a lock box.  We don’t believe the government intends to pay the $2.4 trillion plus interest back to Social Security that’s why it is never shown as a liability on the books. 


The second problem with Social Security is the current receipts are greater than the current expenses.   In other words there are enough people to pay for those receiving a monthly social security check with money left over at the end of the year.  However, the U.S. Government, in order to reduce the amount of the budget, counts this money as income to the U.S. government and spends it rather than placing it in the “lock-box” for future generations.  This increases the future unfunded liability of Social Security. WOW! 


The third problem with Social Security is the Disability Program.  The Disability Program already “borrows” from the retirement and survivors program.  The Disability Program costs are projected to increase, causing an already broke Social Security to be bust by 2020.


b)      Medicare


Begun in the Johnson administration, Medicare cost has grown to the point that is 20% of the current federal budget or $599 billion!  While each working person “pays into” Medicare, the total Medicare spending far exceeds its income to the point that the Medicare Chief Actuary stated that the Medicare Trust Fund will be insolvent in 2019. Another WOW!


c)      Medicaid


While Medicaid is a joint funded program between the individual states and the federal government, the federal government’s responsibility adds to our current economic woes of approximately $210 billion a year.




2)      U.S. Government Owes Countries, Corporations, Communities, and Common People


Treasuries are the United States debt instrument.  Countries, Corporations Communities, and Common people own U.S. Treasuries that were issued by the U.S. to finance debt.  When you buy a Treasury Bond in your portfolio you are lending money to the U.S. Government therein lies the debt to the nation.  We now owe countries, corporations, and common people $197 billion in interest annually and rising.


3)      U.S. Unfunded Obligations


Unfunded obligations are future liabilities for which the U.S. is responsible, yet, has not put the assets aside to pay. This includes the future baby boomers that will join the ranks of those collecting Social Security, government pensions negotiated in the past payable in the near future but never funded.  These include government workers, military personnel and politicians. The U.S. Unfunded Obligations numbers seems to be hard to pin down as it is a moving target, ever increasing.  In September 2009 it was $63 trillion and today it is $114 trillion and increasing.


Debt Laden Future


U.S. Stocks


The current economic woes of Greece may be a foreshadowing of things to come in the U.S. markets.  Most economists are overwhelmingly skeptical that Greece can ever repay its mountain of debt, which has reached 340 billion euros ($486.7 billion) — or 150 percent of the country’s annual economic output.  Many believe the European Union will rescue Greece without major disruption to markets and are using the drop in equity prices as a buying opportunity. But who will rescue the U.S.?


Gone are the days of an ever increasing S&P.  The narrow trading ranges have become the norm in U.S. stocks.  As recently as Wednesday June 15, 2011, the Dow Jones industrial average fell 178.84 points to 11,897.27, extending its loss since its 2011 peak on April 29 to 7.1%. Oil prices were crushed, too, with a barrel falling more than 4%.


U.S. Treasuries


Currently, the U.S. Treasury has Quantitative Easing 2(QE2) in affect.  Quantitative Easing is the Federal Reserve Bank printing more money to buy back 70% of Treasuries issued in the recent period while foreign central banks such as China, buying the remaining 30%.  The hope is that by purchasing treasuries from other banks and private businesses with newly printed money will increase the cash reserve in banks and business raising the price of the Treasuries and thus forcing the yield down making Treasuries unattractive to hold. The hope is the sudden influx of spendable cash.  The banks or businesses now have cash rather than a long term investment; QE hopes the cash will be spent to stimulate the economy.  The problem is the source is new printed money back by new issued Treasuries.   QE is like taking a bucket of water from the shallow end of the pool and then pouring it into the deep end.  The overall level of the pool doesn’t rise.  The question is who will buy Treasuries after QE2?  Who will buy Treasuries if there is a QE3 and QE10?  At some point buying U.S. debt is no longer attractive especially as yields drop and price is artificially high.




The fix is not in!  The U.S. government, and yes we the people, are unwilling to take our heads out of the sand to fix the debt problem.  There have been suggestions such as reform Social Security, Medicare and Medicaid all of which have their own stigmas which make reform a political minefield.  Some say revenue is the problem, meaning the IRS is not collecting enough taxes even to the point of suggesting a reform of current tax laws to provide more revenue.  Of course the suggestion of raising taxes is another political minefield.  And finally, there is the suggestion of lowering taxes as Ronald Reagan did to stimulate the economy and jobs thus providing more revenue as business and jobs flourish. 


Since no one is willing at this time to do any of the above and no one in Washington is willing to stop spending as the recent stimulus plan showed. The U.S. markets will continue to contend with a debt laden U.S. economy well into the next decade.  The current question of raising the debt ceiling has cause market angst as recently as April 2011, when the market dropped due to debt questions. Investors suffered their only double-digit percentage drop in the 27-month-old bull market and dumped risky assets such as stocks and commodities, and plowed their cash into safer U.S. government bonds.


In respond to that market decline on April 18, 2011 on NBC's Meet the Press, Treasury Secretary Geithner reiterated his view that "... if you allow people to start to doubt whether the United States of America will meet its obligations, that would be catastrophic, and we can't take that risk."



What is the relationship between debt and the market?  To be sure, there is no love for the considerable mountain of U.S. debt by the market.  With no one able or willing to deal with this crisis, the debt will continue to grow putting downward pressure on the market, our economy and ultimately the U.S. GDP.  A trillion dollar stimulus package adding to our debt did not work, QE did not work, QE2 did not work and reform of mandate programs is not on the horizon.  What we may be witnessing is the proverbial “fiddling while Rome burns”.  

[1] U.S. Total Debt per citizens includes household, business, state and local government, financial institutions, and federal government divided by the number of U.S. families – The Federal Reserve

[2] US Debt


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