We Owe it to Ourselves

Note:  See continuing thread:  Principles of Circular Valuation

Anyone who knows me also knows how I like to stretch a metaphor – or a running joke – to the breaking point.  So, I’m going to engage in a bit of that sort of fun here. 

In a recent post, I likened our nation’s rapid approach toward a 90% debt to GDP ratio as merely the next stop for the “debt train”.  Let’s work that one a bit more by understanding that this “train” has quite a few cars in tow.  The national debt is but one, albeit large, car “taxing” the labor of our “engine” of growth.   There are others, as the following chart will attest.

Now, you might be familiar with the argument that a rising national debt isn’t a serious concern, “since we owe it to ourselves.”  Since there are always serious repercussions of default, that was never really true, and less so now when so much of that debt is owed to foreign investors.  Sadly, this misguided perspective misses (intentionally) the really important implication:  “we owe it”.  And, one way or another, we will pay it.

As noted above, the national debt is but one account on our collective credit card.  Of course, we intuitively understand that our domestic debt – the money we householders have borrowed – is, first and foremost, a personal burden.  Unfortunately, we’ve also learned to what extent our neighbor’s debt can influence our own financial well-being.  If they can’t (or won’t) make good on repayment, the rest of us do, one way or the other. 

Really, it’s all one big load on this train’s engine and, no matter how you slice it up, we all pay the freight.  Even business debt, bailout or no, is collectively charged to our accounts, whether it is passed through to us in the form of consumer prices or, alternatively, in the social costs of bankruptcy, unemployment, or declining asset values.  

Of course, some debt is, in fact, “good” debt; let’s call it the “coal car” to the extent that it can fuel growth.  In reasonable proportions, such a load can more than pay it’s own way.  The problem is when you’ve limited the coal load to make room for more cheese doodles.  

Consumables and mal-investments as the Austrians call them – hmmm, even the vast majority of what government seems to do – serve as mere dead weight when we’re talking about accrued debt.  What benefit can come from incurring long-term payments for something that is either consumed now, nobody wants or, better still amounts to little more than digging one hole to fill another? 

Why, these are the dreams that bubbles are made of and, sadly, the willingness of debter to pay for something that has no further use tends to be somewhat…..limited.  The bottom line:  Debt, even when defaulted upon, does not just disappear in to thin air, as some might contend. 

Metaphorically (God, I do love to say that), we might imagine that the whole of the above debt load (perhaps $57 trillion) is carried (and served) by our collective income, currently estimated at some $14.2 trillion, just like our personal household debts are carried by our (net) household income.  Apportioned to each household, that load equates to an average income of around $125,000 per year and, nominally, something on the order of $500,000 of “total” or collective debt. (See the US Debt Clock for another take on these figures.)

Naturally, this will look quite different on the margins, as we should know that debt, like income, is not necessarily distributed in a perfect bell-curve.  Still, imagine that at today’s long-term interest rates – say 4.6% on the 30-year – we incur annual interest in the amount $22,800 per household.  Hey, that’s not so bad – only $1,900 per month on that $10,400 monthly income, right?

Well, sure, except that a good portion of that debt is incurred at higher rates and, presumably, we might hope to pay it off some day, perhaps even sooner than 30 years.  When amortized at 6.5% over a 20 year period, this implied collective debt service rises to $3,700 per month, now 36% of our gross income. 

Not done yet….the “retirement” many of us hope for has implied obligations of another $60 trillion (or more) for Social Security and Medicare.   According to the National Center for Policy Analysis:

“The 2009 Social Security and Medicare Trustees Reports show the combined unfunded liability of these two programs has reached nearly $107 trillion in today’s dollars!  That is about seven times the size of the U.S. economy and 10 times the size of the outstanding national debt.

The unfunded liability is the difference between the benefits that have been promised to current and future retirees and what will be collected in dedicated taxes and Medicare premiums.  Last year alone, this debt rose by $5 trillion.  If no other reform is enacted, this funding gap can only be closed in future years by substantial tax increases, large benefit cuts or both.”

Some economist do quibble at the term “unfunded liability”, but at it’s heart, these are just as described above:  the net present value of what’s been promised and what will be collected – under current payment schemes.  Bridging the gap requires either higher taxes or reduced benefits.

In any regard, even the lower figure of $60 trillion, would clearly double the monthly debt service calculated above.  Now we’re talking about more than 70% of our gross income.  Worried yet?  You should be.  Because we’re not actually saving for these future expenses….you know that, right?

Like a bad habit we can’t ever seem to shake, we do fully intend to borrow these funds as we go.  Now, for the simple-minded or truly naive’ among us, what rate interest do you imagine our Chinese bankers might insist upon if they are, in fact, stupid enough (or desperate enough) to lend money this money to our “household”, knowing that it would consume the majority – if not the totality – of our income?  Have you looked at the rates on your credit card statement lately? 

Of course, this is but one reason that the artificially low interest rates we see today will not and can not last.  And, as a quick demonstration of what relatively small changes in Einstein’s 8th Wonder of the World can do:  pushing the average interest rate to 10%, all by itself, increases our potential debt service from, say, 74% to 96% of our gross income.

Quibble all you want about how you might crunch these number, or in what manner the totality of our debt and future obligations will either be met or modified.  The underlying truth is that, by comparison to our total assets, estimated to be in the range of $188 trillion, a realistic measure of our liabilities of some $164 trillion is perilously close to technical bankruptcy, especially when you consider the risks associated with improper valuation of those assets….but, we’ll leave that topic for another day.

In the mean time, I suggest the we – collectively and personally – adjust our expectations accordingly.  The “little engine that could“, of course, is a great American story, a metaphor for the American Dream, which, ironically, even socialists seem to want to co-opt.  But, there are limits to the number of cars, cheese doodles and free-riders, that any train can pull.

Harry Tuttle


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