October 6, 2010
Yesterday, Federal Reserve Chairman Ben Bernanke delivered a speech before the the Annual Meeting of the Rhode Island Public Expenditure Council in Providence, Rhode Island. In the speech, he warned about the current state of the government finances. His conclusion, the situation is dire and “unsustainable.”
It is remarkable that mainstream media has given this speech no coverage. I repeat, the central banker of the United States says in his own words:
Let me return to the issue of longer-term fiscal sustainability. As I have discussed, projections by the CBO and others show future budget deficits and debts rising indefinitely, and at increasing rates. To be sure, projections are to some degree only hypothetical exercises. Almost by definition, unsustainable trajectories of deficits and debts will never actually transpire, because creditors would never be willing to lend to a country in which the fiscal debt relative to the national income is rising without limit.This is as close as you are ever going to see a central banker admit that his country’s financial situation is so dire that it could breakup at any time.
Herbert Stein, a wise economist, once said, “If something cannot go on forever, it will stop.”
One way or the other, fiscal adjustments sufficient to stabilize the federal budget will certainly occur at some point. The only real question is whether these adjustments will take place through a careful and deliberative process that weighs priorities and gives people plenty of time to adjust to changes in government programs or tax policies, or whether the needed fiscal adjustments will be a rapid and painful response to a looming or actual fiscal crisis.
Here’s more from Bernanke’s remarkable speech:
The recent deep recession and the subsequent slow recovery have created severe budgetary pressures not only for many households and businesses, but for governments as well. Indeed, in the United States, governments at all levels are grappling not only with the near-term effects of economic weakness, but also with the longer-run pressures that will be generated by the need to provide health care and retirement security to an aging population.Now, get this, he warns that it is not only the Federal government that has financial problems, but also states and local governments:
There is no way around it—meeting these challenges will require policymakers and the public to make some very difficult decisions and to accept some sacrifices.
But history makes clear that countries that continually spend beyond their means suffer slower growth in incomes and living standards and are prone to greater economic and financial instability.
Although state and local governments face significant fiscal challenges, my primary focus today will be the federal budget situation and its economic implications.Does Bernanke see the tsunami hitting or what?
Then, he put things in historical perspective:
The budgetary position of the federal government has deteriorated substantially during the past two fiscal years, with the budget deficit averaging 9-1/2 percent of national income during that time. For comparison, the deficit averaged 2 percent of national income for the fiscal years 2005 to 2007, prior to the onset of the recession and financial crisis.Then, he explains the deterioration and the problems it will create for the entire economy:
The recent deterioration was largely the result of a sharp decline in tax revenues brought about by the recession and the subsequent slow recovery, as well as by increases in federal spending needed to alleviate the recession and stabilize the financial system. As a result of these deficits, the accumulated federal debt measured relative to national income has increased to a level not seen since the aftermath of World War II.
For now, the budget deficit has stabilized and, so long as the economy and financial markets continue to recover, it should narrow relative to national income over the next few years. Economic conditions provide little scope for reducing deficits significantly further over the next year or two; indeed, premature fiscal tightening could put the recovery at risk. Over the medium- and long-term, however, the story is quite different.Then he tells us how powerful the negative trends are and how the aging population and Obamacare are going to make things worse:
If current policy settings are maintained, and under reasonable assumptions about economic growth, the federal budget will be on an unsustainable path in coming years, with the ratio of federal debt held by the public to national income rising at an increasing pace.
Moreover, as the national debt grows, so will the associated interest payments, which in turn will lead to further increases in projected deficits.
Expectations of large and increasing deficits in the future could inhibit current household and business spending—for example, by reducing confidence in the longer-term prospects for the economy or by increasing uncertainty about future tax burdens and government spending—and thus restrain the recovery. Concerns about the government’s long-run fiscal position may also constrain the flexibility of fiscal policy to respond to current economic conditions.
Our fiscal challenges are especially daunting because they are mostly the product of powerful underlying trends, not short-term or temporary factors.Then he goes back to warn that the financial mess also exists at the state and local level:
Two of the most important driving forces are the aging of the U.S. population, the pace of which will intensify over the next couple of decades as the baby-boom generation retires, and rapidly rising health-care costs.
As the health-care needs of the aging population increase, federal health-care programs are on track to be by far the biggest single source of fiscal imbalances over the longer term. Indeed, the Congressional Budget Office (CBO) projects that the ratio of federal spending for health-care programs (principally Medicare and Medicaid) to national income will double over the next 25 years, and continue to rise significantly further after that…the aging of the U.S. population will also strain Social Security, as the number of workers paying taxes into the system rises more slowly than the number of people receiving benefits.
This year, there are about five individuals between the ages of 20 and 64 for each person aged 65 and older. By 2030, when most of the baby boomers will have retired, this ratio is projected to decline to around 3, and it may subsequently fall yet further as life expectancies continue to increase.
Overall, the projected fiscal pressures associated with Social Security are considerably smaller than the pressures associated with federal health programs, but they still present a significant challenge to policymakers.
The same underlying trends affecting federal finances will also put substantial pressures on state and local budgets, as organizations like yours have helped to highlight.Bernanke then breaks the news that the problem is global:
In Rhode Island, as in other states, the retirement of state employees, together with continuing increases in health-care costs, will cause public pension and retiree health-care obligations to become increasingly difficult to meet.
Estimates of unfunded pension liabilities for the states as whole span a wide range, but some researchers put the figure as high as $2 trillion at the end of 2009. Estimates of states’ liabilities for retiree health benefits are even more uncertain because of the difficulty of projecting medical costs decades into the future.
However, one recent estimate suggests that state governments have a collective liability of almost $600 billion for retiree health benefits. These health benefits have usually been handled on a pay-as-you-go basis and therefore could impose a substantial fiscal burden in coming years as large numbers of state workers retire.
It may be scant comfort, but the United States is not alone in facing fiscal challenges. The global recession has dealt a blow to the fiscal positions of most other advanced economies, and, as in the United States, their expenditures for public health care and pensions are expected to rise substantially in the coming decades as their populations age. Indeed, the population of the United States overall is younger than those of a number of European countries as well as Japan.Bernanke then re-emphasizes the damage this will do to the overall economy:
Failing to address our unsustainable fiscal situation exposes our country to serious economic costs and risks.He then states that we do not know how much time is left before all hell breaks loose:
Larger government deficits increase our reliance on foreign lenders, all else being equal, implying that the share of U.S. national income devoted to paying interest to foreign investors will increase over time. Income paid to foreign investors is not available for domestic consumption or investment.
- In the short run, as I have noted, concerns and uncertainty about exploding future deficits could make households, businesses, and investors more cautious about spending, capital investment, and hiring.
- In the longer term, a rising level of government debt relative to national income is likely to put upward pressure on interest rates and thus inhibit capital formation, productivity, and economic growth.
And an increasingly large cost of servicing a growing national debt means that the adjustments, when they come, could be sharp and disruptive. For example, large tax increases that might be imposed to cover the rising interest on the debt would slow potential growth by reducing incentives to work, save, hire, and invest.
It would be difficult to identify a specific threshold at which federal debt begins to pose more substantial costs and risks to the nation’s economy. Perhaps no bright line exists; the costs and risks may grow more or less continuously as the federal debt rises.From there Bernanke goes into a bit of wishful thinking by identifying ways Congress can rein in spending and make the tax system more efficient. Good luck with all of that.
What we do know, however, is that the threat to our economy is real and growing, which should be sufficient reason for fiscal policymakers to put in place a credible plan for bringing deficits down to sustainable levels over the medium term.
The real important part of Bernanke’s speech is the first half where he warns of the financial crisis just ahead.
October 7, 2010
Since too often financial articles consist of some stooge blathering on and on with opinions instead of facts, I thought today we’d simply focus on some FACTS about our current financial system which few if any want to acknowledge.
#1: The US Fed is now the second largest owner of US Treasuries.
That’s right, this week we overtook Japan, leaving China as the only country with greater ownership of US Debt. And we’re printing money to buy it. Setting aside the fact that this is abject lunacy, this policy is trashing our currency which has fallen 13% since June… as in four months ago. Want an explanation for why stocks, commodities, and Gold are exploding higher? Here it is.
#2: “There are only about $550 billion of Treasuries outstanding with a remaining maturity of greater than 10 years.”
This horrifying fact comes courtesy of Morgan Stanley analyst David Greenlaw. And it confirms what I’ve been saying since the end of 2009, that the US has entered a debt spiral: a time in which fewer and fewer investors are willing to lend to us for any long period of time… at the exact same time that we must roll over trillions in old debt and issue an additional $100-150 billion in NEW debt per month in order to finance our massive deficit.
And only $550 billion of the debt we’ve got to roll over has a maturity greater than 10 years!?!?
So we’re talking about TRILLIONS of old debt coming due in the next decade. The below chart depicting the debt coming due between 2009 and 2039 comes courtesy of the US Treasury itself. In plain terms, we’ve got some much debt that needs to be rolled over that you can’t even fit it on one page and still read it.
#3: The US will Default on its Debt
… either that or experience hyperinflation. There is simply no other option. We can NEVER pay off our debts. To do so would require every US family to pay $31,000 a year for 75 years.
Bear in mind, I’m completely ignoring the debt we took on with the nationalization of Fannie and Freddie, AIG, and the slew of other garbage we nationalized or shifted onto the Fed’s balance sheet. And yet we’re STILL talking about every US family making $31,000 in debt payments per year for 75 years to pay off our national debt.
Obviously that ain’t going to happen.
So default is in the cards. Either that or hyperinflation (which occurs when investors flee a currency). Either of these will be massively US Dollar negative and horrible for the quality of life in the US. But they’re our only options, so get ready.