On the Road to Trouble

On the Road to Trouble

Posted By Vasko Kohlmayer On January 25, 2010 @ 12:02 am In FrontPage


“Is America’s Financial Collapse Inevitable?” asks the title of a recent piece [1] by Patrick Buchanan. The article points out something we have repeatedly discussed here: There is no way the federal government can meet its financial obligations.

If our government were ever to do so, it would first have to eliminate its colossal deficits. For this to happen deep budget cuts would be required. But this is something that is not conceivable in today’s environment. We will understand why when we look at the largest budget items, which are Medicare, Social Security, Medicaid, defense and interest on the debt. Since these constitute the bulk of government expenditures, any meaningful deficit reduction would require that substantial cuts be made there. The problem is that all of the above are for all practical purposes untouchable.

Interest on the debt is out of question, since not paying it in full would put our federal government in default. This cannot be allowed to happen as it would result in the immediate collapse of our currency. As far as Medicare, Social Security and Medicaid are concerned, no elected official will touch them with a ten foot pole, since doing so would mean political suicide. When it comes to defense the prospect of any reductions is likewise nil. The ongoing operations in Iraq, our deepening commitment in Afghanistan as well as numerous challenges presented by the War on Terror make any deep cuts a practical impossibility.

But what about taxes? Could they not be raised to increase revenue and close the budget gap that way? To begin with, any sharp hikes are out of question for the increasingly unpopular president who pledged during the campaign not to raise taxes on the middle class. To even suggest such a thing would be politically precarious if not suicidal. But even if Obama would somehow managed to do it, higher taxes would only further depress the already-overtaxed and over-regulated economy. This would in turn shrink the tax base and forestall the possibility of higher revenue intake.

Buchanan asks how are we ever going to get a handle on our runaway finances if “taxes are off the table, Afghan war costs are inexorably rising and cuts in Social Security, Medicare, Medicaid and entitlement programs are politically impossible.” There is, of course, no satisfactory answer. The truth is that our government is not going to get its fiscal house in order. And even though Buchanan does not state so explicitly, the implied answer to his starting question – is America’s financial collapse inevitable – is “yes.”

Pat Buchanan is not alone suffering from dark premonitions. Last week legendary investor and market commentator Marc Faber pulled no punches when asked what he thought of America’s prospects. “We are doomed,” was his response [2]. The reason for his bleak assessment? The immense and rapidly growing indebtedness of the federal government. In addition to all the other problems, Faber predicts that the rate interest that the government has to pay on the debt will shoot up rapidly in the next few years. Last year interest claimed about 12 percent of the government’s tax revenue. Faber estimates that within five years the figure will climb to some 35 percent. It goes without saying that such a jump would have a devastating impact on the already overextended federal budget.

Marc Faber is not the only one who worries about this. It has been pointed out by a number of finance experts that up until now the federal government has been able to borrow at very low rates due to the dollar’s status as the world’s reserve currency. But there are clear signs that this favorable situation is coming to an end. Sensing that the US will not be able to make good on its debt, governments and investors have been growing increasingly wary of financing our borrowing by buying treasuries. But even as they plead with Washington to end its spendthrift ways, they have been earnestly searching for an alternative to the dollar. Admittedly, this is no easy task, since there is no major government today that can be trusted to conduct its fiscal affairs in a way that would guarantee a stable currency.

It would seem that long-term currency stability is not a realistic possibility in the era of central banking. This is because politicians will invariably exploit the looseness of fiat money to satisfy their insatiable spending urges. But the advantage is only temporal. In the end there is always a price to pay for spending more than one has. This applies to everyone including sovereign governments. In their case the price that is paid is the depreciating currency as central banks print money in order to pay for politicians’ promises. It is paradoxical that the brunt of this is born by ordinary people and not by those who are most directly responsible for the situation. While politicians keep promising and getting elected, the population bears the cost as the real value of their assets and savings decreases with the depreciating currency. This is the situation that we see taking place in this country today.

It may be objected that the people themselves are ultimately responsible, because they vote for politicians who promise all those expensive programs. Perhaps so. There are, however, encouraging signs that the American people are becoming increasingly aware of where the problem lies. In what amounted to a referendum on President Obama’s expansive agenda, the victory of Scott Brown in Massachusetts showed that even a left-leaning electorate can grow wary of government’s ability to provide and finance massive undertakings such as national healthcare. Another sign of shifting sentiment can be detected in a recent Washington Post ABC News poll [3] which asked this question: “Generally speaking, would you say you favor smaller government with fewer services, or larger government with more services?”
Only 38 percent wished for a larger government with more services while 58 percent wanted a smaller government with fewer services.

This is good all news, but it still does not solve that $100 trillion question [4]: How is our government going to pay for all the massive obligations that it has so unadvisedly assumed?

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