I started writing the following piece on the fiscal cliff two-weeks ago. My attention got diverted by that big sell-off in Comex gold futures, and it never got posted. With negotiations on the fiscal cliff and debt ceiling still languishing, I believe it is still content worthy of your time.
Two-weeks ago now, The Wall Street Journal published an article by Chris Cox and Bill Archer entitled: Why $16 Trillion Only Hints at the True U.S. Debt. The key point being: “The actual liabilities of the federal government–including Social Security, Medicare, and federal employees’ future retirement benefits–already exceed $86.8 trillion, or 550% of GDP.”
THE REALITY
This is a harsh reality that I bring up with some regularity, but it is the 800 pound gorilla in the room that everyone in Washington seems to be tiptoeing around. Oh sure, some politicians pay lip-service to entitlement reform, but true and sustainable entitlement reform is the ‘third-rail’ of politics. With a rapidly aging population, politicians mess with pensions, Social Security and Medicare at their own peril.
PIMCO AGREES
Bill Gross, co-founder and managing director of bond giant PIMCO, has repeatedly raised the alarm as well. He tweeted the following In response to the Cox and Archer piece:
Gross: WSJ Op-ed confirms PIMCO thesis: U.S. debt is 5 times what it admits to. Inflation ahead.
WHAT DOES IT MEAN?
In two words, Gross reveals what I too believe is the inevitable consequence of amassing such an incomprehensible amount of debt: “Inflation ahead.”
We are indeed in a massive hole, the true size of which is being purposefully concealed from the American people by allowing spending commitments associated with entitlements to reside ‘off balance sheet.’ Meanwhile, our friends within the beltway are quibbling over nothing more than the speed of our continued digging. There is absolutely nothing on the table at this point that actually starts reducing the debt anytime soon, as the two parties remain primarily focused on political brinksmanship with just 3-weeks now until the sequestration takes effect.
The New York Times however found a glimmer of bipartisanship recently: “President Obama and the House speaker, John A. Boehner, are in general agreement that the relevant Congressional committees must sit down next year and work out changes to the tax code and entitlement programs to save well more than $1 trillion over the next decade.”
For real? Well, I’m glad they can agree on something as inconsequential as that. That’s tantamount to agreeing on chicken salad for lunch and calling it a breakthrough. While I suppose that every journey starts with a single step, $1 trillion dollars over a decade doesn’t even count as a ‘drop in the bucket’. Cox and Archer suggest that the proposals pitched thus far, that purport to put us on sustainable fiscal path, “amount to bailing out the Pacific Ocean with a teaspoon.”
Renowned investor Kyle Bass, founder and principal of Hayman Capital Management, provides some additional perspective in noting that since 1981, the U.S. increased its sovereign debt by 1,560% while its population increased by only 35%. That’s a pretty compelling statistic; illustrating just how difficult it is going to be to climb out of this ever-deepening hole.
The simple solution of course is to perpetuate the status quo: To allow the long-term downtrend in the dollar to continue and to keep interest rates pegged near zero. To accomplish this, a complicit Fed will have to continue buying U.S. Treasuries and expanding its balance sheet, which it appears quite content to do.
LEAVE IT TO THE FED
The beauty of that strategy, from the perspective of Congress, is that it doesn’t require them to do anything more meaningful than raise the debt ceiling. And even that may become unnecessary, if the McConnell provision is extended or made permanent, as Treasury Secretary Geithner has recently been advocating. That would allow U.S. sovereign debt to rise unimpeded, unless Congress votes against it. Just imagine what might happen with no budget and no debt ceiling! I shudder to think…
THE INFLATION TRIGGER?
This may prove to be the catalyst for the inflation Bill Gross warns of. What this also does, is make the dollar increasingly less appealing as the global reserve currency. As foreign demand for dollars and U.S. debt continues to erode, it falls increasingly on the Fed to absorb an ever-expanding supply of both.
Messrs Cox and Archer both served on President Clinton’s Bipartisan Commission on Entitlement and Tax Reform and predicted eighteen years ago that this day was coming: “In 1994 we predicted that, unless something was done to control runaway entitlement spending, Medicare and Social Security would eventually go bankrupt or confront severe benefit cuts. Eighteen years later, nothing has been done.”
I suspect that Alan Simpson and Erskine Bowles, the co-chairs of President Obama’s National Commission on Fiscal Responsibility and Reform, will be singing a similar song of lament eighteen years from now. If they’re still alive that is; Simpson would be 99 and Bowles 85. The recommendations of the bipartisan Simpson-Bowles commission didn’t even garner enough votes among its own members to allow their blueprint to be presented to Congress for approval. However, recently there has been some renewed interest in their plan.
As long as our representatives in Washington are not willing to risk their political careers with bold fiscal initiatives, the Fed will continue to deal with the problem using the only tools at their disposal. While that may suit politicians just fine, let the rest of us recognize that monetary policy is a very blunt instrument.
DOLLAR DEBASEMENT
Further dollar debasement can have a devastating impact on individuals that fail to prepare for the eventuality. That is particularly true for those that are on (or will be on) fixed incomes, such as a pension and/or Social Security. There is no time like the present to begin — or to bolster — your hedge against dollar exposure. You cling to the notion that those in Washington are looking out for your best interests and everything is going to work out just fine at your own peril.
[Do you think the US could be at risk for further dollar debasement? What could this mean for our country’s future? Is the US at risk for losing its reserve currency status. What could that mean? Please post a comment to share below.]
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