By James Digeorgia, Editor | 31 May 2008
• Federal Reserve report says: America is bankrupt!
• Bush Administration warns: Medicare is "drifting towards disaster"
• Why US Social Insurance programs all but guarantee gold will reach $2,500
"Is the U.S. Bankrupt?"
That’s the title of a disturbing paper issued by the Federal Reserve Bank of St. Louis, written by economist Laurence J. Kotlikoff. Most people would rather poke knitting needles under their fingernails than read an academic paper by an economist. So it’s no surprise that Kotlikoff’s paper has received little attention. This is unfortunate. His discoveries are vital to our national future.
Kotlikoff wrote his paper to be accessible to noneconomists, so he took a simple approach. If the United States cannot pay its future obligations, then it is bankrupt. Conversely, if it will be able to meet its future obligations, then America is not bankrupt. Kotlikoff’s discoveries are frightening. He says, "[This] analysis strongly suggests that the US government is, indeed, bankrupt, insofar as it will be unable to pay its creditors...[the] current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds… There are strong reasons to believe the US may be going broke." To understand this assertion, and its implications for your investments, we need to start at the beginning.
The United States’ National Deficit
In a previous issue, we discussed our ballooning national debt. Because it grows larger every year [[that's the deficit and the debt : normxxx]], this tells us our government spends more each year than it receives in revenue. The annual shortfall is the national deficit.
"The Financial Time-Bomb That Will Devastate the American Economy!"
"All the Presidential candidates drone on and on about gas prices, jobs, and so on… while carefully ignoring the real disaster that’s about to overtake our economy. Why? Because it’s too late to stop it! "The magnitude of this catastrophe is horrifying— a $71.1 trillion financial tsunami that’s headed for our shores. Read on to discover the secret about our economy that our politicians won’t discuss!"
Notice that in recent years, the government has been running deficits as high as $400 billion. However, our deficits are "shrinking", so the overall outlook is cheery. Hooray! Pretty soon, we’ll be back to the "good old years" of the Clinton Administration, when the government ran a "surplus". But wait a minute. For several decades now, our government debt has increased every single year. How can our debt grow each year, even when our government was supposedly running a surplus?
The answer is that the government lies to us. According to generally accepted accounting principles, the US hasn’t had a surplus since 1957. It’s had a deficit every single year since then… …if you make a comparison between the announced government budgets, and our actual annual deficits. Our annual deficits are actually far higher than the government claims.
Where does this discrepancy come from? It’s simple. The government is running an accounting swindle. To be blunt, our leaders in Washington are lying to us. The US government is running an accounting flim-flam that’s breathtaking in its scope. If a corporate CEO tried to cook his company’s books like this, he’d be thrown into the slammer. But when politicians do it, there are no consequences whatsoever. The key concept is easily discovered in the Government's own publications. You might have noticed the government’s numbers come from the "unified" budget— the budget that ‘unifies’ social insurance programs (especially Social Security and Medicare) into our national finances. Social Security insurance (SSI) and Medicare are runaway trains… and a spectacular wreck is coming soon [[but, for now, more is coming in than going out: normxxx]].
By using ‘creative’ bookkeeping, Washington is covering up the whole thing. Most people believe these programs are savings accounts. They think the government extracts money from our paychecks today, and saves it for later, to be paid back when we retire. But this isn’t how they work. In reality, the government takes money from you today via payroll taxes, and immediately gives it to current recipients of government benefits. From their inception, these programs have been "pay as you go" transfer programs— not savings accounts. There are no fewer than three impending disasters with this arrangement. Let’s discuss each one.
Impending Disaster #1:
Unstoppable Demographic Trends. SSI and Medicare were constructed on assumptions that are no longer true. When SSI was created in 1935, most people didn’t live to age 65. So only a small percentage of the population would collect benefits under this program. Not only that, a high percentage of the population was of working age. As a result, there were about 16 workers supporting each retiree. In the decades since then, everything has changed.
Thanks to advances in medicine, people now live an average of 12 years longer. Each retiree is collecting benefits much longer than the system was designed for. Plus, costs are soaring. An 85-year-old incurs about double the annual medical costs of a 65-year-old. In addition, the national birthrate has fallen dramatically. The generations after the "Baby Boom" are much smaller [[especially Gen-X, the immediately succeeding generation: normxxx]]. Boomers alone constitute 77 million people— almost one-third our entire population. Because of all this, there are now only 3.3 workers supporting each retiree. And that number will plunge even further as the Boomers retire— down to only two workers per retiree.
What’s worse, the Baby Boomers have greatly expanded the social insurance programs. They’ve voted themselves very generous benefits, while paying little to get them. For example, a married couple that retires now, who earned the median income throughout their lifetimes, will have paid about $43,000 in Medicare taxes. But they’ll get joint Medicare benefits of $283,500. The net loss to taxpayers: $240,200. That’s just for one couple, and it doesn’t even count Social Security (which whacks the taxpayers for another $128,000). Changing demographics doomed the social insurance programs long ago.
But politicians ignored the problem for years. Of course, the longer the imbalance was ignored, the worse it became. Finally, Washington was forced to do something. So, a few years ago, payroll taxes were boosted dramatically. The social insurance taxes taken from your paycheck now exceed the amount required to pay current beneficiaries. In other words, the social insurance programs have never been exactly "pay-as-you-go." The government collects the 'excess' money, theoretically saving it for you when you retire, by lending it to itself. Or so we’re being told. In reality, this is
Impending Disaster #2:
The Trust Account Scam. Rather than fixing the problem, the latest hike in payroll taxes are simply allowing the government to plunge our nation farther into financial crisis. Supposedly, the excess payroll taxes are being saved in special government trust accounts. In reality, Congress spends every nickel as soon as it comes in. (Note that the law which allows the excess payroll taxes explicitly forbids spending this money on anything other than future social insurance benefits.
But Congress does it anyway, under the ruse that SSI and Medicare are "investing" the money by lending it to the government.) This is where the "unified" budget flim-flam comes into play. When Washington tells us about our national finances, the excess payroll taxes are being counted as income. This reduces the announced deficits. However, the government now owes the money to the trust accounts. In other words, the government is spending money and then writing IOUs to itself— an absurd practice whose only purpose is to cover up the scam.
Impending Disaster #3:
The Trust Accounts Are Empty. Remember, the 'excess' payroll taxes were originally designed to defuse the rapidly arriving demographic time bomb. The social insurance programs were built on a worker-to-retiree pyramid that’s turning upside down. That’s why the government collects 'excess' payroll taxes— to save the funds for that day. But, as we just saw, the money is not being saved. Instead, Congress is spending it, and replacing it in the accounts with special non-marketable Treasuries.
These securities are forms of government debt, but they can’t be sold on the open market for cash. This makes them worthless— not real securities at all. In effect, they’re only empty promises from today’s Congress that a future Congress will pay back the money. They’re just an accounting subterfuge, to cover up Congress’ gross mismanagement of our national finances. As the Boomers start to retire, the demographics pyramid will quickly invert. The social insurance programs will need massive infusions of funding, but the money set aside for this is gone. Today’s 'excess' payroll taxes were supposed to defuse this bomb— but they’ve been diverted elsewhere.
So the bomb remains, waiting to detonate once its time arrives. When will the fiscal explosion arrive? Social Security will "invert" when its annual expenditures grow beyond its income. According to the Treasury Department, that will occur in 2017. Yes, that’s just nine years from now. And Medicare will invert in 2010— just two years from now. How big will the explosion be? That brings us back to Laurence Kotlikoff, who has pioneered a groundbreaking new way to answer this question.
Frightening Numbers, Oblivious Politicians
Our leaders in Washington have a disastrous habit. They routinely pass laws to obligate taxpayers to fund various programs— without ever asking how much those programs will ultimately cost. For social insurance programs, this has become a horrible problem. Politicians have created programs that literally span generations— but government accounting tracks revenues and expenditures only one year at a time. In the mid-1980s, Laurence Kotlikoff became interesting in this situation. He created a new financial technique called "generational accounting."
It considers everything the government expects to spend— Social Security and Medicare benefits, salaries, debt-service payments, and so forth— along with everything it expects to collect in taxes and other forms of income. The calculations reach far into the future, so they reveal to us what our future financial situation will be. Early in the Bush Administration, then-Secretary of the Treasury Paul O’Neill commissioned a study of our government using this new method. He asked two prominent economists (Jagadeesh Gokhale, then Senior Economic Advisor to the Cleveland Federal Reserve, and Kent Smetters, then Deputy Assistant Secretary of Economic Policy at the US Treasury) to perform the analysis.
As any other forecast, generational accounting requires the analysts to make certain assumptions. For this study, Gokhale and Smetters decided to be conservative in their assumptions about the growth of taxes, spending, medical costs, and so on. In fact, many think they were too conservative. For example, they assumed medical costs would only rise one percent more than wages each year, even though the historical rate since 1970 has been between 3.5 and 4.6 percent. Even with their unrealistically optimistic assumptions, their results were staggering.
Long-term over the next several decades, our government was facing a $44.2 trillion deficit. That’s more than the GDP of the entire world. It’s also about what you’d get if you sold every asset in the United States: every stock, bond, coin, diamond ring, painting, and piece of real estate. Everything. And that’s not the amount we’ll eventually have to pay, spread out over time. This is the ‘present value’: the amount we’d have to pay now to forestall the deficit from growing even bigger. This is similar to a home mortgage. For example, a $200,000 home mortgage has a present value— a current payoff amount— of $200,000. Stretched out over 30 years at 6 percent interest, the total payoff is more than twice that.
So $44.2 trillion is the minimum amount we owe. The longer we wait to pay, the bigger the eventual payoff becomes. Gokhale and Smetters hoped their study would wake up our government— maybe even be included in President Bush’s budget. Instead, Secretary O’Neill was fired, and the report was met with a stony silence. As Fortune magazine explained, "In Washington, generational accounting is about as popular as a skunk at a garden party." Generational analysis reveals the true extent of the government’s incompetence. Politicians have been lying about our deficits, but it turns out the true deficits are far worse than even they thought. Just look the table below.
Personally, I wasn’t surprised when both Democrats and Republicans swept Gokhale’s and Smetters’ report under the rug. Instead of being part of the budget debate in Washington, the two economists were left to publish their paper in an obscure economics journal. That was back in 2002. Since then, rather than trying to fix this problem, Washington has made it far worse. For example, as you see in the table below, the huge $400 billion Medicare package which became law in 2004 added over $12 trillion to our deficit for that year [[the 'present value' of that huge increase in obligations: normxxx]]. Also, the deficit grows bigger every year it isn’t addressed. Even without the additional pork spending that goes on in Washington, the present value would balloon by $1.5 trillion each year all by itself. That’s $4.1 billion every day. So how big is it now? Gokhale and Smetters updated their analysis in 2005, and found the fiscal gap had swollen to $65.9 trillion. Since then, another $5.2 trillion has been added, bringing us up to $71.1 trillion.
There are 111 million households in the United States. So right now, at this moment, your family owes $640,541. That’s how much your representatives and Senators in Congress have committed you to paying for social insurance and other programs. But actually, it’s even worse than that. About 11 million households in the US are below the poverty line. They will be paying little toward this debt. No, that burden will fall on the rest of us, who are able to ‘afford’ it. Add this to the analysis, and we find that… Your personal share of the debt is $711,000! And it grows bigger each year. Remember, $71.1 trillion is the present value. The number soars higher each year this problem isn’t addressed.
Question: How can this problem be fixed? Answer: it cannot. Not realistically, anyway. In their report, Gokhale and Smetters discussed a few possible solutions. For example, we could immediately and permanently double all personal and corporate income taxes. Or we could immediately and permanently slash the Social Security and Medicare programs by two-thirds. Or we could immediately and permanently cut all federal discretionary spending by 143 percent. The first option is impossible economically— that level of taxation would ruin us.
The second is impossible politically— Congress could never do it. And the third is just impossible, period. (Gokhale and Smetters were just illustrating how serious our financial crisis is.) Now we see the point that Kotlikoff made in his academic paper— the one I quoted at the beginning. If we define bankruptcy as an inability to pay its financial obligations, then the United States is indeed already bankrupt. Or so it would be… except for one factor we haven’t yet considered. There is one way the United States could pay all its financial obligations.
It won’t come from reducing spending. (The opposite is true instead— both political parties are competing to increase spending, not decrease it.) And it won’t come from increasing revenues, although I do expect countless new taxes on everybody who is ‘rich’ (translation: above the poverty line). But even crushing levels of taxation will have little effect on this crisis. (Note that the $71.1 trillion is the amount needed above the current levels of taxation. So you must pay $711,000 in addition to the income taxes, Social Security and Medicare taxes, and all the other taxes you currently pay— not to mention your mortgage, car payment, and so on.)
It can’t even come by reducing the government’s future obligations. After all, this crisis is not new: it’s been obvious for decades that the demographic tsunami would sink SSI and Medicare. Despite that, social insurance is still the "third rail" of politics. Any politician who touches it gets electrocuted. Even though the coming disaster has been looming for years, politicians have made it worse instead of better. And it’s easy to see why. The retiree population has a political clout far out of proportion to its numbers, and any politician who even hints about cutting benefits is thrown out of office immediately. And this is occurring with a smaller group of retirees than the Boomers will be.
Moreover, the Boomers have always been more cohesive, better-organized, and more active overall than preceding generations. So we can expect them to be even more forceful as retirees than the current group— and even fiercer about protecting their retirement benefits. None of this should really surprise us, though. This same problem has occurred over and over again— it seems to be part of human nature. Just look at countries like Argentina, which has been wallowing in near-bankruptcy for a century for exactly this reason. Its elderly population insists on granting itself financial support on the backs of the younger population, perpetuating the exact same trap that American social insurance has constructed for us. No, we can’t solve this problem by reducing spending, raising taxes, or reneging on promises. There’s only one way out of this trap.
As economist James Galbraith recently pointed out, "The US government isn’t going to go broke because it can print money." The US can’t default on its debt, because (as we saw in a previous issue) Congress needs to borrow an additional $1.5 billion each day to finance its ongoing pork-fest in Washington. If we defaulted on past debt, nobody would lend to us anymore. Ultimately, the US will make the same choice as every other government that has spent itself into bankruptcy. We’ll just print the money to repay the debt. More specifically, the Federal Reserve will buy US Treasury bills and bonds with its magic checkbook [[there is every evidence that, sub rosa, the Fed is already doing this for the Treasury by way of 'third party' agents: normxxx]].
The government won’t admit it is printing money far in excess of immediate need, of course. That would panic investors, and further sales of government debt would plunge. No, this will be portrayed as ‘managing interest rates’. As investors get more and more wary of lending to a bankrupt nation, interest rates on US debt will climb. Our government will complain loudly about this, and try to talk rates back down. This effort will fail, of course. So the Fed will step in and buy the debt instead, inflating our money supply in the process. Of course, the markets will notice this.
Investors will get even more nervous as their dollar-denominated assets are swiftly watered down and fall in value. Their increasing reluctance to lend to the US will drive rates up even further, causing the Fed to buy even more debt. As we’ve seen over and over in history, this downward spiral accelerates in short order. Unless the government clamps down hard on the money supply, inflation will quickly roar out of control and turn into hyperinflation. And that’s a frightening prospect, because… Hyperinflation can completely destroy a nation’s currency in just a few months. We’re seeing the early stages of this already.
As I write this in 2008, the Fed has injected unprecedented amounts of liquidity into the markets over the last six months. Nevertheless, long term interest rates remain stubbornly above the government’s target. Meanwhile, there are many signs that the government is trying to hide the true extent of inflation from the public. For example, the Fed no longer reports on M3 money supply— the most comprehensive measurement of how many dollars and dollar-denominated assets are flowing through the economy. Second, the government is manipulating its economic statistics. As economist John Williams reports in his Shadow Government Statistics newsletter, true inflation is about twice the number reported by the government.
Even a casual glance at the daily newspaper reveals that inflation is far higher than we’re being told. As I write this, many commodities have shattered their previous price records (oil, gold, platinum, copper, gasoline, etc.) Even basic necessities are in dire shortages or being sold at exaggerated prices, as evidenced by the food riots we’re witnessing around the world. This isn’t because rice is suddenly rare. It’s only because heavy inflation has distorted supply and demand— which always happens right before a hyperinflation begins.
So let’s summarize… The Social Insurance Disaster Will Force Washington to Inflate the Dollar— and Gold Prices will Explode Upwards.
Americans tend to ignore warnings about inflation. We see old photos of German housefraus throwing handfuls of currency into the fire to heat their homes, and we merely chuckle. How quaint. Surely such a thing could never happen in America. Well, such a thing can happen in America. All it takes is a government which inflates its currency just a little too much… and then the conflagration ignites and roars out of control.
As we’ve seen, Washington has dug itself a financial hole that’s unprecedented in history. A $711,000 debt for each household (including yours and mine) is a surreal, incomprehensible amount. The only way out will be to run the printing presses at full speed, 24 hours per day. Once that process begins in earnest, it will be impossible to stop. We’ve seen it over and over in history. Hyperinflations always destroy the underlying currency— sometimes over several years, sometimes over just a few months.
If a hyperinflation occurs in America— which appears all but inevitable at this point— the dollar’s value will be destroyed. And investors will stampede into gold. Most people will be surprised when that day arrives, but we can see it coming and prepare accordingly. However, once hyperinflation starts, it will be too late to establish a gold position. The yellow metal will be harder to find, and far more expensive, than today.
Conclusion: The time to establish your gold position is right now, before the storm hits. Don’t delay!
Announced Actual Increase in Actual Increase in Immediate Debt
Deficit Immediate Debt and Long-term Obligations
2004 $412 billion $596 billion $12,538 billion ($12.5 trillion)
2005 $319 billion $554 billion $ 2,326 billion ($ 2.3 trillion)
2006 $248 billion $574 billion $ 3,162 billion ($ 3.2 trillion)
2007 $163 billion $501 billion $ 2,097 billion ($ 2.1 trillion)
The government is actually running a deficit of trillions of dollars each year. The large jump in 2004 reflects the new drug benefit added to Medicare that year.
Latest prices as GEA goes to press— May 19, 2008
Comex spot silver contract: $ 16.17
Comex spot gold contract: $ 905.00
Nymex spot platinum: $2,140.00
Nymex spot palladium: $ 450.00
Nymex Light Sweet Crude Oil: $ 125.00
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US Government Official warns: "There is serious danger here." The biggest single financial threat to America is the Medicare/Medicaid program. As US Health and Human Services Secretary Michael Leavitt recently said, "Higher and higher costs are being borne by fewer and fewer people. Sooner or later, this formula implodes… There is serious danger here. Medicare is drifting towards disaster."
This is why Moody’s recently threatened to downgrade its rating of United States government debt. Currently, Treasuries and other government obligations are rated AAA— the highest possible rating, which they have maintained since their first assessment in 1917. But Moody’s has warned that if the government doesn’t change its policies, Medicare and Medicaid would "cause major fiscal pressures… The combination of the medical programmes and social security is the most important threat to the triple-A rating over the long term."
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How the Government Falsifies Its Economic Data
The government’s economic figures are heavily manipulated and distorted. Its reports paint a rosy picture of our economy that’s simply not justified. Among other things, the GDP (Gross Domestic Product) is overstated, and CPI (Consumer Price Index) inflation is understated.
For example, if you own your house, in the government’s eyes you’re paying yourself rent to live there. This is called "imputed" rental income, and is included in GDP. (In one recent year, imputed income accounted for 62 percent of all rental income in the GDP.)
As another example, if you have a checking account and don’t pay interest on it, the government says you’re getting imputed income there too. Supposedly, the bank is ‘paying’ you interest by not charging you any! (Imputed interest is about 21 percent of all reported interest income.)
The worst outrage is probably inflation reporting. The CPI is heavily manipulated downward. This not only covers up the truth about our economy, it also cheats retirees and pensioners of their appropriate cost-of-living adjustments.
Economist John Williams discovered this CPI manipulation several years ago, and now publishes a newsletter called Shadow Government Statistics to expose what’s really happening in our economy. For example, as I write this, official CPI inflation is at four percent. Yet Williams, using the same measurements our government used to use (before the manipulation began), is 7.6 percent— almost twice the reported figures.
Here’s how this works. The problem goes back to before the Clinton Administration, which latter most recently decided the BLS (Bureau of Labor Statistics) needed to change its measurement of CPI. The BLS was using arithmetic weighting; in other words, it used simple addition and subtraction when calculating its figures. But during the Clinton years, the BLS changed to "geometric" weighting.
Under this system, when something goes up in price, it is counted less in the numbers. Conversely, when something goes down in price, it counts for more. Obviously, this suppresses any upward move in inflation.
As bad as that was, the Bush Administration made it far worse. First of all, it added "substitution" effects to the calculations. To understand what these are, we need to talk about CPI for a moment. The CPI was originally calculated by measuring the average prices for a basket of various items. Let’s say it measures the price of a 16-ounce steak, a desktop computer, and a gallon of 89-octane gasoline. Each year, the prices of all these items are remeasured. The average change in their prices represents the change in CPI for that year.
But substitution changed all that. The CPI was climbing too fast, revealing the government’s mismanagement of our economy. So the government changed the rules.
Continuing our example, let’s say the price of steak has shot way up. In fact, many consumers can’t afford it anymore, so they’re switching to hamburger instead. Using the old measurements, CPI would soar. But using "substitution," CPI won’t go up. In fact, it might even go down.
According to substitution, now that consumers have substituted the hamburger for the steak, the steak’s price should no longer be used. The CPI should reflect hamburger’s price instead. Well, this destroys the entire concept of CPI. Using this logic, if hamburger went up 500,000 percent and everybody started eating dog food, the CPI might not change at all. In fact, unless the dog food price went up from all the additional demand, CPI would probably go down. What good is a measurement like this?
But even after substitution was introduced, the CPI numbers were still uncomfortably high. So "hedonic" adjustments were added too. Under this scheme, if the price of something goes up, its price for CPI purposes won’t necessarily change. If its "quality" improved, the BLS counts it the same as before.
For example, in the 1990s, federal regulations required a new pollution-reducing additive for gasoline. Gas prices went up by about 10 cents per gallon, but that price raise didn’t affect the CPI. Why? Because the air quality supposedly improved! Government CPI numbers are almost useless now.
As I mentioned earlier, John Williams monitors our economy using the old pre-Clinton CPI measurements. The real rate of inflation is typically about twice the government’s reported figures. A couple of percent difference doesn’t sound like much. But when inflation gets to a certain level, it starts to accelerate out of control— and Williams’ figures show the US is flirting dangerously close to that level.
Williams is adamant that he’s "no perennial bear." Yet his research has convinced him that hyperinflation will occur by the year 2010. We hope he’s wrong. But unfortunately, it doesn’t look that way. So we need to prepare accordingly.
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Normxxx
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