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Your Wednesday Morning Dose of Doom and Gloom

March 21st, 2012 - 8:34 am

Yesterday, I warned you that “we’re doomed” because the latest Ryan plan to balance the budget is too timid. And longtime reader Neil added a thoughtful response in the comments:

I suspect that a target of zero deficit in 2040 will work. Here’s why: The problem we’re running into right now is that the deficit is projected to increase faster than economic growth, forever. Obviously, that can’t work and the currency markets will punish us for that if current policy becomes set in stone.

The dirty little secret here is that it is arithmetically possible to run a deficit forever, as long as the percent deficit is on average less than GDP growth on average. What Ryan’s plan does is to get the deficit down below GDP growth quick enough to satisfy the bond markets that our debt will be paid.

And, strictly speaking, that’s all that is necessary.

In normal times, this is absolutely true. Problem is, we’re not in normal times. In fact, the federal government of the United States of America is sitting on top of the world’s biggest adjustable rate mortgage — and the payments are set to radically increase.

Let me explain.

Historically, Washington financed most of its debt by selling 30-year Treasuries. But then a couple things happened during the Naughts:

• The Fed dropped interest rates to record lows, to keep the economy juiced in the aftermath of 9/11.

• The Bush administration began financing the debt with two-year and three-year Treasuries, to take advantage of those low interest rates. And, not coincidentally, to mask the true size of its spending problem.

As a result, we ran up the total debt to $10,000,000,000,000. But our interest payments — the mortgage payments, if you will — didn’t bust the budget, thanks to low rates on short terms.

Then the financial crisis of 2008 hit, caused in no small part by all that cheap debt made available by the Fed. Unemployment payouts skyrocketed. Tax revenues plummeted. The Obama/Reid/Pelosi “stimulus” added another near-trillion in debt, in one fell swoop.

Our “unsustainable” and “unpatriotic” borrowing soared from a measly couple hundred billion (“Hey, no problem, man — I can cover that in my sleep!”) to almost two trillion dollars in 2009 alone. That’s a two followed by twelve zeroes, like this: $2,000,000,000,000. And the next two years weren’t much better.

As an aside, the spending problem in 2009-2010 was even worse than it appears at first glance. Democrats love to remind you that Bush’s last deficit was $1.4 trillion — not much less than President Obama’s record $1.8 trillion the next year. However, Bush’s number includes $700 billion (half the total) in emergency TARP funds — most of which were paid back over the next two years. In other words, TARP shows up as an expense in Bush’s final budget, but the paybacks show up as income in Obama’s first two budgets. TARP made Bush’s spending problem look worse than it actually was, and it masked just how awful Obama’s spending problem was and is.

But let’s get back to the matter at hand.

Obama’s budgets added more debt in just three years than Bush did in eight. So now we’ve jacked the “mortgage” up to $15,000,000,000,000. Meanwhile, the Fed has kept interest rates even lower these last three years than it did during the Naughts. As a result, our mortgage payments have remained pretty low, considering the size of the debt.

Some, like Paul Krugman, will tell you it’s actually irresponsible not to run up more debt while rates are this low.

Here’s the problem: Obama has continued Bush’s shameful policy of financing our long-term spending problem with short-term Treasuries. We’ve racked up trillions in new debt, which must be refinanced each and every two or three years.

This year alone, we must re-fi $2,800,000,000,000 of existing debt, on top of the $1,000,000,000,000 or so of new debt we’ll tack on to the total.

But, hey, rates are low! Right?

For how long will they remain low? That’s the devil in the details.

The Fed has pumped trillions of free money into the system, to keep the economy buoyant. It’s done so largely by buying up debt from the Treasury to finance the spending orgy. Now, eventually, the economy will pick back up and the Fed will have to sell off all those Treasuries.

Why? Why can’t Ben Bernanke just keep the Treasuries under his mattress?

Well, when you have extra billions of dollars floating around during normal economic times, you end up with inflation. When you have trillions of extra dollars out there, and trillions more in deficit spending, you end up with hyperinflation. So Bernanke’s plan is this:

• Keep buying up Treasuries until he gets the desired stimulus (I know, I know) and the economy is growing again and people are working again.

• Then sell those Treasuries back to any willing buyers in order to suck those extra trillions back out of circulation.

Presto, change-o — Bernanke turns a $15,000,000,000,000 problem around on a dime. The money goes out, the money comes in, and Bernanke the Magnificent saves the world.

If you’re thinking of the word “hubris” right now, well, I hope you’re not the only one.

There’s one other teensy little thing the Fed has to do: It must return interest rates to something normal, or those excess trillions will flow right back into the economy as “free” debt.

If rates bounce back up to just five percent — which is actually not high at all — then our interest payments get jacked up to $800,000,000,000 a year, every year, forever.

And that’s just on the money we already owe. Every additional dollar we borrow gets added to the total, and the interest payments go up even higher. Every year, forever.

We could balance the budget right now, and our interest payments would still be on a short slope to nearly a trillion dollars a year. Every year, forever.

So the problem isn’t balancing the budget by 2040, or 2027 or even tomorrow. The problem is, we need to start paying down the debt, and we need to do it very soon. Because thanks to our World’s Biggest and Dumbest Adjustable Rate Mortgage, we’re about to have a debt payment that’s bigger than our defense budget, that’s bigger than Social Security, that’s bigger than Medicare/Medicaid.

The only other options are default, or hyperinflation. Or, perhaps most likely: Both. Either results in the immediate destruction of our economy as we’ve known it. Say hello to your house that’s worth nothing, and gas you can’t afford.

So that’s our problem. That’s the brick wall we’re running into head first. Obama’s non-plan runs us into the wall sooner. Ryan’s plan gets us there a little later. But we’re still going to crash into that wall if we don’t start paying down the debt, and paying it down in a big way.

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