Tuesday, October 5, 2010

Our National Debt, the Age of the Universe and Our Future

There has been a lot of controversy centered on the size of the U.S. National Debt and rightly so, because it has never been a larger number. Today, the national debt is approximately $13,550,000,000,000 dollars. Such a large number needs context. I could say that if we stacked a trillion $1 bills on each other that this stack would stretch around the Earth 2.72 times. Unfortunately, that boggles the mind, especially if I say that our debt is 13.55 times that. Clearly, we need another way to understand the vastness of this number.

Using the Hubble Space Telescope, scientists have a clearer picture of the origin of the universe. Scientists estimate that the universe is approximately 13.7 billion years old. When we compare the age of the universe with the size of our national debt, our national debt is a 1,000 times larger. In other words, if we had spent about $1,000 a year, every year, since the beginning of time, we would have a number about the size of our national debt. Or, suppose you had spent $2.71 a day, every day, since the universe began. You would have spent as much as our current national debt.

How did the debt get so large if there was a surplus in the Clinton years? It is true that the federal government collected more tax revenue than it spent in the late ’90s and national debt shrank, however the debt did not fall to zero. (The last time the national debt was zero was in 1836, under President Andrew Jackson.) We have since had budget deficits—with each borrowed dollar adding to the debt. With the TARP funds, bail-outs, stimulus injections, and other spending programs, there is little wonder that the resulting deficits are so large.

There are three ways that we can get ourselves out of this hole. The first is to monetize the debt. In essence, this means that we can convert the debt into dollars and pay everyone we owe. In fact, this can be done tomorrow. How? Quite simply, allow the central bank of the U.S., the Federal Reserve, to buy up all the existing debt. Let it buy up all the T-Bills, Treasury Notes and Bonds—all of it. Dollars would replace the outstanding debt. Where would the Federal Reserve get all this money? The answer is simply that the Fed would get it out of a big black hole of nothingness. The dollar isn’t backed by anything—not gold, not silver, nothing but the “full faith and credit” of the United States (whatever that is). That means the Federal Reserve can just create money at will. It can create an infinite supply. It doesn’t even need to print new bills. The Fed could simply type numbers into a computer account and it’s done.

What is the problem with monetizing the debt? When $13.55 trillion new dollars hit the economy, the banking system multiplies the new dollars by a factor of a little more than 9. That means the money supply will swell by more than $120 trillion. (The current size of the money supply, as measured by M2, is $8.7 trillion.) If we took this route, we would be well on our way to hyperinflation. There have been several historical instances of hyperinflation, which wipes out life savings and destroys resources that form capital. The most famous instance was the German hyperinflation of 1923. Prices were rising so fast that people had to be paid multiple times a day. When workers were paid mid-morning, the men would run to the gates to give the money to their wives so that they could buy something before the money became worthless. Inflation was so bad that the price of a cup of coffee tripled by the time one finished drinking it. And this was happening for all prices! Germany could not continue with this situation. It had to abandon the Paper Mark and eventually switched to the Reichsmark.

The second way out of this deficit is to increase the amount of tax revenue that flows into the Federal Treasury. This approach has failed miserably for two reasons. The first is that the politicians always seem to find ways to spend all the additional money brought in and leave us no better off. The second reason is that increasing taxes is like having the economy drop an anchor. Taxation slows the economy, stunts business activity and penalizes the behavior of entrepreneurs. As a result, the higher tax rates take a larger percentage from a smaller pie, leaving a small and short-term increase in the revenues flowing into the Treasury followed by a drop-off in tax revenue a year or two down the line leaving a large debt and a stagnant economy.

This leaves the third option: a cut in spending. By a cut in spending, I don’t mean what politicians have been calling a cut, “a reduction in the rate of spending.” I mean, “Stop the car, put it in reverse, and back it up.” We need to cut spending to levels that are below our revenues. This will constitute many broken promises and real pain. The federal government has made very large promises. In fact, the size of the Unfunded Liabilities for the federal government exceeds $110.7 trillion. In other words, just to fulfill the promises already made, another $110.7 trillion are needed in the bank collecting interest right now. (U.S. GDP is only $14.5 trillion.)

So where can we cut our spending? If we look at the amount that we have spent on national defense this year (and I mean all of it), add up the total money spent on all the branches of the military—including equipment, personnel, operations, the wars in Iraq and Afghanistan—we have a year-to-date total of a little more than $527 billion. That is a lot of money and there are certainly areas that could be cut. Yet, if we look at how much we have spent on Social Security over the same period of time, we see the total to be above $534 billion. Furthermore, if we look at Medicare and Medicaid, that number is nearly $604 billion. Unlike defense spending, Social Security, Medicare and Medicaid are currently considered “Non-discretionary” budget items, so radical structural changes are needed to fix this problem, as well as the courage to solve this deficit issue.

I recently heard a good analogy. Imagine that you received some terrible news: your child has an awful, horrible disease. This disease will cause a lot of pain and suffering and could possibly result in the child’s death. Any parent’s natural reaction would be to fall to one’s knees and pray to God, “Give it to me. I will take the pain. I will suffer the burden, but please spare my child.”

Our National Debt is that disease. Why are we so willing to pass on the pain and suffering to the next generation, to our sons and daughters? Why are we so unwilling to bear the burden of our past excesses? The country is already broke. At this point, we are simply piling on. We have to address this issue now; it is getting worse. We have to look in the mirror and ask ourselves, “What kind of a person am I? What am I willing to do? What am I willing to sacrifice?” It has come to the point where the only way to fix this problem is through a sacrifice in today’s comforts. Will we try to spare our children from this disaster or will we impose this debt on them for our own comfort today? What are we willing to sacrifice for our children? What are you willing to sacrifice?


P F Cwik said...

A friend of mine argued, "The main thing is that I think most people would argue that you leave out the alternative that most people—not libertarians—would say they are suggesting, which is some combination of the three. I think the argument would be that no one is suggesting that you pay off the entire debt with all new money, all higher taxes or all spending cuts. You are in essence presenting false alternatives. In fact, I don’t think that anyone is suggesting that the entire debt be paid off all at once at all—with any method, and yet this seems to be what you are proposing."

I agree with this insight, however, it does not change the fact that we are going to have to take these dreadful steps. Even if a combination of spending reduction and tax increases are spread out over a decade, major negative impacts will fall on the economy. That much is unavoidable.

The path with the least economic distortion is spending cuts. The path that politicians tend to take is monetary expansion. Monetary expansion is a hidden and redistributive tax. It takes from the people who get the new money last and transfers the wealth to those that get the new money first. As prices rise, the government acts like it is innocent, and in the past has imposed disastrous price controls to combat the very inflation it caused.

There is a storm approaching and we need to get ready now.

David Wozney said...

Re: “If we took this route, we would be well on our way to hyperinflation.

If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

The October 4th metal value of these nickels is “$0.0599352” or 119.87% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” at Coinflation.com.

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