The Fiscal Sword of Damocles

debt2“The first point I want to get across is that our nation is broke. Our nation’s broke, and it’s not broke in 75 years or 50 years or 25 years or 10 years. It’s broke today. Indeed, it may well be in worse fiscal shape than any developed country, including Greece.”   Lawrence Kotlikoff, Ph.D., the William Fairfield Warren Professor of Economics at Boston University.

Testifying before the Senate Budget Committee on February 25, 2015, Korlikoff said that our insolvency would only be a shock to those who swallow the government’s official reported federal debt as a measuring stock for what our country owes.  The official government debt is not an economic measure of anything – . It’s merely linguistic constructs, fiscal labeling conventions. The federal debt is a word game, not a well-defined measure of fiscal policy. Choose the right words and you can make the debt any number, positive or negative.   Its use in understanding sustainability and generational policy is no different than driving in Los Angeles with a map of New York.

One way to clearly see the vacuity of standard fiscal accounting is to consider the two sets of checks my 95 year old mother receives, from the US Treasury; her social security and her coupon payments on Treasury bonds. Despite the identical nature of their appearance, only the present value of the Treasury bond payments is included as part of government debt. The present value of the Social Security payments is not.

Yes, the Treasury bonds bear “the full faith and credit of the US government,” but those fancy, legal words don’t make those bonds safe in any real economic sense. Our government has periodically defaulted on the real value of official debt by running inflation. In 1946 it wiped out a quarter of the real value of War Bonds by lifting price controls. In the 1970s our government used inflation to wipe out hundreds of billions of dollars in the real value of federal debt.

Her Social Security in contrast which are inflation indexed and backed by the lobbying power of 50 million Senior citizens, are secure against both inflation and changes in legislation, yet not one penny of these liabilities are included in the government debt.

Congress’s economically arbitrary decisions as to what to put on and what to keep off the books have not been innocent. Successive Congresses, whether dominated by Republicans or Democrats, have spent the postwar accumulating massive net fiscal obligations virtually all of which are kept off the books.   Spending six decades raising or extending transfer payments and cutting or limiting taxes helped members of Congress get reelected. But it has placed our children and grandchildren under a fiscal Sword of Damocles that gravely endangers their economic futures.

Economic theory is crystal clear in what we are to measure when it comes to fiscal sustainability and generational policy – infinite-horizon fiscal gap. This “gap” equals the present value of all projected future expenditures less the present value of all projected future receipts. Its purpose is to let us know if the government has enough money to cover its projected spending. But in order for it to work, everything must be put on the books, all expenditures regardless of what they are called and all income the government receives on its real and financial assets.

The US fiscal gap currently stands at $210 trillion, based on the CBO’s July 2014 75 year Alternative Fiscal Scenario projection. Constructing the infinite-horizon fiscal gap from the CBO’s projection takes less than five minutes. Yet the CBO refuses to make the infinite horizon fiscal gap calculations and continues to focus almost exclusively on “official debt,” deliberately misleading the public and Congress about our true fiscal condition.

The size of the US fiscal gap at $210 trillion is massive.  It amounts to 211% of the United States’s $18.2 trillion GDP, making it higher than Greee’s 175% debt to GDP ratio.  It’s 16 times larger than government’s official US debt, indicating how useless government speak is  for understanding our true fiscal condition.  It represents 58% of the present value of projected future taxes. Eliminating the fiscal gap via tax hikes would require an immediate and permanent 58% hike in federal taxes. Stated differently, the overall federal government is 58% underfinanced. 

You can read Professor Kotikoff’s testimony in full at this link.   Unless you have a background in accounting, you may find some of the testimony a bit confusing, however it is well worth the read.

The problem is simple. Unfunded and underfunded liabilities are promises politicians made to get elected or to push a social agenda. These liabilities are hidden from the public through official government speak and underhanded accounting practices that would possibly land us in jail.  Kicking the can down the road is no longer a viable option. 

According to the U.S. Treasury, for the first five months of the 2014/15 fiscal year, inflation adjusted tax revenues hit a record $1,185,613,000,000. However, the government spent $1,572,149,000,000, leaving a deficit of $368 billion.

In 2014, the world’s central banks bought 477.2 metric tons (15,342,000 Troy ounces) of gold, 17% more than they bought in 2013 and the second-highest annual increase in the last 50 years. In a report released in mid-February, the World Gold Council (WGC) said that central banks exchanged about $19.4 billion in paper money for gold in 2014. In the last five years, central banks have bought 1964 metric tons of gold, an average of 393 tons per year. For 2015, the WGC expects central banks to buy another 400 tons of gold, as they continue to dilute their own currencies with more money printing and negative interest rates.

“History is littered with examples of major economic and financial crises in countries that have engaged in public spending profligacy. That sad experience should be raising red flags in the United States, where the unsustainable longer-run trajectory of the US public finances is now suggesting the real risk of either a destructive burst of inflation or an outright government debt default. This is particularly the case in today’s US context where an ever-increasing portion of the US budget deficit is being financed by foreigners and where entitlement programs threaten over the longer haul to compound an already highly compromised public finance position.” Desmond Lachman, On the Road to Serfdom


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