Everyone knows that the US government is bankrupt and
has been for many years. But I thought it might be instructive to see what
its current cash-flow situation actually is. At least insofar as it's
possible to get a clear picture.
As you know, the so-called Super Committee recently
tried to come up with a plan to cut the deficit by $1.5 trillion and failed
completely. To anyone who understands the nature of the political process,
the failure was, of course, as predictable as it was shameful. What's even
more shameful, though, is that the sought-after $1.5 trillion cut wasn't
meant to apply to the annual budget but to the total budget of the next 10
years – a fact that is rarely mentioned.
Now whenever the chattering classes talk about cuts,
it's always about cuts over the course of 10 years. Which is a dodge, partly
because most of the supposed cuts will be scheduled for the end of the
period, but also because new programs, new emergencies and hidden
contingencies will creep in to offset any announced cuts. So the numbers
below aren't a worst case; they're the rosiest possible scenario. People have
thought I was joking when, asked how bad the Greater Depression was going to
be, I answered that it would be worse than even I thought it would be. But I
haven't been joking.
To sum up the situation, given its financial condition
and the political forces working to worsen it, the US government is facing a
completely impossible and irremediable situation. I'm going to try to
illustrate that here. But because I'm a perpetual optimist, not a
gloom-and-doomer, I'm also going to give you solutions to the purely
financial problems – albeit with some good news and some bad news. The
good news is, there actually are solutions. The bad news is that there is
zero chance that any of them will be put into effect.
The problems are one hundred percent caused by the US
government, not by bankers, brokers or the real estate industry –
although they have been complicit. Recall what government is: an organization
with a monopoly of force within a certain geographical area. Its purpose is,
ostensibly, to protect the inhabitants of its bailiwick from the initiation
of force. That implies three functions: an army to protect against aggressors
coming from outside of its borders; police to protect citizens from
aggressors inside its borders; and a court system to allow citizens to
adjudicate disputes without resorting to force. Assuming you're going to have
a government, it's important to limit it strictly, lest it get completely out
of control – it's got a monopoly of force, after all – and
overwhelm the society it's supposed to protect.
Here I want you to distinguish government from society.
They are not only two totally different things, but are potentially
antithetical to each other. This is because the essence of government is
force, not voluntary cooperation. Everything that people think the government
provides (beyond some forms of protection) is really provided by society or
with resources the government has taken from society. It's critical to
understand this, or you won't see the slippery slope the US is now sliding
Is there any chance that the US government can reform
and go back to a sustainable basis at this point? I'd say no. Its descent
started in earnest with the Spanish-American War in 1898, when it acquired
its first foreign possessions (Cuba, the Philippines, Puerto Rico, etc). It
accelerated with the advent of the income tax and the Federal Reserve in
1913. It accelerated further with World War I, when the government took over
the economy for 18 months. The New Deal and World War II made the state into
a permanent major feature in the average American's life. The Great Society
made free food, housing and medical care a feature. The final elimination of
any link of the dollar to gold in 1971 ensured ever-increasing levels of
currency inflation. The Cold War and a series of undeclared wars (Korea, Viet
Nam, Afghanistan and Iraq) cemented the military in place as a permanent
focus of the government. And since 9/11, the curve has gone hyperbolic with
the War on Terror. It's been said that war is the health of the state. We
have lots more war on the way, and that will expand the state's spending. But
the Greater Depression will be an even bigger drain, and it will likely
destroy the middle class as an unwelcome bonus.
In all that time, from 1898 to today, there have been no
substantial retrenchments of the US government, and the situation is getting
worse, on a hyperbolic curve. Trends in motion tend to stay in motion until a
genuine crisis changes them, and this trend has been gaining momentum for
over a century.
Let's divide people into three classes – rich,
poor and middle class. Rich people are going to be okay. They can bribe the
politicians to change the laws, hire the lawyers to interpret the laws, the
accountants to limit their liabilities, advisors to help them profit from
distortions and travel agents to get them out of Dodge. They may get eaten
later, but for the moment, don't worry about them.
The poor don't have much to lose, and the government is
going to keep throwing benefits at them to keep them happy. That's a shame
because it cements them to the bottom as poor people – but that's a
topic for another day.
The real danger is to the middle class, and it's a
serious matter because the US is a middle-class society. These are people who
try to produce more than they consume and save the difference in order to
grow wealthier. That formula has worked well up to now – but almost
everybody saves dollars. What happens, however, if the dollars are destroyed?
It means that most of what they saved disappears, and most of the middle
class will disappear with it, at least for that generation. They'll be very
unhappy, and they'll be up for some serious changes. I'll come back to those
Take a look at the following pie chart of US government
spending. It's cut into 10 slices, by function. The government used to break
down and report its spending according to agencies – Defense
Department, so much; Department of Agriculture, this much; FTC, that much.
They've de-emphasized that and now seem to prefer reporting by function,
because most of the agencies do many things. Actually, with thousands of
agencies, departments, divisions, bureaus, units and contractors, it's
impossible to figure out exactly who does what in the government. It's so
large, so irresponsible and so unmanageable that the only solution is to
abolish things wholesale. Bureaucracy naturally grows unless it's pulled out
by the roots; reform, or pruning it back, is doomed to failure.
The chart shows a tiny little yellow sliver, 2% of the
pie, equaling $55 billion, for administration of justice. That's the police
and the courts – by far government's most important functions, but also
by far its smallest expenditure. That's a lot of money, but how much of it is
really necessary? Of the 2.3 million people currently incarcerated and the
tens of millions more who are ex-convicts, parolees or otherwise "in the
system," most are there because of victimless crimes, mainly drugs. In
the Constitution, only three federal crimes are mentioned –
counterfeiting, piracy and treason. Dope isn't there. Now there are over
5,000 categories of federal crime. Most of them should be abandoned to the
states. So the most important function of the federal government could be cut
This is the red chunk, 24%, equaling about $850
billion. The very title of this part of the budget is an Orwellian misnomer.
Until 1946, there was a War Department (for declared wars) and the Department
of the Navy (for miscellaneous foreign adventures). Regrettably, the Defense
Department doesn't defend the US so much as its own budget. By having troops
all over the world, they're actually attracting danger to the US. As you
know, the US spends more on so-called defense than the rest of the world
combined; in effect, it's bought a gold-plated hammer that makes everything
start to look like a nail. Are there dangers in the world, and bad people?
Absolutely. But bankrupting yourself while developing new enemies isn't an
A bit of perspective is in order. World War II, by far
the biggest war in history, is said to have cost 288 billion 1940 dollars. Today
that's only a third of TARP. Of course, those were 1940 dollars, equal to
perhaps about 4.1 trillion of today's units. One other thought about the
military budget and where it's going: You may recall that, for a while after
the Soviet Union collapsed, there was talk about a "peace dividend"
of $50 billion. It seemed like a lot of money at the time, but it evaporated
like water on a hot skillet.
Americans seem to love their military, if only because
it's a part of the government that seems to work (at least when cost is no
object), and it doesn't seem corrupt (at least below the level of the
Pentagon). They'll be loath to cut military spending and hard pressed to do
so with new wars clearly on the way. So it's likely to grow. That said, 90%
of this piece of the pie should be eliminated before it’s too late.
This is the big blue chunk, at 20%, for about $706
billion. People who receive it don't like to hear this, but Social Security
is a classic Ponzi scheme, where late entrants are essential to pay early
entrants. But it's worse than a Ponzi scheme because it's involuntary. It's
justified by alleging "it's for their own good." But that's a lie,
because it actually discourages saving on the part of the poor in two ways.
First, it makes many believe saving is unnecessary because they figure
they'll have Social Security to rely on when they're old. Second, it takes
6.2% off the top of an employee's pay, plus another 6.2% from his employer,
up to $106,800 of earnings. That's over $13,000 every year that can't be
saved. Further, it doesn't go into some mythical "lock box." It
goes into the government's general revenue, and payments come out of general
revenue. It's not somehow "set aside" anymore, as was once the
case, when it went to buy a special class of government bonds. Even when that
was the case, it was a fraud. Those bonds never represented savings; they
just represented future tax revenues that would need to be extracted from
If the government insisted on making citizens save
– itself a bad idea that I don't have space to dissect here – it
should be in the form of an individually owned IRA. Chile has had these for
30 years, and as a result today the average Chilean has more net wealth than
the average American. They have real assets in the form of shares, not a
liability in the form of government debt.
What, then, is going to happen to Social Security?
Right now, 12% of the US population are 65 or over, therefore eligible for
Social Security. By 2030, that number is going to rise to 23%; about two
workers will be supporting each retiree. That's probably impossible, but I
doubt we'll have to confront the eventuality because the system is unlikely
to last that long. It's a real time bomb, however, because few Americans any
longer have sufficient savings to support them in their dotage. So don't look
for any cuts here. It's become an insoluble problem.
This next-biggest item equals $624 billion, for 17% of
the budget. It's a catchall of many different programs from many different
agencies that could more accurately be termed "welfare spending."
It includes food stamps for over 45 million. Unemployment benefits for
perhaps 12 million more. Housing assistance for millions more. Pensions for
federal employees and a myriad of other welfare benefits.
Can much of this $624 billion be cut? I would say it
should be cut to zero. It's a morally corrupting influence and a financially
bankrupting one. But because unemployment is going much higher and the
standard of living is going much lower, there's not much chance of any cuts
here. People now fervently believe this is what government is for –
entirely apart from the fact that the unemployed and the poor are voters.
At $451 billion, 13% of the budget, this item is
growing the most rapidly. What should happen to Medicare? The answer, of
course, is that it was the height of hubris and stupidity for the government
to have created this cancerous monster – but that doesn't address the
current issue. This isn't a question that lends itself to a technocrat's
answer; even more than other categories of spending, it's a philosophical
proposition. Let's address it from that direction.
What, historically, have men done upon reaching a
certain age, when the body starts to desert you and you become an active
liability to your fellows as well as to yourself? In pre-industrial cultures,
the honorable course was to wander out into the wilderness (while you were
still able), make your peace with reality and die. Eskimos would step out
onto an ice floe and disappear. An especially loved or valuable person would
be cared for – a good incentive to be loved and of value. Only a
coward, a degraded and despicable person, would attempt to hold on to life at
the active expense of others.
Of course we now live in relatively rich industrial
cultures. But, I submit, the moral principles are the same. We now have
savings, and if you save up enough, and if you want to dissipate your assets
by putting yourself in a hospital bed, surrounded by strangers, with a tube
up your nose for ten years before you kick the bucket – it's your
money. But you certainly shouldn't require other people to do that for you
– which is what Medicare is about.
The answer is to take care of yourself. If you think
advances in technology can keep you alive to age 200, save the money to pay
for it. Assuming you don't care enough for your progeny to leave them
As with Social Security, the demographics for Medicare are
disastrous. Again, 12% of the population now is over 65, but by 2030 it will
be 23%, so, everything being equal, spending is going vastly higher. But it's
much worse than that because of skyrocketing medical costs. Note that there
is no necessity, in a free market, for medical costs to rise. Rather, they
should be expected to fall, like the cost of most technology. But as medicine
becomes ever more regulated and (theoretically) available to everyone, just
the opposite will happen. This is one reason the FDA should be renamed the
Federal Death Authority. By raising the prices of new drugs and devices
literally tenfold, it probably kills more people every year than the Defense
Department does in a decade.
At $369 billion, 10% of spending, this is another
Orwellian misnomer. People are, understandably, willing to pay most anything
to preserve their health. But the government's spending has almost zero to do
with health. Health is something you and only you are responsible for. You
maintain it by proper diet, exercise and general lifestyle – plus a
dollop of good genes. It's inaccurate and deceptive to call medical care
health care. Medical care is needed for emergencies, but it's a poor
substitute for health care.
So where does all this money go? Part of it is
Medicaid, for people too young to qualify for Medicare and too poor to pay
their own bills. Many are the morbidly obese types you've seen fighting for
bargains at the Black Friday sales at Walmart. Some funds go to buy a scooter
for an oldster – you've seen the ads on TV, an excellent scam for the
companies marketing them. If health is what is wanted, the answer lies partly
in abolishing public housing and food stamps; some people might actually go
out and exercise. The whole thing is corrupt from top to bottom.
Where is this item going? If Obamacare goes into
effect, vastly higher. Medicare and Medicaid are exact templates for
Education, training and social services
Here we have $125 billion, but that's only 3% of the
budget. Most of it is direct school expenditures and school subsidies. Of
course education is a good thing, but I don't feel out of line saying
that most government schooling amounts to indoctrination – or just day
care. It should be abolished and education left to parents (who are more
interested in their kids than any bureaucrat) and to communities, churches
Much of the money is for higher education, most of
which is doled out in places where kids go to misallocate four to six years
of time, pick up bad habits, acquire destructive notions from professors and
incur a pile of debt that they can't get rid of. Between the bad ideas and
the debt, they graduate as serfs – psychologically from their classes,
financially from having to pay for the experience. Education, like health, is
something every individual must acquire on his own; throwing other people's
money at schools to keep kids sitting at desks is counterproductive. Taking a
hard science, math, medicine or engineering course in school is one thing;
taking courses in political science, English and gender studies is something
else. 90% of the universities and colleges in the US should, and would, go
bankrupt without federal aid. But since it's anathema to cut education
funding, there's no help from this quarter.
$92 billion per year, 3% of the budget, is a lot to
spend for highways that are falling apart; the interstate highway system
should be privatized and run as toll roads. The government railroads, Amtrak
and Conrail, are disasters; they, too, should be privatized. Air traffic
control, which the FAA provides with technology from the '50s, should be the
province of the airlines or of privately owned airports.
The TSA is part of this slice, and it's expanding. It
now has sixty thousand employees providing "security theater" not
just at airports but bus stations, highways and NFL football games, where you
have to be examined at the gate.
Note the violet slice labeled "other," for
$119 billion, or 3% of the budget. This catchall includes general science,
space and technology, natural resources, environment, agriculture, community
and regional development. Other than the police agencies, the military and
the courts, this category encompasses most of the government's traditional
– which is not to imply necessary – functions and services.
Let's look at a few random items, mostly for amusement,
since it would take a large book to even summarize the government's budget.
It's a vast array of miscellany, including flood insurance nobody else will
sell you because you chose to build your house on a flood plain. It
encompasses the $2.7 billion Bureau of Indian Affairs, which has forever been
the most corrupt agency in the government but still exists 125 years after
the frontier was closed. It includes the FCC, with its $1.2 billion budget (a
trivial cost relative to the economic distortions it pays for). Although the
agency serves no useful purpose, its average employee makes $147,000 per
year; but then the average government employee makes $74,311 per year, which
itself is 40% more than the average private-sector employee. The FDIC, which
provides stickers on bank doors to bolster confidence in failed institutions,
has $3 billion of assets left to insure over a trillion dollars in deposits.
The General Government slice also includes the national
parks and administration of the roughly one-third of the US that is directly
owned by the US government. Of course all that should be privatized; it's dead
capital. The US government should not be in the real-estate business or any
other business – like the Post Office, which currently runs an $8
billion annual deficit. Perhaps some of its employees would "go
postal" if its assets were sold off, but many would qualify for a job at
FedEx or UPS. It includes NASA, which has devolved into just another
turf-protecting bureaucracy, slowing down the development of the private
space industry. It should be sold; I doubt they could get much for it, but
that beats a $14 billion expenditure every year.
The US government made net interest payments of $196
billion, for only 5% of the budget. It seems like a reasonable enough figure,
financing so many laudable projects, and small by comparison to other categories.
As I've indicated above, the other categories of spending are likely to grow
– but interest will explode. I expect, in the next few years, it will
become by far the largest category of spending, possibly larger than the next
two largest put together, even while most of the others grow like cancers.
The reason is simple. Right now interest rates are at
extremely low levels. That's partly because few people want to borrow in
today's uncertain climate. But it's also because rates are being suppressed
by the government. They want to "stimulate" the economy with low
rates – so people can borrow more and they can avoid default for a
while longer. And the US government is itself, by far, the world's largest
debtor. They have $15 trillion in official national debt, on which they are
paying $200 billion per year in interest. Most of that debt is short term,
with less than a year to maturity. At some point very soon, they won't be
able to roll over most of that $15 trillion, in addition to floating $1.5
trillion of new debt incurred each year, at anywhere near current interest
At some point, we'll see rates go to the levels of the
early '80s, when The Long Boom started. And probably even much higher. But
even at 12%, the interest cost alone would be $1.8 trillion per year –
a completely unbearable amount. But it's also both inevitable and imminent.
As unnecessary, corrupt and destructive as almost all
of the federal budget is, I suppose the government could get by for a good
number of years to come, on some basis. As Adam Smith accurately put it,
there's a lot of ruin in a nation. But as the current financial crisis in
Europe is illustrating, debt can bring it all to a head very quickly. The US
is only slightly behind the Europeans. The same is true of China and even
truer of Japan.
My point is to make it very apparent that there really
is no conventional solution to the US government's financial crisis. It's
reached a stage where the government will have to start defaulting on some of
its obligations. You decide which. The only questions are political; the
economics are quite clear. Nothing will be done, as the Super Committee
showed. I believe they would have done something if they thought it possible
and knew how.
Actually, the situation is much more serious than what
I've briefly illustrated. We've only discussed one aspect of the income
statement, which itself is enough to bring down the whole structure, and
soon. We haven't discussed the government's balance sheet. Estimates vary,
but the US government has direct and contingent obligations that go far
beyond its $15 trillion in accumulated borrowing. The present value of its
Medicaid, Medicare, Social Security, veterans, financial insurance and
numerous unfunded liabilities might be another $200 trillion. Nobody knows,
and it's probably impossible to calculate.
So, the US government will go bankrupt. That's not the
end of the world. Lots of governments have gone bankrupt, some of them
numerous times – like almost all of them here in South America, where I
am at the moment.
In fact, there's a temptation to look forward to it
eagerly. After all, the state is the enemy of any decent human. One might
hope that when they bankrupt themselves, maybe we will get to live in a
libertarian paradise. But that's not likely the way things will come down;
rather, just the opposite. Not all state bankruptcies are just temporary
upsets. Most of the great revolutions in history have financial roots. Great
revolutions are more than just unpleasant and inconvenient; they're extremely
The French Revolution of 1789 was brought on by the
financial collapse of the French government. It was a good thing to depose
Louis XVI, but things didn't get better – they got much, much worse
with Robespierre and then Napoleon. In Germany, the destruction of the German
mark in 1923 set the stage for the Nazis – and then the Depression
ushered them in. The collapse of the Czar's regime in Russia in 1917 seemed
to be good news at first – but then things got worse, and they stayed
worse for a long time.
The fact is that when a government collapses,
especially when the government is providing all the things the US government
does today, people want somebody to fix it; they want their goodies back.
It's well known that over 50% of the US population are net recipients of
state largess. And the degree of state support and involvement in the US is
far, far greater than it was in France, Russia or Germany. After a period of
chaos, it's always the people who are most political, who have the most rabid
statist ideas who get the public's attention and rise to the top.
It seems highly likely that the US will get a savior,
someone full of bravado, who assures the booboisie that he can straighten
things out – if he is given sufficient power. Perhaps it will be an
arrogant windbag like Gingrich, perhaps some general. The government won't
wither away; it will reassert itself. I don't see any way around it,
actually. We are already moving into a police state (evidenced most recently
by the Senate's Nov. 2 vote allowing the military to indefinitely incarcerate
anyone they accuse of terrorism). But at least it's a police state with a
fairly high standard of living, one with Walmarts, McDonalds, and SUVs
– at least for the time being.
But rest assured that if the situation evolves the way
I expect, the standard of living will drop steeply, financial markets are
going to become chaotic and the US will become a quite repressive place for
some time – at least as long as the War on Terror lasts. I will bet you
money on this. In fact, I am betting money on it.
So what can you do about it? Well, actually, there is
nothing you can do about it. At least as far as changing the course of
history is concerned. The best you can do is to speculate intelligently on
further, new distortions that will be cranked into the system, as well as
others that are inevitably going to be liquidated.
It seems to me that this is a trend that can no longer
be turned around. The US government's budget is, in fact, the biggest thing
in the world; it won't be turned around, because it is like a gigantic
snowball rolling down a hill. It will only stop when it smashes into the
village at the bottom of the valley. The best thing you can do is capitalize
on it as well as you can and get out of its way while you do.
[If Doug is
right and this trend cannot be reversed, the time to start preparing for
what's ahead is right now. This
free investor briefing will help you get started.]