rancorous fiscal-cliff negotiations dominating newsflow, the markets are
rightfully on edge. Will a deal be reached as time relentlessly dwindles, or
not? How the fiscal cliff is resolved has massive implications for the US
economy and markets in 2013 and beyond. But provocatively, the fiscal cliff
is a minor sideshow in the real crisis. The United States of America is
drowning under federal debt.
commentators, and politicians always talk about deficits. This whole
fiscal-cliff debate centers around how to reduce the
federal deficit. Should we cut government spending, raise taxes, or do both?
But a deficit is merely the current shortfall, the government spending more
in any given year than it takes in. The true problem lies in the past's accumulated
deficits, which collectively add up to the national debt.
deficits and debt are often confused in public discourse. If you spend $1000
a month more than you make, that is your deficit. The cash for this excess
spending can only come from borrowing. A year of $1k monthly deficits adds up
to $12k in new debt, not including interest. Merely reducing your monthly
deficit does absolutely nothing for your already-existing debt, which
continues right on growing.
as your debt expands, so does your interest burden. And since you are already
operating at a deficit, you have to borrow even more money just to pay the
interest on your existing debt. This leads to a vicious circle that spirals
downwards into bankruptcy. This ironclad law of finance applies to nation
states as surely as it does to families and businesses. Deficit spending
ultimately leads to financial ruin.
fiscal cliff the United States now faces is an early milestone in this
disastrous process. And sadly, every single major proposal on the table from
both sides is a total joke. Using that $1000-a-month analogy for a
family, the current ideas would only cut that by $60 to $150 at best.
They leave 85%+ of the government's deficit spending intact, doing absolutely
nothing to pay down its mind-boggling debt.
chart shows the sorry state of US government finances with data from the
Federal Reserve. The blue bars show how much Washington is spending annually
in billions of dollars. Meanwhile the yellow bars reveal how much the federal
government is receiving in taxes. The differences result in the red bars, the
federal deficits. And since Obama won the presidency, they have exploded
to record levels.
government living beyond its means has been common since the Great
Depression. But the degree of deficit spending we've seen in recent years is
far beyond anything except the second World War. And regardless of your
politics, the Obama years stick out like a sore thumb. The great majority of
today's debt problems, of which the fiscal cliff is merely the tip of the
iceberg, originated under Obama.
gargantuan deficits of the past four years were driven by record
government spending. Notice above how fast the blue spending line has
outpaced the yellow receipts line. Per this Federal Reserve dataset, on
average the US government has taken in $2398b annually during the Obama
years. This compares to $2219b during Bush the Younger's reign, and $1608b while
Clinton commanded office.
government's average take from taxation under Obama grew by 8% from Bush and
49% from Clinton. Absolute tax receipts have proved remarkably stable in the
last four years despite the struggling US economy. The yellow line above,
which provocatively saw big growth after the Bush tax cuts, hasn't
shrunk dramatically during Obama's term. His deficits are almost exclusively
the result of overspending.
the Obama Administration has been spending a mind-blowing $3614b per year!
This is 44% higher than Bush's average of $2508b annually and 115% higher
than Clinton's $1683b. The result of such unprecedented government largesse
is crystal-clear above, the largest deficits by far in the history of our
Union. If you are a Democrat, you have to own the indisputable fact that
these are Obama's doing.
last four years, the Obama Administration ran average annual deficits of
$1274b per the Federal Reserve! The size of this overspending defies belief.
This week Apple, widely considered one of the most successful companies in
world history, was worth about $500b. Washington is spending the equivalent
of over two Apples per year more than it is taking in! We are talking
$3.5b per day in deficits!
Bush's tax cuts that are widely reviled by Democrats, during his entire
8-year presidency his Administration's deficits only averaged $251b. Obama's
were 408% higher! And Clinton, which is the Democrats' greatest and
most-loved hero, merely averaged deficit spending of $40b per year. Obama's
deficits were 3081% higher than Clinton's! Clearly Obama has an unprecedented
inarguably it is in the best interests of Democrats to get this record overspending
under control. If Obama continues along this path, history will remember him
as the president who bankrupted the United States of America! And as
the dire real-world financial consequences of such deficits come home to
roost, the Democratic Party will increasingly shoulder the blame with
American voters. They have to act.
the Obama Administration has on the table today to address his gargantuan
deficits is a $1600b tax hike on high-earning Americans and $400b in murky
future spending cuts. But in the crazy way Washington has come to operate,
these numbers are over the entire next decade. So for 2013 alone,
Obama is asking the Congress to agree to $160b of tax hikes and no
spending cuts to avert the fiscal cliff.
But $160b is
nothing compared to the size of the problem! With average annual deficits of
$1274b, a $160b tax hike on the top 2% of American earners will merely close
one-eighth of the shortfall. The Republicans offered Obama an $800b tax hike
over 10 years, or $80b per year. That is only a sixteenth of the Obama
Administration's average deficit spending. The current fiscal-cliff talks are
truly a total farce.
government spending is always a big problem, whether it happens under the
Democrats or Republicans in power. But the upcoming deficit in 2013 pales in
comparison to the collective accumulation of all past deficits, the national
debt. This next chart looks at US federal debt and average annual interest
rates as measured by the yields on 1-year and 10-year US Treasuries. The
picture it paints is utterly terrifying.
Obama's record federal overspending, the United States has suffered record
national-debt growth in the last four years. Before Obama took office, the
federal debt was $9986b. Today it is running near $16,345b, a 64% increase!
The Democrats want to run this country, and half of the Americans who
recently voted awarded them that privilege. So they have no choice but to
deal with this huge problem.
interesting that today's entire fiscal-cliff mess is the direct result of
Obama's record deficits. Back in the spring of 2011, the incredible federal
spending of the Obama Administration threatened to slam the national debt
into its statutory ceiling. Remember that every dollar that the government
spends beyond what it takes in must be borrowed, the exact way deficit
spending works for families and businesses.
Democrats wanted to give Obama a blank check to continue exploding the
national debt, the Republicans in Congress balked. They understood the data
behind the first chart in this essay, and knew that those levels of
government spending were unsustainable. So Congress wanted spending cuts before
it gave Obama the authority to borrow even more, but Obama recoiled at such
US government is so deep in debt, it has to borrow money to pay interest on
its existing debt. So the first default in modern United States history
threatened, and a deal narrowly avoided it in early August 2011. That was the
Budget Control Act of 2011, which raised the debt ceiling immediately but
foolishly delayed any real spending cuts until 2013. This earlier showdown
created today's fiscal cliff.
But again the
national debt is the real problem, and merely reducing deficits does nothing
to address it. I suspect most Republicans and Democrats love our country
deeply, although we certainly differ on the appropriate levels of government
spending. But if this debt problem isn't tackled head on, if deficits don't
become surpluses to actually pay down existing debt, all government
spending is greatly threatened.
debt that Obama foolishly grew by two-thirds is a ticking time bomb due to
current interest-rate levels. Washington borrows to get the cash for its
deficit spending by selling Treasury bonds, and the yields these Treasuries
pay are the national interest expense. Catastrophically as national debt
skyrocketed in the last four years, the Federal Reserve manipulated interest
rates to record lows.
interest rates are shown in this chart, the yields of short-term 1-year
Treasuries and long-term 10y Treasuries. During Obama's reign so far when his
$1274b average annual deficits added up to $6358b in new national-debt
growth, 1y Treasuries averaged just 0.3% and 10y Treasuries averaged just
2.8%. These record-low interest rates drove average annual interest expenses
of just $209b per year.
rates can't and won't remain near these record lows forever. Either the Fed
will eventually raise them as the economy improves or inflation heats up,
or the global bond markets will sell Treasuries so aggressively they will
force yields higher. Rising interest rates are as utterly inevitable as the
sun rising tomorrow. There is no force on the planet, including the Fed's
printing presses, that can stop them.
the Obama Administration has chosen to do most of its borrowing on the short
end of the yield curve. When interest rates are abnormally low, most families
choose to lock them in for the long term. But the Obama Treasury has instead
concentrated new Treasury issuances in shorter-term bonds since their yields are
near zero. That means national interest payments will skyrocket rapidly
with interest rates.
government runs on fiscal years, starting October. In fiscal 2012 which ended
a few months ago, the federal interest expense divided by the national debt
yields a rate under 1.4%. Yet between 1965 and 2008, the pre-Obama years in
other words, yields on 1y Treasuries averaged 6.3% and 10y Treasuries
averaged 7.2%. So if interest rates merely revert to long-term averages,
federal interest expenses soar.
And we are
talking on the order of 5 times or so! So at average modern interest
rates and current national-debt levels, the federal interest expense alone
would soar to an unimaginable $1113b per year! This ought to terrify
Democrats as much as Republicans, because such skyrocketing costs would cut all
government spending to the bone if not eliminating much of it entirely.
Social programs would vanish!
frightening, historical average interest rates are conservative. After
extremes, markets tend to mean revert and overshoot to the opposite
extreme. And since interest rates have been held abnormally low by Fed
manipulation in recent years, odds are they are heading much higher than
normal once they start reversing. The Reagan years were the last time such a
mean-reversion overshoot occurred.
8 years, 1y and 10y Treasury yields averaged 9.6% and 10.8%! This is on the
order of 7 times current interest costs on the
federal debt. This would force interest payments up to $1558b a year,
compared to tax receipts of roughly $2400b. And in addition to rising rates,
continuing large deficits will continue ballooning
the debt. Even an optimistic scenario on Obama's second term bodes more
Obama's first-term deficits averaged $1274b per year. Even though all he is
proposing now is a measly $160b-per-year tax hike on job creators, let's
assume he somehow manages to cut his average deficits in half in his second
term. This would still leave annual deficits of $637b, pushing the national
debt to $18,893b. A best-case one-sixth growth in debt drives up
interest expenses accordingly.
catapult the yearly debt burden to $1299b in an average-rate
environment and $1818b in a mean-reversion-overshoot high-rate environment!
Once again there would barely be anything left over for all the transfer
payments, welfare handouts, and social programs the Democrats hold so dear.
And our massive military budget many Republicans support would be starved of
virtually all funding as well.
of national debt accrued while interest rates are near record lows is the
most dangerous economic threat our nation has ever faced. If we love our
country, we have to force our politicians to not only reduce deficits but to create
surpluses that pay down this debt. And all the tax hikes in the world are
not going to make this happen. Obama's mind-boggling excessive spending has
to be slashed quickly.
chart looks at federal spending, federal receipts, and federal deficits as a
percentage of US GDP. Gross domestic product of course is the flagship
measure of the size of our country's total economy. This is the
most-accurate-possible portrayal of the crisis facing America today because
it effectively adjusts for inflation. And the history of government finances
offers plenty of pain for both parties.
Even as a
percentage of GDP, Obama's record deficits utterly dwarf everything seen
since the second World War. Democrats ought to be totally embarrassed by
this. The 60-year-average deficit before the Obama years was 1.7%. Yet
Obama's gross overspending averaged annual deficits of a staggering 8.7% of
GDP! To get an idea of how scary these are, all we have to do is look to the
fiscal disasters in Europe.
Union was formed by the 1992 Maastricht Treaty. One of the core requirements
that all signing countries bound themselves to was
government spending as a percentage of GDP. Deficits were legally limited to 3%
of GDP. So Obama's approaching 9% are so horrendous that it defies
belief. This year, the deficit-to-GDP ratios of troubled Greece and Spain are
only 6.6% and 7.3%. 9% is outrageous.
And the blue
and yellow lines above tell the crystal-clear story of why Obama's record
deficits arose. Over the 60 years before Obama took office, federal spending
averaged 19.5% of GDP. Yet Obama's wild overspending catapulted this critical
ratio up to an average of 24.5% in his first four years! Outside of the
extreme case of World War 2, this is unrivaled. The federal government is now
spending a quarter of our nation's entire output!
utterly unsustainable. No matter how much Democrats like their pet social
programs or some Republicans like a big military, we can't afford such
excessive spending. If Obama wants to be seen as a great president instead of
an economic disaster, he has to slash government spending dramatically.
The entitlement programs have to be cut until federal spending falls back
down near its historical average relative to GDP.
possible, as Clinton managed to run surpluses late in his presidency.
Granted, he had the great fortune of enjoying the booming economy of the
bubble-end of a 17-year secular
bull market in stocks that created a big surge in tax receipts. Obama
won't, as we are languishing in the subsequent 17-year secular bear.
But surpluses can still be achieved if the Democrats finally get serious
about cutting government spending.
On the tax
side, Republicans aren't going to like to see that federal receipts as a
percent of GDP indeed fell to their lowest level in over a half century under
Obama's first term. The 60-year average before Obama was 18.2% of GDP, yet he
had to deal with 16.2%. So the Democrats do have a strong point about tax
levels being low in historical context, whether or not you agree with their
But again the
lion's share of the cause of the Obama deficits occurred on the spending
side. While tax receipts were indeed about a tenth lower as a percent
of GDP than the long-term average, he still chose to spend a quarter more
as a percent of GDP than the long-term average. Obama has to start leveling
with the American people and explaining why all government spending needs to
be cut dramatically, or his legacy is doomed.
And on the
spending front, the targets for cuts should obviously be the biggest
outflows. Medicare and Medicaid together account for about a quarter of
government spending, and Social Security and national defense each account
for about a fifth. Together these programs represent over three-fifths of
federal-government spending, so they are where Obama and the Democrats need
to target to make progress.
of the record national debt and abnormally low interest rates, merely
reducing the deficits isn't enough. The debt has to be addressed, and
there are only three ways to do it. The honorable way is to slash spending
until the government runs surpluses long enough to pay it down. The chances
of that under Obama are sadly zero. With a $223b
interest expense even today, a surplus would have to be much larger
than that to make any progress.
alternative is to default, for the United States of America to effectively
declare bankruptcy. But as Greece has seen in spades, the economic
consequences of telling one's international creditors to bugger off are
catastrophic. Despite the bitter debt-ceiling debates as Obama burns through
borrowing capacity like mad, a default isn't going to happen. Which leads to the third and likely debt outcome.
The US dollar
is a fiat currency, merely paper that the Federal Reserve can and does create
out of thin air at will. As it has done extensively already, it can print
money to help Washington inflate its way out of this crushing debt
burden. New dollars pay off old bonds, but the result is rising
prices as our currency becomes worth less and less. The Fed's quantitative-easing
campaigns have already inflated away about a quarter of Obama's total
really the only viable outcome, and investors should act accordingly. Obama's
record deficits and debt growth guarantee big
inflation is coming, which is wildly bullish for the precious metals and
their miners' stocks in the
coming years. No matter what happens in the fiscal cliff, the dollar supply
is guaranteed to mushroom far faster than the global mined supplies of gold
and silver. So their prices will surge as investors seek inflation
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line is the fiscal cliff is a sideshow. The real problem is the staggering
national debt Obama's gigantic deficits have ballooned. As this debt
continues to mount and interest rates start mean reverting away from their
record lows, the federal interest expense will eventually grow to consume
everything else. Merely reducing deficits won't even make a dent in this problem, we need to see surpluses to pay down debt.
class-warfare tax hikes the Democrats desperately want are only about an
eighth the size of Obama's annual deficits at best. And the Republicans are
right do demand gigantic immediate cuts in the record levels of government
spending. But sadly the likely outcome is nothing gets done, and the national
debt keeps growing. This guarantees serious inflation as the Fed continues to
monetize this crazy overspending.
Adam Hamilton, CPA
December 08, 2012
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