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NOTE: Originally published at www.metalaugmentor.com on December 2,
2009 at 7:30AM EST.
I am starting a new series of commentaries focused on the idiocy that
passes for “market intelligence” and “informed
thought” these days when it comes to the Internet. I believe this
idiocy is quite dangerous to unsuspecting investors and thus it deserves to
be exposed, and even ridiculed, when warranted. I will not be spending a lot
of time on this stuff so the writing isn’t going to be very polished or
formal. I will, however, consider requests so if you’d like to see a
future Charlatan Exposed cover a particular topic please just leave a
comment.
The first Charlatan Exposed goes to the blog “Monty
Pelerin’s World”, which purports to examine “Economics, Finance
and Politics through the Prism of Classical Liberalism”. Unfortunately,
the blogger appears to be using a fact checker that consists of a
“Prism of Obsidian Glass” in explaining how the United States
is Spiraling to Bankruptcy.
Before getting to a few of the rotten details, let’s be clear
that the general premise of this Monty Pelerin commentary is essentially
correct in concluding that the debt level of the United States government,
much less of U.S. consumers and businesses, is unsustainable. If these debts
were called by creditors today, the United States would indeed be
bankrupt. But that’s a big “if” and essentially an
impractical way of looking at it. More relevant than the possibility of
having debt called is the ability to service the debt according to its
contractual terms. While projected debt levels in the U.S.
certainly cannot be serviced in the long run, it is not a foregone conclusion
that debt levels cannot return to serviceable levels without sovereign
bankruptcy. For one, there are going to be a lot more individual (consumer
and corporate) bankruptcies before things are over and done with and such
bankruptcies will reduce debt levels. For two, private credit is going to be
constrained, and consumer attitudes about credit have changed, for a long
time into the future. For three, interest rate structures are going to remain
under pressure for a while. For four, a certain amount of reflation has already
been built into some asset prices (most notably gold) and this reflation will
eventually transfer to some extent into other asset prices (most notably real
estate). I’m not saying home prices will recover anytime soon to their
crazy 2005-2007 peak, only that they will eventually recover to the point
where most homeowners are back in the black in terms of equity.
In any case, the critical thing to consider is the ability to service
debt, not absolute debt levels. But Monty Perelin unfortunately gets even the
absolute debt levels wrong so there is no point to following his math to its
logical conclusion.
Consider the following:
The Federal Government admits to over $12 Trillion dollars in debt. In
reality, its obligations are multiples of that figure. The unfunded promises
from Social Security and Medicare total around $100 trillion. That is, to
properly fund the forecasted future deficits in Social Security and Medicare,
$100 trillion would have to be put in the fund today. This liability is
growing at the rate of about $5 trillion per year! The Government has
promised benefits that they cannot honor. These programs are Ponzi schemes that make Bernie Madoff look like
Mother Teresa. As evidence, the total net worth of the
country (the country’s total assets less liabilities) is slightly above
$50 trillion. If the Government confiscated everything, the programs would
still be $50 trillion short and the Government would still be bankrupt.
Furthermore, no company or individual would be left with anything.
Now, you should easily recognize how preposterous the above argument
is on the face of it. Supposedly the United States has $100 trillion in
unfunded promises but only $50 trillion in assets. But, those unfunded
promises by definition are not liabilities payable today and they are not
going to be paid from the sale of assets but rather from past, current and
future employee contributions. This is no different from the idea that a
business pays interest on debt not from selling its productive assets but
rather by placing those assets into service for profit. Yes, there are major
demographic and other issues that make it impossible for Social Security and
Medicare to sustain current funding levels beyond another few years but minor
reductions in benefits and/or minor increases in withholding rates would keep
these programs solvent for a few years more. The looming entitlement
situation is certainly a big problem that should have been resolved a long
time ago but it is definitely not going to be the cause of the United States
“spiraling to bankruptcy”.
In any case, those “unfunded promises” actually include
past employee contributions amounting to approximately $2.5 trillion in U.S.
Treasury securities that are being held by the Social Security
Trust Funds as of October 2009. So, $2.5
trillion of the $12 trillion in U.S. government debt is essentially a wash.
In fact, another $1.9 trillion in U.S. government debt is held by other
government agencies such that the actual public debt is closer to $7.7 trillion as of November 30, 2009. Now
that’s still a lot but it ain’t no $12 trillion.
Moreover, if we are going to talk about bankruptcy of an entire
country then obviously we need to look at who actually holds the debt. If,
for example, Tom owes Dick $100 and the debt is not repaid, then we
don’t have an international U.S. dollar issue or a sovereign debt issue
but rather the netting of an asset and a liability. Similarly, if Tom Corp.
owes Dick Investor $100 in corporate bonds and the debt is not repaid, there
are no international currency implications. In other words, what matters from
a sovereign standpoint isn’t gross debt level but rather the amount of
debt held externally by foreigners.
In the case of U.S. government debt, the foreign holdings are
approximately $3.5 trillion as of September 2009. This is a lot, but it ain’t no $12
trillion. In sum total, the gross amount of U.S. debt held by foreigners
including private U.S. debt and bank deposits is around $13.5 trillion as of June 2009. That is definitely a lot and obviously more than $12
trillion but it includes everything including the kitchen sink (or at least
the loan on the kitchen sink). And while it’s true that $13.5 trillion
is huge in absolute terms, it is a little less shocking when compared to the
size of the U.S. economy. At under 100% of GDP, it turns out that U.S.
external debt held by foreigners is by no means the largest in the world. For
example, Germany has an external debt to GDP of 140% and Switzerland has
261%. Meanwhile, the UK comes in with an absolutely dismal 337%. You can get
the most recent external debt figures here and GDP figures here. Obviously the reason to
measure external debt in relation to GDP is that GDP is a pretty good proxy
(though not perfect) of the size of an economy and therefore the potential
ability to service debt.
Interestingly, the external debt ratios of many countries have
actually been falling recently despite the financial crisis. In particular,
the external debt of the United
States fell from $13.7 trillion in March 2008 to $13.5 trillion in June 2009. I’m not sure this is what “spiraling”
is supposed to look like. In any case, if the United States is on the verge
of bankruptcy, what about Germany or Switzerland, much less the United
Kingdom, France (174%) or even Hong Kong (300%)?
In conclusion, Monty Pelerin uses bad debt figures and a completely
bogus measurement (that includes gross internally-held debt which is
essentially a wash) to make the case for an impending United States sovereign
bankruptcy. Yet what matters isn’t gross debt levels, much of which
consist of internal assets and liabilities, but external debt owed to
foreigners. And even then, the relevant measure is the percentage of
foreign-held debt to GDP, which provides a reasonably accurate measure of
ability to service debt. According to the external debt to GDP ratio, the
United States is not even close to being in trouble compared to many other
countries including most of Europe, Hong Kong and a smattering of other
countries. Yes, if the United States continues to binge on debt as it did the
past few years (although external debt has actually shrunk recently), it will
certainly be a very big problem somewhere down the road, but to say —
“Is the country heading for bankruptcy? Yes. Is there anyway to avoid
this end? No! Not unless you repeal the laws of mathematics!” —
is nothing more or less than the words of a charlatan.
Tom
Szabo
Silveraxis.com
Also by Tom
Szabo
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