What Washington really fears: being out of money and out on their ass

Byline: | Category: Economy, Government, Taxes & Spending | Posted at: Friday, 22 July 2011

As I was driving to work yesterday, I heard the news that French President Sarkozy was departing for Berlin to meet with Chancellor Merkel to see if they might come to an agreement about what to do about Greece’s debt.  Meanwhile in the US, the House, the Senate and the President were still involved in debates about what to do about America’s debt.  Conventional wisdom on both sides of the Atlantic is that an immediate failure to address the liquidity problems faced by both Athens and Washington will plunge the world into a new era of darkness. 

Conventional wisdom, as it so often is, is wrong.  The problem is not illiquidity; it is insolvency, and it is a problem shared to some degree by not just the governments of Greece and the US, but by most Western nations around the globe.  While it is true that the failure to address the liquidity problems in both nations might cause worldwide economic hardship, it is true that addressing liquidity without fixing solvency guarantees that the Western world will face eventual worldwide economic catastrophe on a scale unimaginable to anyone who didn’t live through the 1930s.

First Greece.  It is flat out insolvent.  The size of Greece’s debt is about one-and-a-half times the size of its economy.  It can’t hope to ever pay back that amount of debt.  Banks know this, that’s why interest rates are well over 20%.  Greece pays what amounts to Visa/MasterCard interest rate levels for the exact same reason.  In both cases creditors offer unsecured debt to borrowers, knowing that a good percentage of those loans will never pay off. 

The United States is insolvent too.  Then again, it’s not.  That’s because US debt to actual creditors is currently at a level that doesn’t push the country into insolvency.  Total US obligations, however, will never be met.  Let me explain the difference.

The total debt held by the public is about 60% of GDP.  That’s significantly less than the $14.3 trillion number you often hear–and that is currently the subject of pending legislation in Washington. 

The difference is the debt that the government owes to itself.  Remember Al Gore’s “lock box”?  It never existed and it never will.  It is an accounting myth that treats money that the government “borrows” from social security taxes as a tangible asset.  It isn’t.

Instead, think of it as something like this:  Imagine that my wife and I both work and that she sets aside 15% of her income for retirement and gives that 15% to me.  I go through the years spending all of my income, plus all of the 15% that she gives me, plus a little bit more.  Eventually, my wife starts to ask questions about her retirement fund.  “Relax,” I tell her.  “You’ve been ‘earning’ 5% interest on that money.”  And I hand her a nice little official looking annual accounting statement to that effect.  Unbeknownst to her, I’m only adding that 5% interest to that amount that I “owe” her.  In truth, I’ll never pay her that money.  It doesn’t exist.  It’s already spent, and I don’t have the income earning potential to ever repay it.  But–and this is the key point–that amount I owe my wife is not a debt in the legal sense.  Sure, I still have other debts; remember, I’ve been spending all of my income, plus 15% of hers, plus a little bit more.  That “little bit more” is money that I owe to outside creditors.  And I will have to pay them back or they will make my life miserable.  When my wife finds out that there is no money for her, my life will be miserable too.  But that’s a different kind of misery–one that will lead to a bitter and nasty divorce. 

This is why I say that the United States is insolvent, but it’s not.  The US can conceivably pay back its external creditors, but it can not afford to pay back its “wife,” in this case, its citizens, who were taxed in exchange for a non-legally-binding promise.  However, the US government is borrowing from its external creditors at such a high rate that in just a few years (before the end of this decade) it will have borrowed more in legal external debts than it can ever conceivably pay back. 

Returning to Greece, it is very possible that a Greek default could plunge the world back into recession.  That’s because, although Greece is a tiny economy–only about 3% of Europe–its debt is owned by banks around the world.  And due to Bretton Woods rules, its debt, like all sovereign debt, is treated extra specially.  It is considered to be “safe.”  in truth, this is ludicrous.  Historically, sovereign debt has always been a huge risk, since from the pharoahs to Robert Byrd, kings and senators have forever been prone to bankrupting their countries to build monuments to themselves.  But the Bretton Woods rules giving sovereign debt special treatment weren’t enacted to stabilize economies, but to stabilize governing classes.  The fear among governing classes is that when Greece cracks the dam, governments downstream in Lisbon, Dublin, Rome, Madrid, and beyond will likewise be flooded too. 

Here’s the rub, if creditors charged governments interest rates commensurate with their actual risk, those huge interest rates (probably at Visa/Master Card levels) would cripple all Western governments’ ability to continue to spend at extravagant levels.  And that would be the end of those governing classes.  You see, it’s not about protecting you, the citizen.  It is, and always has been, about protecting “them” from being like you.

Now let us return to the husband and wife analogy.  If my wife was ten years away from retirement, would she be better off learning the truth of her financial situation now, or waiting another ten years?  Obviously the former.  A divorce, while nasty and bitter, is inevitable anyway, but if it were now instead of later, she would have ten years to actually do something positive toward providing for her own retirement.  I, on the other hand, am much better off the longer she doesn’t know the truth.

The situation in both Athens and Washington (and, as mentioned, around much of the Western World) is similar.  The money isn’t there.  In the case of Greece, default is a mathematical certainty.  In the US, while it’s not certain yet, what is certain is that America’s citizens will not get the full value of its government’s future promises, and also certain is that if America doesn’t stop borrowing from its creditors immediately, it will find itself very shortly in the same situation as Greece.

In other words, the nasty truth is that the citizens of most Western nations find themselves in the same situation as my hypothetical spouse: There is no money set aside for them.  And the governments find themselves in the same situation as hypothetical me:  If my wife divorces me, I’ll be out of money and out on my ass.

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13 Responses to “What Washington really fears: being out of money and out on their ass”

  1. T J Sawyer Says:

    Pretty good analogy! But you forgot about the kids. When they discover mom’s plight, they will have to take her in and provide for her. This will cripple their plans for the rest of their lives, too.

  2. david mendicino Says:

    This should be in a letter in every mailbox of every family in the country.

  3. QOTD: Who are you protecting? | SnarkyBytes Says:

    […] QOTD: Who are you protecting? Posted on July 22, 2011 “…if creditors charged governments interest rates commensurate with their actual risk, those huge interest rates (probably at Visa/Master Card levels) would cripple all Western governments’ ability to continue to spend at extravagant levels. And that would be the end of those governing classes. You see, it’s not about protecting you, the citizen. It is, and always has been, about protecting “them” from being like you.” –Bob Krumm […]

  4. willis Says:

    While we’re talking about it, the fear expressed by our president is that by defaulting now, rating agencies will downgrade our credit rating and the downgrading will wreck havoc with our economy. The fact that the factors pushing our economy and credit into a crisis are what is and will wreck havoc with our ecomomy is given no mention, only that calling attention to these factors via a bad credit rating will cause havoc. This reinforces you assessment of the true concerns of governments.

  5. What Washington really fears: being out of money and out on their ass. » UrbanGrounds Says:

    […] Bob Krum: “Conventional wisdom on both sides of the Atlantic is that an immediate failure to address the […]

  6. Reilly Says:

    Bob, what if your wife had a nice life insurance policy. You could bide your time and hope she kicks the bucket, allowing you a way out.

    Our ruling class knows we have 401k’s and to save their jackasses, all they have to do is pass legislation legalizing theft of private

    My advice is to liquidate, lock & load, and buy a safe.

  7. richard40 Says:

    Good article. The real economic risk is not that we wont raise the debt ceiling, but that we will raise it while doing nothing about our long term trend toward bankruptcy. The dems and MSM talk constantly about the minor risk of the first point, while ignoring the 2nd.

  8. President Golf N.Smoke Says:

    I have the answer to all these problems. We must invest in our country by way of revenue enhancements to be funded by the 437 billionaires in America who all, by the way, own corporate jets. Close those loopholes, and we all golf and smoke for free permanently!

    Oh, and when you buy your golf clubs, be sure to look for the union label!

  9. AMB Says:

    To President Golf N. Smoke: If you taxed the billionaires 100% and stole all their property, it wouldn’t cover our government’s spending spree! As Krumm said above, the public debt to other countries is over $14 trillion. But a quick look at the usdebtclock.org site, I just learned that the US UNFUNDED debt (remember – no lockbox Al Gore) to its own citizens for medicare, social security, and prescriptions is, are you sitting down? closing in on the $115,000,000,000,000. (115 tril) That doesn’t include welfare, unemployment checks, food stamps! This has to stop!!!!! Wake up America and stop spending and start saving!

  10. teapartydoc Says:

    How many people contemplating the end of Western Civilization ever dreamed that it would end because that civilization ran up too many markers with loan sharks?

  11. ELC Says:

    I came up with a similar analogy a while back:

    “A husband and wife are saving up to buy a large flat-screen TV. Nostalgic for the simpler times of childhood, they contribute from their individual earnings into a piggy bank.

    “One day, the wife calculates that their combined contributions have reached the sum where they can afford to buy that large flat-screen TV. She opens the piggy bank and dumps out the contents… to find it had been stuffed, not with bills, but with IOUs.

    “She storms into the room where her husband is relaxing and screams, ‘How could you? After putting our money in here all this time, you already spent it on other things! Without telling me! How could you?’

    And he looks up and calmly says, ‘What’s the problem, Honey? You know I’m good for it.'”


  12. The Solvency Illusion at Patriots for Freedom Says:

    […] Krumm explains, yesterday: …. The United States is insolvent too. Then again, it’s not. That’s because […]

  13. Dorothy Says:

    Social Security has been paid for by those who worked and invested in it. This is not a hand out by the Federal Government. Thanks to Pres. Johnson it was put into the general fund. It was never meant to go into a general fund. It would have been solvent if it had been left alone.