Bankruptcy 2015 ? (Part I.)

Is the US going bankrupt? With an intractable trade deficit and a national debt in excess of $9 trillion dollars, and an ongoing collapse in both the financial sector and of the national ($$$) currency, it may seem so. With that in mind, it is timely to consider documentary evidence of just what such a national bankruptcy would look like.

(NOTE: This is a republication of a diary originally published about a year ago at the Big Orange Political Blog, with minor updates to incorporate events that have occurred since)

The signs of a looming US sovereign bankruptcy and how it would happen were the subject of the 1991-2 bestseller entitled "Bankruptcy 1995," written by members of a Reagan-era Commission tasked to advise of the consequences of persistent government deficits. That the prophecy didn't come true is in part due to the book's own warning, for budget responsibility was a major theme in the 1992 presidential platforms of both Bill Clinton and Ross Perot. In 1993, without a single supporting republican vote in the house or senate, Bill Clinton and Congressional democrats passed a budget including a tax increase that ultimately gave rise to a budget surplus for the first time in 30 years, in 1999. Then came George W. Bush and the borrow-and-squander republicans, who took the surplus, looted it, and doled it out plus plenty more to their cronies.
I recently re-read "Bankruptcy 1995," to examine the questions: Why didn't it happen? Do any of the signs of an impending US bankruptcy exist now? Are we facing "Bankruptcy 2015"? The answers are sobering.

First, I will describe the "Consequences of Deficit Spending" as discussed in "Bankruptcy 1995: The coming collapse of America." As described there, ultimately as the percentage of tax receipts that must be used to finance the national debt increases, insolvency nears, and the economy undergoes one or both of two deaths: "Death by Hyperinflation," and/or "Death by Panic."
In the case of the US, depending on whether one includes the Social Security and Medicare trust funds in the funds due and owing, presently either $250 billion or $400 billion of Federal tax receipts goes directly to debt service. That amounts to 9% or 17% of tax receipts, depending on whether Social Security and Medicare are counted or not. If that percentage always remained the same, presumably the US could run deficits forever and never reach the point of insolvency. The point of insolvency occurs when a debtor country realistically can no longer even pay the interest on its debt out of its tax returns; technically this is a "default".
Remember that all of the predictions you are reading below are being made in the year 1991.

Consequences of Deficit Spending (as predicted in 1991)

All things being equal, deficit spending creates the need to issue greater amounts of government debt, which we call Treasury Bills and Bonds. As more and more are issued (creating an ever-greater supply), in order to attract more buyers (i.e., demand) higher interest rates must be offered. So, first of all, deficit spending leads to higher interest rates than would otherwise exist.
Since deficit spending injects more dollars into the economy than would otherwise occur, it is inflationary (more dollars chasing the same amount of goods for sale).
Any attempt to close the gap via higher taxes both directly and via bracket creep, leads to less disposable income by consumers, more tax avoidance or non-compliance, more under-the-table jobs, and disincentivizing labor, savings and investment.
Rising interest rates make mortgages and auto loans less affordable, leading to declines and layoffs in those businesses. Bondholders lose money in "real" terms as the value of their bonds is eroded. For the same reasons, loans cease to be profitable. Because of increased US-based costs, American companies are less able to export.
Credit shortages occur, where a seize-up in the credit markets means that companies and individuals alike find they are unable to borrow at the ever-higher interest rates dictated by the "crowding out" of other debt instruments by government debt. If credit seizes up, major purchases must now be made with large, e.g., 50% downpayments.
There is increased financial speculation as companies and individuals alike realize that the best way to make money is to bet it in the financial markets rather than increase production of goods.
Meanwhile, the standard of living of the average American decreases. Investment in infrastructure (roads, bridges, sewer and water lines) decreases substantially.
With less disposable wealth, charitable giving declines. Real per capita economic growth lags behind that of other nations who do not run deficits. Investors from those same foreign nations begin to buy parts of the US economy, leading to a loss of internal US control over its economy.
The structural increase in interest rates and inflation means that the Federal Reserve Bank is unable to lower interest rates during a recession.
At some point when the national debt surpasses 100% of the gross national product (it is about 67% now, as compared to 65% when I first published this diary a year ago), the crisis -- whether by hyperinflation, panic, or a mixture of both -- begins.

Death by Hyperinflation (as predicted in 1991)

One way to attempt to deal with spiraling deficits is for the US Treasury to force the Federal Reserve Bank to buy all the debt it needs to offer to pay its bills. The Treasury "monetizes" debt or, put another way, prints money. as the Federal Reserve prints dollar bills in exchange for the budget IOUs. To absorb these extra dollars, interest rates on debt are raised by the banks. This in turn causes the carrying cost of debts and the deficit to increase -- a vicious cycle. So many new dollars entering the economy causes demand to increase (as those who hold the dollars are able to spend more). This in turn causes the prices of those items to increase. As trust in the currency begins to break down, consumers make sure that they spend their ever-inflated dollars immediately. This speeds up the cycle, causing interest rates and inflation rates to rise at the level of 1% a month, and then even more ever faster until at last the currency is seen as worthless, and the entire currency-based economic system breaks down.
Astute individuals may observe several warning signs. If the US hyperinflation were to resemble the 1980s episodes of hyperinflation of Bolivia, Argentina, and Brazil, the actual trigger for the above-desribed inflationary spiral would be a real estate boom followed by an actual deflation in real estate values that then begins to spread into the rest of the economy. The US might not be able to collect enough in taxes to service its debt. The Federal reserve buys that debt. Interest rates rise. Stories appear in the media as banks and economic commentators fret about the growing money supply.

Death by Panic (as predicted in 1991)

Death by panic would occur if, instead of monetizing the debt, the US Treasury continued to sell its debt to investors.
Higher interest rates mean that those who own existing fixed rate income assets (i.e., last year's bonds) -- such as pensions and insurance trusts -- find those bonds decreasing in price. This is what happened in the 1970s, when US Treasury Bonds received the nickname "Certificates of Confiscation", because every year their real value became less and less. Eventually, if the cycle continues, some pension funds and insurance annuity trusts become insolvent. They default and go out of business. Those who were counting on the pension benefits or annuity checks find their income slashed.
Confronted with ever higher pension and other expenses, companies either shut down or move overseas.
Consumers withdraw money from safe institutions like FDIC insured banks and seek out higher-paying riskier income streams, such as money markets (or for that matter, junk bonds), as banks are unable to match the higher interest rates offered. This flood of cash does temporarily increase investor income, but the income then declines as too much money is chasing the same income stream (called "reaching for yield"), driving the yields on even risky income producing assets down.
Companies begin to close less profitable operations. For example, GM closes the Oldsmobile division.
As the value of the dollar plummets, foreigners buy more and more (relatively cheap for them in their local currencies) US assets, including entire US companies, sometimes just shutting them down afterward.
At the very end, Social Security and Medicare, and other government services (like infrastructure maintenance) are slashed or simply stop. The value of US Treasuries plunge in a panic as respected foreign investors, government ministers or central bankers declare that the US in insolvent and cannot pay its bills.

What US Bankruptcy means (as predicted in 1991)

Creditor nations and international organizations such as the IMF will dictate the terms of recovery after any default in payments of interest or principal by the US. There will be a concurrent loss of economic, diplomatic, and military power.
Individuals and families suffer greatly. Foreign companies close their US plants, as US consumption plummets. One or both wage-earners in household lose their jobs, and lose their medical benefits. Future promised benefits (Social Security and Medicare) are slashed. Their savings -- in dollars -- become essentially worthless. What devalued savings they might have buys far less than before the crisis.

So, why hasn't the US gone bankrupt? In part II, I will discuss the one major trend that the authors of "Bankruptcy 1995" got totally wrong, and the consequences if that trend is now ending or reversing.

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Comments

Damn Mayans

I heard they were predicting the end in 2012, but this wasn't what I had in mind. Those Mayans, who'd a thought they were fiscal hawks, eh?

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Seriously though

This damn "President" has essentially turned back the clocks on us. I remember that sense of crisis roaming about the country. The nation was in a recession and folks knew that we had gone too far this time. But, as you mentioned, we got lucky and dodged a bullet. Only this time, it seems, the villain in the form of George W. Bush is carrying two pistols this time.

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FIRST THINGS FIRST ...

America has to borrow and tax more, just to pay off the interest on the money we already (over) borrowed. If you cut through the crap, and go back to simple basics, all economists agree that the first thing an individual should do to get their finances back into the black, is to pay off their credit cards, and get out from under paying the interest each month. The U.S. is no different. Instead of solving the problem by borrowing hundreds of Billions more, and assuming Billions more in interest, our first priority should be to pay off our loans, and stop paying all that interest on loans !!!

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