Saturday, September 20, 2008

Debt Bomb

It looks like the size of the latest government bailout will total $700 billion, which works out to an additional 8.2 AIGs or roughly the GDP of the Netherlands. Of course, the U.S. doesn't have an extra $700 billion in savings sitting around to fund this program, so we'll have to borrow it. As a result, our government will yet again need to increase the statutory limit on the national debt, this time from $10.6 trillion to $11.3 trillion.

I'm surprised Congress still calls it a debt limit, since it's nothing of the sort. They've never adhered to any limit. Whenever they bump against it they simply vote to increase it further. Usually, they're far more creative with their nomenclature. You'd think by now they would have changed the name to "Government Stimulus Threshold","Graduated Investment Target", or "Super Patriotic Pro-U.S. Funding Goal."

For those of you keeping score, this latest $700 billion payoff works out to $2,333 per U.S. man, woman, and child. It also works out to $6,350 per U.S. household. The new debt limit of $11.3 trillion comes out to $102,700 per U.S. household. These figures ignore unfunded liabilities (Medicare, Medicaid, Social Security) which conservatively come out to another $50 trillion, or $450,000 per U.S. household. All in, your family's share of our country's debt comes to $552,700.

Are there any proposals to offset this $700 billion with tax increases (which I abhor) or expenditure cuts (which I love)? Of course not. To the contrary, there are discussions about another fiscal stimulus program. McCain and Obama certainly have no plans to lower the debt. We haven't heard either talk of any specific and substantive cuts in expenditure.

This is the problem with Keynesian economic theory. It looks good on paper, but it doesn't work in the real world. Everyone loves the front end of the theory -- borrow money and go on a shopping spree. It's the American way! But when times are good, no one wants to take away the punchbowl, upset the voters who are now dependent on the new government programs, and risk not getting reelected.

So, our national debt spirals ever higher, which is a bit ironic since it was ever-rising debt of increasingly poorer quality that led to the current credit collapse in the financial sector. Increasing debt necessitates the printing of ever more dollars. The more of something that exists, the less valuable it becomes. In light of this, it's difficult to be constructive on the dollar long-term. There is no way we can ever repay this mountain of debt short of inflating the currency.

We owe a debt of gratitude to the Chinese for their delicious food, movable-type, a beautiful wall, their inexpensive exports, and their continued purchase of our Treasury securities. So far it's been in their best interest to fund our debt and keep the dollar from imploding. A dollar meltdown would lead to higher interest rates which would kill our economy and severely impact our appetite for Chinese goods. In addition, a falling dollar and rising rates would decimate the value of their U.S. Treasury holdings. Over time, China will become less export driven and less dependent on the U.S. consumer, and at some point, the Chinese are going to view the risk of increased dollar purchases as greater than the reward. That is the day when U.S. interest rates will begin an ugly march higher.

Ironically, it was the Chinese who invented paper money.

Disclosure: The Rubbernecker is long gold, silver, and the Renminbi and short the greenback and government bailouts.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.