Overview
The awful truth about deficits and this week's "solution" to the debt limit crisis in the United States is that government debt isn't actually the core problem, but rather represents the costly cover-up of the bigger problem, that of a depression-level unemployment crisis.
The private sector in the United States fell into a depression in 2008 and has not emerged since then. Absent an extraordinary level of government intervention in the economy – which cannot possibly be paid for by taxes or ordinary revenues – the depression in the private economy and a level of unemployment that rivals that of the Great Depression become impossible to hide.
When we talk about the "debt limit crisis", what we're really talking about is the price of the cover-up. The debt limit crisis and the associated Federal Reserve monetary creation fiasco represent the costs of essentially blasting the economy with massive fire hoses full of both created and borrowed money on a non-stop basis, in the (unsuccessful) attempt to make the economy look and feel normal. We can stop the debt crisis at any time by turning off the fire hoses of money that have been flowing since late 2008, but then the depression in the private sector - and the full depression-level rate of unemployment - become plainly visible for everyone to see coming into a presidential election year.
So when we look at the recent so-called disastrous employment "surprises" on the very same financial pages where the debt limit "crisis" with its vague and inadequate "solution" is being covered, we're not really seeing two separate crises, but rather two aspects of the same crisis.
Pierce through the cover-up, look at what the extraordinary level of deficit spending is hiding, and the "surprises" stop. It is then and only then, once we've seen the true nature of the problem, that we can begin to take effective action as individuals to protect ourselves.
The Source Of The Deficit
The United States federal budget deficit is currently at an almost surreal level that is so large that it becomes difficult to comprehend. But let's try. The official budget deficit is currently running about $1.5 trillion dollars per year, or about 10% of the US economy. Now this is not to say that only 10% of the US economy is going through the government (that number is 41% for all levels of government as discussed below), but rather 10% of the current US economy is created by way of - and is reliant upon - the government spending money which it doesn't have. (The vague and toothless "solution" just signed into law hardly puts a dent in this situation, even in the unlikely event that future Congresses and Presidents actually make the hard choices that proved to be politically impossible in 2011.)
Where did this explosive growth in deficits come from? How did things get so out of control, and so quickly?
To understand why this is happening, we need to go back to the financial crisis of 2008. During the end of that year and the beginning of 2009, the US private economy imploded. At high speed, it plummeted from an annual level of approximately $9.4 trillion to a level of $8.1 trillion - a loss of $1.3 trillion dollars, or about 14%. In ordinary circumstances a drop this fast and sharp would throw a nation straight into a Depression with a capital "D".
Yet when one looks at GDP, the total economy only shrank by about $300 billion, or less than a quarter of the fall in the private economy. How could that be? The answer - which lies at the very heart of the current crisis - is that the economy is usually displayed as one number, which is the sum of private and federal spending. When we stick to this one number only and call it reality, it means that a decrease in one side of the economy can be seemingly made to go away by increasing the other side of the economy. As shown in the graph below, what happened was the federal government started spending an extra trillion dollars per year to cover up and smooth over the economic damage from this fundamental, fantastic blow to the private economy, the wealth-producing core of the entire economy.
The graph below shows that the total government (federal, state and local) share of the US economy went from 35% at the end of 2007, to 43% by the end of 2009. Outside of a major war, this is unprecedented growth in government spending, and it occurred almost instantaneously. For 2011 - after three years of the federal government blasting the economy with created money - some current estimates are that GDP will be .1 trillion (assuming a 2.7% nominal growth rate), and that total federal, state and local government spending will be about .2 trillion, meaning the government sector share may be little changed at roughly 41% of the overall economy. This appears to be the new, albeit unsustainable, "normal" (estimate source: usgovernmentspending.com).
In other words, the fire hoses aren't working.
To better understand just how dramatic this change was, let's look at the relationship between private and government economies in another way. In 2007 (as the result of decades of government growth), there was .4 trillion in the private economy, compared to .1 trillion in total spending by the federal , state and local governments. What that means is that for every .00 in government spending, there was only .86 in the private economy. This was already quite questionable territory in terms of a private sector supporting a public sector, at least outside of an explicitly state-directed economy.
Two years later, by the end of 2009, the private economy was .1 trillion, the total government economy was .1 trillion, and there is only .34 in private economy total wealth generated (GDP) that is available for every .00 in government spending. As noted above, estimates for 2011 are that the total GDP will be .1 trillion, that total federal, state and local government spending will be .2 trillion, and therefore the private economy will be .9 trillion (not adjusting for inflation since 2007). If these estimates for 2011 hold up, then there will be a mere .44 in private economic output for each in government spending.
If you were born in the United States after the end of the Depression of the 1930s, then what is shown in the graph above represents what is arguably the single most important economic event of your lifetime.
(These are the optimistic numbers, by the way, because they're based only on official US government spending and not the far larger annual growth in unfunded government obligations. These official deficit totals do implicitly include the money created out of thin air by the Federal Reserve when used to purchase Treasury bonds, but are deceivingly incomplete as they don't include the Fed's trillions in (effective) bank bailouts nor the previous creation of an artificial mortgage market, each of which relied upon using manufactured cash for politically motivated spending that was outside of the official deficits.)
So, we've had arguably the biggest economic change in most of our lifetimes, it's still going on all around us - but there is comparatively little discussion about it. Not directly. Instead, the symptoms of the central problem (unemployment) fill the headlines, as does the cover-up (the deficits) - but not the heart of the problem itself (the grievously wounded private economy).
We see headlines about the deficit, the debt limit, and even more seriously, the projections showing how the deficit grows without end into the future, at least under any major proposal from either party that details actual cuts. But, the supposedly impossible-to-control deficit that seemingly came out of nowhere to overwhelm the nation isn't some random fluke - the graphs above show exactly where it came from. The government needed an extra trillion a year in spending to fund the cover-up, on top of the massive annual deficits that were already in existence. So using the justification of temporary fiscal emergency, the federal government nearly entirely separated federal spending from federal revenues, which quickly became an integral part of how the government operates.
And that is the real story behind how in a very short period of time the United States jumped from large deficits to almost unimaginably huge deficits.
The Reason For The Cover-Up
There is a reason for this fantastic government intervention. Recessions or depressions with growing job losses are usually the number one reason why large numbers of incumbent politicians lose all personal power. And if there had not been a massive government intervention, that was sustained by both parties, there would have been a fall in the total economy that was a minimum of six times as great as the fall we actually experienced (before multiplier effects). This would have translated to a frightening drop in employment, far larger than what has been seen so far.
To illustrate how bad the economic carnage would have been, absent intervention, let's begin by taking the .3 trillion fall in the private economy into account. Next we say that if the private economy is shrinking, and if the government sector is to maintain its size relative to the private sector, then government expenditures must shrink to go along with the new smaller size of the private economy. With a roughly 14% reduction in the private economy leading to a roughly 0 billion (14%) reduction in the previous .1 trillion annual level of government expenditures (2007), this means almost trillion dollars of the US economy would have disappeared – along with the associated jobs – in a period of months after the implosion of September 2008 (before any multiplier effects).
This trillion plunge in GDP (.3 trillion private plus $.7 trillion government) would have been more than six times the reduction in total GDP that resulted from the "fire hose" cover up approach that is currently bankrupting the nation. Of course, this scenario was not allowed to happen.
To expand on the metaphor, the United States Treasury and the Federal Reserve effectively created a series of fire hoses, stuffed them full of money, pointed them directly at the ailing US economy and the bank system, turned them on full pressure, and these monetary "fire hoses" have been running day and night ever since. The fire hoses create the fantastic level of government deficit spending, they are the source of the debt limit crisis, and they are also precisely why we do not openly see the far greater unemployment that would otherwise be expected to accompany a financial earthquake of this magnitude.
What the deficit constitutes is a denial of reality. It is a cover-up that has been going on for what will soon be three years now – without having made any significant progress in healing the badly wounded private economy that is the true crisis. As with any cover-up that doesn't fix the underlying problem, it is ultimately doomed to failure, and its failure will likely destroy the value of the dollar and most private savings and investments in the United States.
The Problem With Balancing The Budget
On a stand-alone, fundamental basis, there never was a debt limit crisis. Stepping away from politics and returning to the fundamentals, let's keep in mind that what we are talking about is the President of the United States, the United States Senate, and the United States House of Representatives. They are the government and they are the source of the law. There are constitutional issues involved, but given the magnitude of the danger, and the previous flexibility of the Supreme Court when it comes to "interpreting" the U.S. Constitution, there is little from a legal perspective that prevents the United States government from rolling the clock back four years and doing it in a single weekend.
So why didn't they, and why won't they?
The issue, of course, is what happens next. Let's hypothesize and say that the budget is balanced in a weekend, and the economy takes that .5 trillion hit.
Because we are now looking at the real state of the US economy– with no cover-up in place – the true employment numbers appear in a matter of weeks or months, as the public workers and government contractors whose employment can no longer be funded, all lose their jobs. As do all the people whose jobs rely on income from those government workers and contracts. And then add in the third round of this jobs-multiplier effect as the impoverishment of the first two rounds of laid-off workers further reduces sales and economic activity. With little of the unemployment benefits to smooth things over either, as the money never really existed for that in recent years.
This wouldn't take long. The implosion of 2008-2009 only took a matter of months. What would likely happen on a quite rapid basis is that the US unemployment rate would go straight to a level of 25 to 30% (and that's a bit on the optimistic side) which means that it would exceed the greatest level of unemployment seen at the very height of the United States depression of the 1930s.
These are not arbitrary numbers or guesses.
Instead they represent the current state of US unemployment when we break it out into all three boxes, as I've previously explained in my article "Hiding A Depression: How The US Government Does It" (linked below). As documented in that article and shown in the graph below, what the government has essentially done is to take a 26%+ rate of unemployment and segment into 3 boxes.
https://danielamerman.com/articles/Hiding.htm
The first "box" is the official U3 rate of unemployment which is currently about 9.2%. The second box is based on the equally official but less often discussed U6 rate of unemployment, which adds in the discouraged, long-term unemployed as well as involuntary part-time workers, taking total unemployment to 16.2%.
The third box is the public and private workers who are effectively finding employment solely by way of the government's "fire hose" of money that is being pumped into the economy, money the government does not have and cannot be reasonably expected to repay (at least at the current value of a dollar, which is another topic altogether). If we remove the deficit, then about 10% of the economy disappears, with a corresponding reduction in job losses and at the very least (without factoring in the likely multiplier effect on job losses), the country goes to a combined unemployment rate in the 25 to 30% range.
The peak US unemployment rate of the 1930s was "only" about 25%. We are already there and worse - if the fire hoses of deficit money stop blasting.
"Then keep on blasting away and turn on some more fire hoses!" one might think, and some commentators are advocating this very approach. Unfortunately, things aren't quite that simple, and there are extraordinary dangers for this approach. For if the monetary fire hoses keep on blasting, then the dollar eventually collapses, the value of savings and most investments are wiped out, and the unemployment levels go to 25-30%+ anyway.
So the destination is the same, and the reality of depression-level unemployment hits anyway, with the difference being that the savings and the retirement accounts have been wiped out in the process of delaying its arrival. The future then is that more than a quarter of the country is unemployed, and the price of delaying the recognition of reality, is that almost everyone is broke as the value of their life savings has been destroyed by the endless, reckless monetary creation and spending without resources that is at the heart of the "fire hoses".
Seeking Societal Solutions
The United States is truly between a rock and a hard place, and the only way out is not to smooth things over, but to face - and fix - reality. The deficit is a catastrophe, but it is of secondary importance compared to the devastation that has been wreaked upon the private economy. Money is ultimately just a symbol, the scorekeeping system that we use for distributing reality, with reality itself being jobs, goods, services and resources. If a country doesn't produce the economic output that is necessary to support the national standard of living, then the real national standard of living eventually falls, regardless of how many clever boys and girls are manipulating the symbol.
In the immediate aftermath of the votes, President Obama immediately shifted the focus to jobs, which is a most welcome shift from the cover-up to the crisis itself. Unfortunately, as an administration source put it, the President doesn't have any "magic beans", in apparent reference to the need to grow a massive beanstalk of an economy.
This gets to the heart of the dilemma, because the "magic beans" are there, as they always have been, but they can't even be seen through the current political filters. The "magic beans" can be found by rewriting the laws to favor the true source of job creation and economic growth in the US. Which is simply to let a million small businesses flourish by stripping away onerous and anti-competitive government regulations. Strip away the corporate welfare that lets mega-corporations (who destroy domestic jobs) dodge taxes altogether while entrepreneurs (who create domestic jobs) pay the highest marginal all-in tax rates in the country. That needs to be turned upside down.
After decades of neglect, the anti-trust laws again need to be vigorously enforced, as we cannot afford to continue the current anti-competitive economy of oligarchies and corporate fiefdoms, locked in their deadly, economy-destroying symbiotic relationship with the political powers-that-be. Keep in mind that when a major corporation splits into four - the jobs effect is the reverse of what happens with mergers. It doesn't mean the corporate employees lose their jobs (or that the shareholders lose their investments), but rather there is a major increase in jobs, on average, instead of the layoffs on a massive scale that are the usual immediate or eventual result of corporate consolidation. (With a good number of those job increases occurring not with cashiers and cooks, but in desirable and well-paying upper and middle management positions, as well as skilled technical support positions.)
Let the free market decide where the resulting resurgent new growth occurs, instead of government micro-management on a partisan basis that is all too often effectively controlled by campaign contributions.
As this approach would involve turning the current political paradigm upside down, negating the influence of wealthy special interests even while removing the partisan and congressional district components of government-directed "stimulus" spending, it is no surprise that the "magic beans" in question remain invisible to policy-makers. Indeed, the "magic beans" are a double negative from a political perspective, as incumbent politicians lose much of the financial power coming from special interest campaign contributions, even as they lose the raw political power to reward friends and punish enemies through controlling the spending of the "stimulus". Meaning such a solution is still likely out of reach at this time, politically speaking.
Individual Implications
Because the politicians fear the personal consequences, it is unlikely that the fire hoses will be turned off. A moderate reduction in the flow seems to be the most aggressive option on the table, and if that occurs (which is far from assured) it still is simply not enough to change the outcome.
Run the fire hoses indefinitely, blasting artificial money into the economy even while politics as usual determines how the money is spent - and the value of the currency is all too likely to collapse.
Historically, a collapse in the value of a currency necessarily forces a major redistribution of wealth, and the segment of the population that is most devastated by this seems to always be the same. It’s the retirees, and the people close to retirement. When we look to Germany, when we look to Argentina, when we look to Russia – it is the pensioners who are impoverished more than any other group. Unfortunately, it appears that history could be in the process of repeating itself.
Of at least equal importance, stocks are profoundly overvalued when compared to a private economy in depression, where the semblance of earnings is likely to collapse when the output of the fire hoses can no longer be sustained.
When we look at the headlines about the destruction of retiree investment values, pension assets and so forth, we're really just seeing the beginning - because most assets are overvalued for a nation whose private economy remains in depression even while the government takes on new debt at a ludicrously unsustainable rate.
When the value of money and the value of assets are falling together, then we have simultaneous price inflation and asset deflation (in inflation-adjusted terms). It is a one-two combination that the conventional financial wisdom is simply incapable of dealing with.
The intertwined results of the crisis and its "solution" may represent the annihilation of most of the retirement dreams of the baby boom generation, even if that is not yet recognized. There is not an even cost that is being born by society as a whole, rather some segments are bearing much more of the burden than others. If your peer group (particularly Boomers and older) is headed for disproportionate financial devastation, then happenstance is unlikely to offer a personal way out. Instead, you must take quite deliberate actions to change your personal financial position so that wealth is redistributed to you, rather than away from you.
To get out of step with your generation, and have wealth redistributed to you even as your peer group is being devastated by this extraordinary destruction of wealth, you need to start with an essential and irreplaceable step: education. You need to gain the knowledge you will need to turn adversity into opportunity.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will redistribute real wealth to you, and the higher the rate of inflation – the more your after-inflation net worth grows? Do you know how to achieve these gains on a long-term and tax-advantaged basis? Do you know how to potentially triple your after-tax and after-inflation returns through Reversing The Inflation Tax? So that instead of paying real taxes on illusionary income, you are paying illusionary taxes on real increases in net worth? These are among the many topics covered in the free “Turning Inflation Into Wealth” Mini-Course. Starting simple, this course delivers a series of 10-15 minute readings, with each reading building on the knowledge and information contained in previous readings. More information on the course is available at DanielAmerman.com or InflationIntoWealth.com.
Contact Information:
Daniel R. Amerman, CFA
Website: https://danielamerman.com/
E-mail: mail[at]the-great-retirement-experiment[dot]com
This article contains the ideas and opinions of the author. It is a conceptual exploration of financial and general economic principles. As with any financial discussion of the future, there cannot be any absolute certainty. What this article does not contain is specific investment, legal, tax or any other form of professional advice. If specific advice is needed, it should be sought from an appropriate professional. Any liability, responsibility or warranty for the results of the application of principles contained in the article, website, readings, videos, DVDs, books and related materials, either directly or indirectly, are expressly disclaimed by the author.
