Five Charts: Why the Federal Government Will Default
Reality Check
I have been arguing for years that the United States government will default on its debt.
As to which form this default will take, I am not sure. That will be decided by politics during the default. It will not take place overnight. It will be a long, drawn-out process. All of America's political sacred cows will be gored, some more than others.
Either Washington's checks will bounce or else Washington will stop sending them.
To prove my case, I will present five charts. I will then add a few obvious comments concerning these charts. Adding them together leads to not-so-obvious conclusions.
This default will mean a huge loss of legitimacy for the federal government: breaking promises made in 1935 and 1965 by the two most statist Presidents in American history.
The bipartisan establishment in Washington will be left holding the bag when the default empties it. To take advantage of this tremendous political opportunity, Tea Party types must be ready to say, "We told you so." This means: "We told you that Social Security and Medicare were immoral from day one. They have blown up in the faces of all older Americans, who became dependent on these programs. We must now say: 'Never again!'"
The Tea Party refuses to say this. The entire conservative movement has refused to say it.
It should also say this: "Ronald Reagan was a fiscal disaster for America. He destroyed the Republican Party's opposition to the national debt." No conservative politician has said this.
In short, there is no political movement today that is prepared to take advantage of this historic opportunity.
But am I correct? Will there be a Great Default? Or will the politicians be able to postpone this literally forever.
Some conservative pessimists who have spent their lives opposing the debt and taxes have given up. They have become operational Keynesians. They have joined the other side. They say in effect that deficits don't matter. They say that Washington will always be able to keep this evil system going. In short, evil wins. Righteousness loses. Forever.
Anyone who holds this is part of the problem, not the solution.
FIVE CHARTS
I begin with a chart on the federal debt. You can see when it began moving up sharply: under Reagan -- not under FDR and not under Johnson. Reagan did it to us. The conservatives said nothing, other than David Stockman, who resigned as the head of the Reagan's Office of Management and Budget. He warned what would happen, and he resigned in protest. He was correct. It happened.
The second chart is the ratio between the federal debt and GDP. You can see which Presidents oversaw disaster: Reagan, Bush I, Bush II, and Obama. These were bipartisan disasters.
The third chart shows that the federal government has not been able to extract more than 21% of GDP in tax revenues. Not even the patriotism of World War II and withholding taxes enabled the federal government to extract more.
The fourth chart shows the percentage of government spending: discretionary vs. nondiscretionary. Nondiscretionary spending -- built into existing laws -- is around 85% of the budget. It is growing, year by year.
The fifth chart is the adjusted monetary base of the Federal Reserve System.
The Federal Reserve ceased inflating in mid-2014.
There are some economists who think the Federal Open Market Committee stopped inflating in order to "keep its powder dry." I am one of them. So is the president of the Federal Reserve Bank of Philadelphia, who recently said this: "The funds rate will be our primary monetary policy tool, and we'll keep the unconventional ones in the arsenal in case we need to use them again, which I hope we won't." The FOMC wants to be able to inflate in the next recession without driving up prices too much.
Why does the FOMC have to keep its powder dry if there were not a major threat of renewed price inflation?
This raises the crucial question: How long will the Federal Reserve's monetary inflation finance the government's deficit once T-bond rates start rising in the next round of price inflation? Rising rates will expand the nondiscretionary percentage of the budget going to interest on the federal debt. Put differently, how long can monetary inflation fund the federal government without producing hyperinflation in the price indexes?
The political problem with hyperinflation is simple: it cannot go on more than a few years. The public will switch to a replacement currency, or else there will be a national currency reform. But the liabilities of Social Security and Medicare stretch for 75 years. Hyperinflation kicks the can down the road a few years, but the can gets bigger. Also, Social Security has a cost-of-living adjustment clause.
Bottom line: the unfunded liabilities of Social Security and Medicare will force the Great Default. So will rising payments on the national debt. Hyperinflation does not solve these problems. At best, it delays the day of fiscal reckoning.
"ACCOUNTING DOESN'T MATTER!"
Yet there are those who say that Washington will always be able to mail out checks "forever." Literally forever. In short, they say that accounting does not matter. The U.S. government can and will grow forever. There is no hope of deliverance by default.
They believe in magic. They believe in a world without economic cause and effect.
They believe that there really are free lunches, and bipartisan deficit spending in Washington is the source of free lunches -- forever.
Who are these people? Keynesians and emotionally defeated conservatives.
Their ship will go down in the Great Default.
We need a generation of conservatives who see what Stockman saw in 1985, and who say, "It's going down. I'm getting off the U.S.S. Bankruptcy." When this ship sinks, the bipartisan Washington establishment goes down with it. This will include beltway conservatism and its well-funded think tanks.
Then it will be time for a political civil war. It will not be fought in Washington. It will be fought primarily in the counties. Nobody pays much attention to the counties. This will change.
There will come a time when electing a sheriff will be more important to Americans' lives than electing a Congressman.
Congressmen will vote for laws. Sheriffs will decide which of these laws to enforce and on what terms.
When Washington's checks bounce, federal SWAT teams will be de-funded. Federal laws are no more authoritative than the ability of Washington to enforce them. It takes money to enforce them. That is the political bottom line.
It is time to make this move mentally. It is time to prepare locally. We hear of "preppers" who store up groceries and ammunition. They are vocal. We do not hear of "preppers" who are quietly organizing local political resistance. They are not vocal.
We will know that the changing of the guard has begun when local bond issues always fail. That is the test of the new politics.
The test is always the same: whether or not the local Good Old Boys and the national Old Boy Network can get into our wallets because a majority of Americans vote to allow this. The limit for all levels of government in the United States has been about one-third of GDP. Beyond this, the federal political establishment must borrow the money: from private investors, federal government agencies' preposterously named trust funds, and the Federal Reserve.
When the Great Default comes, the costs of borrowing will skyrocket. At that point, the minority of citizens who always vote against the flow of funds into government will at long last have an opportunity to gain the upper hand.
In short, to monitor the progress of political revolution that is surely coming in the wake of the Great Default, follow the money. You will be able to measure the extent of the revolution by measuring the decline in the flow of funds into governments at every level. Less is more. Small is beautiful. Starve the beasts.
CONCLUSION
It is time to begin thinking about what the political and economic implications will be locally when Washington's checks bounce. My old friend Angelo Codevilla is thinking about this in detail. He and I go back to my days on Capitol Hill with Ron Paul in 1976. He was also a Hill staffer. Read his assessment here. Then read it again.
Prepare.