Wednesday, July 11, 2012

A must-read: What happens when the dollar dies?

In Investment News, the brilliant Peter Schiff describes the real fiscal cliff facing Americans.

The current national debt is about $16 trillion (this is just the funded portion...the unfunded liabilities of the Treasury are much, much larger). The only reason the United States is able to service this staggering level of debt is that the currently low interest rate on government debt (now below 2 per cent) keeps debt service payments to a relatively manageable $300 billion per year.

On the current trajectory the national debt will likely hit $20 trillion in a few years. If, by that time interest rates were to return to some semblance of historic normalcy, say 5 per cent, interest payments on the debt would then run $1 trillion per year. This sum could represent almost 40 per cent of total federal revenues in 2012!

In addition to making the debt service unmanageable, higher rates would depress economic activity, thereby slowing tax collection and requiring increased government spending. This would increase the budget deficits further, putting even more upward pressure on interest rates. Higher mortgage rates and increased unemployment will put renewed downward pressure on home prices, perhaps leading to another large wave of foreclosures. My guess is that losses on government insured mortgages alone could add several hundred billion more to annual budget deficits. When all of these factors are taken into account, I believe that annual budget deficits could quickly approach, and exceed $3 trillion. All this could be in the cards if interest rates were to approach a modest five per cent.

If the sheer enormity of the red ink were to finally worry our creditors, five per cent interest rates could quickly rise to ten. At those rates, the annual cost to pay the interest on the national debt could equal all federal tax revenues combined. If that occurs we will have to either slash federal spending across the board (including cuts to politically sensitive entitlements), raise taxes significantly on the poor and middle class (as well as the rich), default on the debt, or hit everyone with the sustained impact of high inflation. Now that's a real fiscal cliff!

By foolishly borrowing so heavily when interest rates are low our government is driving us toward this cliff with its eyes firmly glued to the rear view mirror. For years I have warned that a financial crisis would be triggered by the popping of the real estate bubble. My warnings were routinely ignored based on the near universal assumption that real estate prices would never fall. My warnings about the real fiscal cliff are also being ignored because of a similarly false premise that interest rates can never rise. However, if history can be a guide, we should view the current period of ultra low rates as the exception rather than the rule.

And what happens when our colossal debts truly become unmanageable? Chris Martenson provides the sobering lessons from one such episode that occurred less than a century ago in "Our Money Is Dying."

In the book When Money Dies by Adam Fergusson, which details Weimar Germany's inflation over the period from 1918 to 1923, the most riveting parts for me were the first-hand accounts from the people caught in the storm.

So many people left their wealth in the system only to watch it get eroded and utterly destroyed over time. The reasons were many: patriotism, inertia, disbelief, and denial cruelly fed by hope every time prices moderated or even retreated momentarily.

The simple observation is that many people had a blind belief in the money system. They lost their wealth because they were unable or unwilling to allow reality to challenge their beliefs. It's not that there weren't numerous warning signs to heed -- in fact, they could be seen everywhere -- but most willfully ignored them.

Most mysterious is the fact that in Austria and Germany, where the inflation struck most severely, there were numerous borders and currencies into which people could have dodged to protect their wealth. That is, protecting one's wealth was a relatively straightforward and simple manner. And yet…it did not happen.

What can you do to protect yourself? I'm no expert, but according to the real financial gurus like Mike Shedlock, investing a portion of your assets in gold could help protect your portfolio. Shedlock recommends GoldMoney to do so.

I would just recommend preparing. Because annual trillion-dollar deficits are certain to end in disaster, unless we return this country to Constitutional conservatism.


Andrew_M_Garland said...

Bankruptcy of the West

The West is bankrupt. The solution is to declare bankruptcy. People were stupid to loan resources to their governments, and they will receive the usual reward for their stupidity.

The meaning of government debt is that governments have taken real, current resources and have applied those resources to whatever is now built. Almost all has been wasted, building the wrong things in the wrong places, or building nothing. Politicians have nice houses by lakes and on beautiful hilltops. That is all.

Let the people who bought government bonds take the loss. Sorry, they should have looked into the plans and the planners before entrusting their wealth to those guys. Investing with crooks will always result in losing your wealth, especially when those loans are promoted as "riskless". Their only expectation of repayment was by the use of government force to extract higher taxes from the populace. That expectation was ruthless and immoral.

Each day, a population participates in production or idleness. At the end of the day, it trades what it has produced. There is prosperity if most have worked on useful things. There is poverty if most are disorganized or misled.

Europe (and the US) can be prosperous, and it has nothing to do with current debts. Europe and the US only need to discard the rules which prevent the natural organizers and planners (business people) from doing those useful things. Otherwise, no bailout or financial arrangement will prevent poverty.

Anonymous said...

Was this an ad for that gold company)

Anonymous said...

You wrote...interest payments on the debt would then run $1 trillion per year. This sum could represent almost 40 per cent of total federal revenues in 2012!

I've always wondered where the interest payments go to. Whose name or which institution receives the interest payments?

Gary in Texas