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‘$3.7 trillion in federal spending.’

Time and again I see experts discussion 2010 federal spending using the figure $3.7 trillion.

That is the amount to be spent this year on operating the federal government, mostly shelling out all the entitlements like Social Security and Medicare.

But we have to cut checks for $7 trillion, not just that $3.7 trillion. The other $3.25 trillion is required to pay off U.S. Treasury bonds that will come due this year.

Do the math. We have a $13 trillion national debt. That is the sum of all the U.S. government bonds we have sold.

Those bonds have an average term of 49 months—roughly four years. That means we have to pay off 1/4 of the bonds each year. $13 trillion divided by four years = $3.25 trillion per year.

The payment pattern on U.S. government bonds is what real estate people call interest only. That is, the U.S. government pays interest only quarterly to owners of U.S. bonds then pays back the principal at maturity which comes after four years on average. Again using real estate terminology, that principal repayment is a balloon payment.

We can’t pay $7 trillion of operating expenses and bond rollovers with $2 trillion of tax revenue.

People frequently say the U.S. government needs to “live within its means.” In the long run, there is no doubt about that. All government spending ultimately must be paid with tax revenue. Borrowing by selling bonds does not change that. It only postpones it—and adds interest to the amount that must be raised from taxes.

U.S. government bonds are owned 72% by Americans and 28% by foreigners. The higher our deficit-to-GDP and debt-to-GDP ratios go, the sooner the world bond market stops buying U.S. bonds. The public seems not to understand the meaning of the world bond market deciding U.S. bonds are not likely to ever be repaid.

When the bond market stops buying our bonds, we have bills of $7 trillion and only $2 trillion of tax revenue with which to pay them.

That would force an immediate renouncing of our national debt AND about a 38% immediate cut in federal spending. The 38% comes from this calculation: $3.7 trillion minus $2.105 trillion = $1.395 trillion. That amount is $1.395 ÷ $3.7 trillion = 38%.

Most readers will react to that by saying, “Oh, they would never do either of those things. The bond holders and voters would go nuts.”

It is true that the bond holders and voters would go nuts. But if that was you’re reaction, you do not yet understand the basic concept and problem here. If the bond market declines to buy our bonds, the U.S. government HAS NO CHOICE but to renounce the national debt and to cut spending 38% immediately!

Our federal government bills have to be paid every working day. When the tax revenue of $2.105 trillion runs out, and the bond market refuses to buy the bonds, there is no money. Nada. Zip. Zilch. The week that happens, some bonds will come due for their balloon payments to be paid. If the tax revenue is gone and there are no new proceeds of bond sales, the government has no ability to pay the bonds. If that payment date arrives and the payment is not made, the headline on every news media in the world will be “U.S. defaults on its bonds!”

Similarly, the Social Security checks and military pay checks and all that could not go out if the government spent all the tax revenue. The 38% cut would require that the federal government do that all year long to stretch the $2.105 trillion of taxes over as many payments as possible. If they made zero cuts until the day the $2.105 trillion ran out, the entire U.S. government would shut down completely the next day. U.S. military personnel overseas would have to hitchhike home.

Cannot just raise tax rates

If you are still thinking this could not happen, please explain the source of the new revenue. Liberals think they can just raise tax rates on the rich. Do the math. To spend $7 trillion starting with only $2.105 trillion in tax revenue you would have to raise taxes by 3.5 times.

If you actually raised tax rates on the rich 3.5 times, most of them would owe more than 100% of their income. Furthermore, those who would still owe a little bit less than 100% would owe such a high percentage of their income that they would stop working. Most would emigrate to another country and renounce their U.S. citizenship because U.S. citizens have to pay U.S. taxes no matter where they live. (Citizens of other countries generally do not have to pay taxes to their home country when they live outside their country. To stop paying U.S. taxes, you have to not only leave the country but also change your citizenship.)

Would broadening the tax base fix the problem?

We have now reached the point where half of Americans—generally Democrat voters—pay no income taxes other than Social Security. Would going back to the old ways of making all non-poverty adults pay federal income taxes cover the $5 trillion gap?

No. Since World War II, U.S. tax revenues have been 18% of GDP year in and year out, plus or minus about 1.5%. So changing tax rates, which has been done again and again since World War II in both directions, does not change federal tax revenues. What changes federal tax revenues is GDP growth.

Can we grow our way out of the deficit spending?

GDP is now $14.8 trillion. To get the $5 trillion we need to cover a lack of new borrowing, we would need GDP to grow as follows:

$5 trillion ÷ 18% (% of GDP that goes to federal government as taxes) = $27.78 trillion more GDP. In order for the current GDP of $14.8 trillion to grow another $27.78 trillion to $14.8 + $27.78 =$42.58 trillion in, say, five years, would require a growth rate of $27.78 ÷ 5 = $5.56 trillion per year which is an annual growth rate of $5.56 ÷ $14.8 trillion = 37.6% per year. The GDP of the entire world is currently $70 trillion, of which the U.S. is 20%. A GDP of $42.58 trillion would be 61% of of all the GDP in the world.

Has there ever been such a growth rate in the history of the U.S.?

The average growth rate in the U.S. since 1970 has been 3.2%, not 37.6%. From 1946 to 1973, the average U.S. growth rate was 3.8%. The highest annual growth rates in U.S. history appear to be in the 6% range, not 37.6%.

So the answer to the question can we grow our way out to the $5 trillion shortfall is, “No way.”

Hyperinflation

How about just printing the $5 trillion? Yes, we can start down that road, but it is immoral. And it would cause hyperinflation which means that all dollars and dollar-denominated assets, like your bank accounts and U.S. government bonds would become worth zero, literally.

Within a year or two, the people of the U.S. and the world would refuse to accept U.S. dollars for anything including paychecks for government employees. As happened in Germany in 1923 and in many other countries since, the government would be required to issue a new currency that was backed by some hard asset. in Germany in 1923 it was called the Rentenmark and was backed by German homes, farms, and businesses. Hyperinflation ended almost overnight when that currency was introduced.

So will it be all better after the U.S. introduces its version of the Rentenmark? Yep, except that if you owned dollars or dollar-denominated assets when the hyperinflation hit the fan, you will have lost all that portion of your life savings. Also, many historians think that Germany’s traumatic hyperinflation in 1923 led to the election of Adolf Hitler as chancellor of Germany in 1933 which led to substantial destruction of Germany in World War II.

What about renouncing the national debt and cutting government spending 38%? Would that make it all better? Yep, except that those who own U.S. bonds would lose that money, 38% of federal employees would lose their jobs, and those receiving government checks would see the amounts of those checks drop by 38%.

Which is the better course: renouncing debt and cutting spending or hyperinflation?

Renouncing the debt and cutting. See my article on defaulting on the U.S. national debt making surprising sense from both a moral and a practical perspective. And read my book How to Protect Your Life Savings from Hyperinflation& Depression to learn how to protect yourself from the government that has few options and will probably choose the worst one. as the back cover of my book says,

There is no grown-up in Washington or on Wall Street looking out for you. You have to be your own grown-up.

My book could have been titled

How to Be your Own Grown-Up.