Solutions For The Debt Crisis
© Martin A. Armstrong
The general perception of interest rates and debt within the financial community is about as far from reality and common sense as one might be in this day and age. With government deficits still a major problem and no solutions from the political arena in sight, one must question the fact that the majority still anticipate lower interest rates in the long-run. Is the financial community confusing their hopes and dreams with expectations and forecasts? The answer to this question appears to be a very blunt -yes!
While everyone is looking at the deficit of the United States and the debts in South America and Africa, a monumental problem exists chugging along ever so silently behind the headlines of the day. This problem is the “Real Debt Crisis.”
If we look at the international debt levels and the individual differences on a nation by nation basis, we not only see the causes for gyrating capital flows and market activity, but a series of diverse solutions facing each nation. Obviously, the United States remains the primary focus, largely due to its standing as the world’s largest debtor. Nevertheless, the predicament in which the United States finds itself is far less critical than that of Canada and Europe.
Most look at the debt levels from a superficial perspective. In other words, the traditional method of comparison is limited only to federal levels and overall debt as well as fiscal deficits are normally expressed in terms of Gross National Product. This approach is off the mark and lacks true in-depth comparisons.
For example, throughout most of Europe, governments from the federal down into the local levels remain in deficit. Even in Australia, where the Commonwealth enjoys a surplus, state and local levels remain in deficit. The United States, on the other hand, is a rather unique exception. Although the federal government is the largest debtor and the fiscal deficit is quite large, state and local levels remain in surplus. In fact, the surpluses at the state and local levels equal about 60% of the federal deficit in the United States. When the state and local levels account for such a high percentage of the federal deficit, obviously we must learn to look at government collectively, not just federally.
There are different facets to this debt problem. Clearly the combined approach to the cost of government on all levels is essential. But we must also consider the breakdown of government expenditures. Far too often the political rhetoric obscures the real issues at hand in virtually every nation. The parties which are “liberal” oriented, meaning bigger government and more social spending, seem to have the greatest difficulty coming to grips with our crisis in debt. Generally, the philosophy of these political groups tend to tax the rich for the benefit of the poor and middle class under the pretense that a vote for their party will redistribute the wealth through a mirage of social programs. They have failed to realize that capital has the unique ability to move. If taxation on the corporate sector becomes excessive, as was the case in the U.S. during the 1960s, higher taxes only drives corporations and capital offshore , taking with them both jobs and liquidity. The lower and middle classes cannot hoard their labour nor move it offshore. Consequently, it is always the middle and lower classes within society who pay the tax bill. As long as we are a free society without an iron curtain to restrain capital from moving offshore, this is the net result of labour or social policies over the long-term.
Yet still this is not the entire picture. We must look deeply into the component structure of government expenditure. When we do, the realities which emerge are very unnerving. For example, the following table illustrates the percentage of net interest expenditures within the total federal expenditures on a fiscal basis. Because governments can cut social and defense, but they cannot cut interest expenditures without defaulting on the bonds, interest expenditure growth is a sacred cow which cannot be touched. The growth rate within interest rate expenditures since 1981 is 11.29% annually. You will recall t hat 1981 was the peak in interest rates. Therefore, this growth rate reflects a largely declining interest rate environment since it is being calculated from the post-’81 interest rate highs.
|1976…. 6.0%||1977…. 7.0%||1978…. 7.0%|
|1979…. 8.0%||1980…. 8.0%||1981…. 9.0%|
|1982…. 10.0%||1983…. 11.0%||1984…. 12.0%|
|1985…. 12.0%||1986…. 13.1%||1987…. 13.4%|
Now if we ASSUME no change in the immediate trend including interest rates themselves, then compounding 13.4% at a 11.29% rate of growth, we find that in 19 years, interest rates would consume 100% of total federal expenditure (See Table 1b). Obviously, a government cannot function with 100% of total expenditures going for interest to carry the back debt. It is also unrealistic to assume that the situation would ever come close to such a level. No social programs would exist. No defense would be possible. But even more unrealistic, there would be no politicians, no tax agents, no meat inspectors and no court system.
By now, you should be catching a glimpse of our real debt problem. Consider that in Canada, 30% of revenues is being consumed by interest expenditures – nearly twice that of the United States. Europe is currently spending over 20% of total government expenditures on interest. In Japan, the figure remains 23%.
No matter how hard our politicians of any party try to carry on, this game of revolving debt will eventually come to an end. We must realize the difference between theory and reality. Social and defense spending will be crowded out by interest expenditures. Perhaps it was a great idea to borrow rather than print money to cover the deficits of the postwar era. But eventually, the piper must be paid. While we have borrowed, believing it to be less inflationary, our debts have increased tremendously around the world and eventually we will still be forced to either default or print our way out of this dilemma.
There are a few solutions which can be implemented to avoid a crisis in debt. But each country holds a few different options. Clearly, cutting social and defense will not solve the problem. Raising taxes will only reduce economic growth and in the end force a rise in social expenditures as unemployment rises in the wake of existing corporations and jobs.
We must address the interest expenditures now before the growth rate increases further. The U.S. should consider making Treasury bonds tax free as many municipal bond issues already are today. Although there will be a slight decline in revenue, the yield can be cut nearly in half. Pension funds do not pay tax on interest earned. Foreign investors do not pay tax of any consequence on interest earned. Any decline in revenue will be far less than the gains afforded by lower interest rates as a whole. If all retiring debt were issued in this manner, the savings in interest expenditures would rise significantly. A series of gold backed bonds should also be issued, cutting yield as well. Currently, nearly $24 billion flows out of the United States as interest expenditures to foreign bond holders. If we are not careful, this will become hundreds of billions by the 1990s. That amounts to the exportation of our national wealth without benefit to the domestic economy in the slightest.
If this were combined with an increase in monetization in small doses, US Treasury bonds would actually become scarce and would rise in value on world markets resulting in greater acceptance. This would also help to relax interest rates and thereby reduce expenditures in the future. Coupled with a serious drive to keep spending in check and a line item veto for the President, the US could easily create a surplus and begin to retire debt.
The issue of debt has long been a key issue in the world. The first Secretary of the Treasury in the United States, Alexander Hamilton argued in favour of a National Debt. He said, “…to us, a national debt will be a national blessing.” Perhaps any thing in moderation is not that bad. But when excess develops, the outcome is lethal.
|Year 1….. 14.91%||Year 5….. 22.87%|
|Year 10…. 39.05%||Year 15…. 66.67%|
|Year 18…. 91.89%||Year 19…. 102.27%|
The alternative, points to rising volatility in interest rates along with outright higher rates worldwide. Inflation will continue to rise and it will eventually force government to inflate their way out of the current debt problem.
Canada could easily float gold backed bonds. As long as the Canadian people understand that social programs must be curtailed or trimmed down to run efficiently, the situation can be avoided. Privatizations should be the main goal. Proceeds from the sale of such industries should be applied to reducing the debt.
Assuming no change in interest rates is certainly unrealistic, particularly since they have already risen since the end of the last fiscal year. But even more unrealistic, in the midst of such an assumption, we are also ignoring the roll-over costs. For example, each refunding retires expired 30 year bonds which once yielded 3.5% with 9.5%. So even if interest rates do not rise and the budget is balanced, interest expenditure will still rise as a percent of the total budget crowding our both defense and social programs. This alarming growth rate in our interest expenditures of all nations, will eventually cause a political crisis of untold proportions on a global scale by the time we reach the last half of the 1990s.