January 9, 2012

Has U.S. Economic Policy Reached the Point of No Return?

How much influence does government spending play in the affairs of the financial markets? First, as the size of government expands, its debt rises. Second, when the amount of money needed to continue government functions surpasses what its revenue will support, deficit spending results. Third, when deficit spending occurs, the debt accelerates.

One solution to continue to carry on 'things as usual' is to increase taxes, and that's precisely where the conflict resides. With a finite amount of capital in the system, as taxes rise, money is extracted from the private sector and private sector growth is stymied. To combat this, the money supply may be increased. However, if the money supply increases at a rate faster than economic growth, inflation may result. Therefore, increasing the money supply in a slow growth environment, as we have today, may prove hazardous. 

Every country travels down its own fiscal path."However, there may come a time when they reach the point of no return. Has America reached this point? Here are the numbers; you decide. 

Let's use some rough assumptions to examine the issue. Currently, America's "on balance sheet" debt is around $15 trillion. However, you cannot ignore the "off balance sheet" debt which includes Social Security and Medicare Parts A, B, and D, which is somewhere around $90 trillion. Therefore, for our purposes, let's place the total debt at around $105 trillion. With annual revenue of approximately $2.2 trillion and expenses around $3.6 trillion, the annual shortfall is in the vicinity of $1.4 trillion. With an income and expense growth rate of 2.0% and an average interest rate of 2.25% on the outstanding debt, you can easily see how the debt grows over time. 

 

At some point, our creditworthiness could decline further, and although supply will be abundant, demand for our debt may not be. If demand does dry up, there will not be enough money to continue operating and default would be inevitable. The effect on the private sector? Default would send global markets spiraling downward and the fallout would be severe. If you think Greece's problems had a serious effect on global financial markets, I shudder to think what a widespread American default, or even the hint of such, would do. 

The only thing we can do to fix this is reduce spending, lower taxes to stimulate economic growth,and grow our way out of this. Even so, it's going to take decades to climb out of this hole. What a legacy for our children, grandchildren and even great grand children!

Take care and have a great week!

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