Aug. 11 (Bloomberg) -- Lets get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.
What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.
Yep. We've been over most of this before in The Ticker, but I'll be happy to do it one more time. But before I do, let's get to this:
The U.S. fiscal gap associated with todays federal fiscal policy is huge for plausible discount rates. It adds that closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.
Gee, where did I see that number before? Oh yeah, right here:
14% eh? Gee, that's a suspiciously familiar number.... (look above, and then look below - there's your output gap and the federal government's attempt to cover it up!)
The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.
Got that? Just like in the 2003-2007 time frame, the deficit that has been built into the economy by the actions of government has become STRUCTURAL. This is exactly what I've been arguing now for THREE YEARS.
So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.
Well, no. The IMF is saying that this is what we'd have to do if raising taxes brought a dollar-for-dollar increase in revenue. But it doesn't.
Right now if you're "rich" you get to keep about half of your income. The rest is taxed away in some form or fashion. A doubling on those people would mean that they would keep effectively none of their incremental earnings.
The problem with such a tax is that there's no reason to earn that incremental dollar. Imposition of such a tax causes an immediate avoidance move by those who earn such incomes - and if they can't avoid the tax, they avoid the work - and the tax!
As someone who spent many years literally on-call 24x7 as the CEO of a moderate-size company (MCSNet), I can tell you this with certainty: If I had not been able to keep a very substantial amount of the money I earned, more than half, I would not have worked anywhere near as hard - there would be no reason to, when I was simply working for the government - and the people that I employed would have been UNemployed!
For this reason, irrespective of how you feel about the class-warfare game that many play with "tax the rich!" (even though the "rich" pay the majority of all federal income taxes) I can tell you that such a strategy is doomed to fail. Indeed, The richest 1% of taxpayers pay 40% of all (yes, including FICA and Medicare) federal taxes, which is more than the entire bottom 95% pay - even with the Bush "tax cuts."
(The next-top-slice, the 4% directly under the top 1%, pay the other 20% of federal taxes. That is, the top 5% pay about 60% of all federal taxes.)
Many people say that the rich should pay "their fair share." To those I retort: What is their "fair share", when the top 1% already pay 40% of EVERY tax dollar collected, and the top 5% pay 60% of it? Are you truly going to argue that unless you're super-rich you shouldn't pay anything at all?
Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit.
Well, no, it's worse than that. The IMF is not counting the Social Security and Medicare tax theft. I do. This means that the real damage is about 4-5% higher, which means that the IMF's numbers are low. Congratulations.
Oh wait - you do get it. Let's continue....
Based on the CBOs data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our official debt and our actual net indebtedness isnt surprising.
Ah, there's recognition. Incidentally, that $202 trillion is materially higher than my numbers, but once you get into the hundreds of trillions do the rounding errors matter? I think not.
Congress, of course, simply takes things "off balance sheet" it doesn't want to count. Incidentally, so does The Fed in their Z1 tables, which means that the graphs I present are somewhat-misleading, in that even the on-balance sheet portion of Social Security and Medicare aren't counted. The off-balance sheet forward liabilities, of course, aren't counted at all, because legally they're not "liabilities" - they're political entitlement programs. In economist-speak they're "not really there" as a liability and in legal-speak (so said the Supreme Court repeatedly, from 1939 onward, with the latest being when Social Security's retirement age was changed) both of these programs are, from a revenue point of view, nothing other than a bare tax.
That is, there's no obligation to pay. If you're a senior, or about to become one in the next 40 years or so, you might want to think about that. Carefully.
Some doctrinaire Keynesian economists would say any stimulus over the next few years wont affect our ability to deal with deficits in the long run.
This is wrong as a simple matter of arithmetic. The fiscal gap is the governments credit-card bill and each years 14 percent of GDP is the interest on that bill. If it doesnt pay this years interest, it will be added to the balance.
Ding ding ding ding ding ding. Notice that Mr. Kotlikoff didn't resort to fancy math. He in fact said arithmetic.
Well, to be more correct, exponents.
Back to basics:
The above is a (hypothetical) Ponzi Scheme.
That is a REAL (not hypothetical) Ponzi Scheme - our economic Ponzi Scheme.
All exponential growth functions - that is, "5% annual growth" - if projected out into the indefinite future - are Ponzi schemes.
IN EACH AND EVERY CASE.
The percentage increase dictates only when the Ponzi ultimately collapses. It does not, however, determine if it will collapse. That it will collapse is a mathematical certainty.
When I wrote the original business plan for MCSNet the five-year pro-forma financial statements made the following assumptions:
That is, I recognized that "forward growth estimates" that projected double-digit (or more) five-year growth rates were entirely unrealistic. It was unrealistic because of the math, and nothing I wanted to do about this could, or would, change it.
As it turned out my projections were pretty accurate. By the time I sold the company the technology was mature and growth rates were way down. The "go go rah rah" 100%+ growth rates had abated to replacement + cannibalization + a bit more. But the business was stable and crazy-profitable, because I had not committed to spending and financing activities that required those sorts of growth rates to make the payments!
Go find some old S-1s from some of the failed firms. Look at their five-year projections. Hell, look at the 5-year forward growth "estimates" for AMAZON (AMZN): 27%! Worse, the SECTOR growth rate estimates on a five-year forward basis are 15.38%.
Not a snowball's chance in hell folks. And yeah, I know, the last five years were great on a annualized basis in sales. But this sort of projection on a forward, permanent basis IS A PONZI SCHEME.
Unfortunately this is the premise of all such Ponzi schemers. David Lereah and his "housing bubble" books was one such claimant. Remember these?
Ponzi. Why? Because the projections made in those books required an ever-expanding price on a compound growth rate. It did not project an end to the growth rate, and a reasonable date and reasoning by which that end would occur. Instead, it simply took the view that "for the foreseeable future" prices would continue to rise (and then went on to cite a bunch of "reasons".)
So did the Internet Bubble.
And so do the projections that government and market analysts are making for forward growth rates, the stock market and the economy.
To solve these problems we have to do the following:
The Fed appears to have recognized the above facts, but won't come out and say it. If they do the DOW goes down 5,000 points in about a week, and the SPX trades under the 666 low.
But refusing to say it doesn't make it not happen, or change the facts. It simply means that you don't say it out loud.
And yes, this sort of recognition will result in a major economic contraction. I've opined on this before - we are running a debt level some 60% above sustainable levels, and GDP 40% above. Both must correct to sustainable levels, and the pain that this will bring to our society will be sizable. Every "Big Bank" - all of them - are in fact insolvent, as all are relying on perpetual growth in the debt ponzi that cannot, mathematically, occur. The depositors can be protected but nobody else can be, including the pension funds that own their paper. The over-levered must be forced through resolution - bankruptcy - with the equity holders wiped out and the debt holders converted to equity. Yes, this too will hit pension funds and individuals. Prices must fall generally, especially in housing but also in all other asset classes, to the point where asset valuations reflect forward cash flows without the promise of an indefinite-forward growth rate that cannot occur. This is not deflation per-se, it is reversal of the ponzi-based inflation that resulted from the fraudulent schemes foisted upon our society by the political and bankster classes.
(Incidentally, if we don't cut this crap out right now the correction will be worse than 40%. Thus far, from the above graph, it's 9.7% + 11.6% + 12.35% - compounded, or 37.67%, and that's just the distortions from the last three years. The longer we let this go on the worse it will be - there is no way around the mathematics of this.)
Markets eventually suss out the truth. The heroin high of credit expansion always feels real good at the time you take up the new credit, but the compound annualized growth rate of DEBT in the system, not including the off-balance-sheet Federal programs, has been 8.78% since 1953!
In the same time the compound growth rate of GDP has been 6.81%.
This is the definition of a Ponzi Scheme - the premise that one can growth GDP forever (and business plans are made and predicated on that) but also that credit can grow faster than GDP forever.
Neither of those premises is true, and having run this scam for sixty years we've now found the end of the rope - and it's 20 stories up from street level.
For more than three years I have been banging this drum. It is delightful to finally read these facts in a mainstream media publication, but at the same time rather sad that it took this long.
Buckle up folks.
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