The Real 2013 Cliff

There’s a much bigger cliff than the so-called fiscal cliff. The absolute worst result of the fiscal cliff would be a moderate uniform tax increase at a bad time, resulting in a moderate contraction. It is an obvious — but ultimately rather cosmetic — stumbling block on the so-called “road to recovery”.

The much bigger cliff stems from the fact that the so-called recovery itself is built on nothing but sand. This is a result of underlying systemic fragilities that have never been allowed to break. I have spent the last year and a half writing about this graph — the total debt in the economy as a proportion of the economy’s output:

This is the bubble that won’t go away. This is the zombified mess that the Federal Reserve won’t let dissolve (as happened regularly in the 19th century and early 20th century each time there was an unsustainable debt bubble). This is the shifting sand — preserved by the massive monetary stimulus programs — that the so-called recovery is built upon. During the 1980s and 1990s and 2000s cheap money pumped up the debt level in America. In 2008, the bubble burst, and the hyper-connective fragile financial system was set to burn. Then central banks around the world stepped in to “stabilise” (or as Nassim Taleb puts it, overstabilise) the financial system. The unsustainable reality of debt vastly exceeding income was put on life support.

A high pre-existing residual debt level makes growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load, they are drained by pre-existing debt service costs, and they are wary about taking on debt or investing in a weak and depressed environment. It’s a classic Catch-22. The only true panacea for the depression is growth, but the economy cannot grow because it is depressed and zombified. That’s where a crash comes in — the junk is liquidated, clearing the field for new growth. That is what Schumpeter meant when he talked of “the work of depressions”, something that many mainstream economists still fail to grasp. (In fairness, a similar effect can probably be achieved without a depression through a very large scale debt relief program.)

Japan has been stuck in a deleveraging trap for twenty years, to no avail, all that has really occurred is that the private debt load has been transferred onto the central bank balance sheet — there has been very little net deleveraging) and while the Japanese central bank has completed round after round of quantitative easing — sustaining and preserving the past malinvestment and high debt load — the Japanese economy is still depressed.

Japan-Debt-Hoisington-27

That is the road America and most of the West are now on. And just as Japan’s bank stocks did multiple times even after the Japanese housing bubble burst, American banking stocks — even in spite of a year of fraud, abuse, mismanagement and uber-fragility — have been shooting up, up, up and away:

1220sp_data

The zombie financial sector is the real cliff — as interconnective as ever, as corrupt as ever, and most importantly, nearly as leveraged as ever:

Margin Debt November 2012

This is a reinflated bubble built on foundations of sand. I don’t know which straw will break the illusion (middle eastern war? Hostility between China and Japan? Chinese real estate and subprime meltdown? Student debt? Eurozone? Natural disasters? Who knows…) but this bubble poses a far greater threat in 2013 than the fiscal shenanigans and the Boehner-Obama “Boner-Droner” snoozefest.

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Obama’s Fiscal Projections: A Doorway to a New Dimension of Reality

Submitted by Andrew Fruth of AcceptanceTake

Get ready to travel to a new dimension of sound, sight, and mind because President Obama has proposed to spend less on discretionary spending in 2022 than in 2011 in real and nominal terms.  That means he expects to spend fewer dollars in 2022, even after being debased by inflation, on discretionary functions than he did in 2011.  These projections come from a President that increased the entire U.S. debt by over 45% in a matter of 4 years.  We may have a credibility problem:

A closer look at the 2013 budget shows that Obama, in inflation and population adjusted dollars, wants to decrease discretionary spending from $1261 billion dollars in 2013 to $982 billion in 2022 for a decrease of 22.1%!  So, for the exception of Social Security, Medicare, Medicaid, other mandatory programs, interest, TARP, and a very small amount for “adjustments for disaster costs,” Obama plans to cut spending by 22.1% in adjusted dollars. Do we have any believers out there?:

But it doesn’t stop there.  Look at the interest rates the government expects to pay on its public debt.  The net interest row does not include intergovernmental debt.  All years are estimates except for 2011:

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
2.27% 1.94% 1.96% 2.30% 2.75% 3.22% 3.60% 3.85% 4.04% 4.18% 4.27%

Public debt is set nearly to double from 2011 to 2022 and increase by $9.358 trillion.  Yet, by 2022, the government expects to pay interest rates on the public debt that are less than they paid on the total U.S. debt in the 1990s.

You may notice a slight difference between the interest rate in the table above and the interest rate shown in 2011 on the chart below.  Unlike the table above, the chart below measures average interest rates on the federal debt outstanding, so it includes intergovernmental debt interest.  The interest rates on the intergovernmental debt brought the average up from the table above to the chart below.

The differences, however, are slight.  The 1990s still had significantly higher interest rates in the 1990s than Obama projects, even for 2022:

You might be thinking that the government plans on the Federal Reserve buying up Treasuries to keep Treasury rates low.  Well, maybe, but the government only projects the “GDP chained price index” to range from 1.6%-2.1% from 2011 to 2022.  Needless to say, unless banks, as a whole, are deleveraging throughout the whole period, the Federal Reserve’s intervention in the Treasury market would create more than 2.1% price increases.

But wait, that can’t be because if the banks are deleveraging, then it’s really unlikely the economy is going to be growing as strong as Obama projects.  From 2012 through 2018, Obama projects the economy will grow between 2.7%-4.1% YOY in real terms.  Then the real growth rate drops off to 2.7%-2.5% from 2019-2022.  For comparison’s sake, the economy grew in the 2%-4% range from 2003-2006 during the boom times.

So, then, where is the $9.358 (minus whatever amount has been borrowed so far in fiscal year 2012) trillion at 1.94%-4.36% going to come from if not the Federal Reserve?  Pick you choice: a) the free market in the U.S. b) China c) Japan d) not going to happen.  I would provide an answer key for this question, but I don’t want to insult your intelligence.

So, if the government does plan on borrowing this much, assuming it can get it from somewhere other than the Fed, what happens if interest rate levels rise to rates similar to those found in the 1990s and 1980s?  Well, fortunately, in my book The Debtor’s Ultimatum: Defy, Debase, or Default I’ve done the research.  By the way, the following chart doesn’t even include the interest on the additional interest that would develop over this time from higher interest rates.

Here’s the Hypothetical Average Interest Rate Paid on the Public Debt Alone:

Government Numbers for both the chart above and below are sourced from the Midsession Review 2012, so the data are a little bit different from the data mentioned previously that is from the 2013 budget.

Here’s the Net Interest on Public Debt Alone in Billions of $:

Yeah, and there’s even more.  The government receipts projections are incredibly optimistic.  Part of that optimism is due to projected increase in economic growth and part of it is due to Obama’s proposal to let the Bush tax cuts finally expire.  We’ll see if either of those possibilities comes to pass.  I have my doubts about both.

Rather than pontificate, I’ll let you look at the 2013 budget data yourself.  The following are federal receipts, in trillions of dollars.  2012-2017 are estimates:

2003 2004 2005 2006 2007 2008 2009 2010
1.78 1.88 2.15 2.41 2.57 2.52 2.10 2.16
2011 2012 2013 2014 2015 2016 2017
2.30 2.47 2.90 3.22 3.45 3.68 3.92

Did you notice that crazy jump from 2012-2013?  The government is expecting some pretty big economic growth.  We know those increases in receipts are not due to inflation, because the government expects hardly any at all.

Funny, in the 2012 budget, the government had the following data with only 2010 being a non-estimate:

2010 2011 2012 2013 2014 2015 2016
2.16 2.17 2.63 3.00 3.33 3.58 3.82

Notice the big jump from 2011 to 2012 they projected and compare it to the jump from 2011-2012 in the 2013 budget table.  They’re really counting on that surge of receipts, and if they’re off by a year, they’ll just delay the surge another year or so.

Take a look at the 2011 budget.  Only 2009 is a non-estimate year:

2009 2010 2011 2012 2013 2014 2015
2.10 2.17 2.57 2.93 3.19 3.46 3.63

Yep, once again, the projected jump from 2010-2011 was far less than actually occurred.

The President’s budget assumes no increase in nominal dollar spending from 2011-2022, interest rates to stay in the 2%-4% range despite needing to borrow around $9 trillion over the next decade, the Fed to not be a major player in buying that debt, because inflation numbers are low, and expects revenues to get a sudden boost, even after being wrong about his revenue predictions over and over again.  And to top it all off, all of these predictions come from a President who has increased the total U.S. debt by over 45% in his first term of office.  Oh, yes we can’t!