The 'Myth Of Morning In America'-----How The Public Debt Went From $1 Trillion To $35 Trillion in Four Decades, Part 2

I have finished my book on the upheaval represented by the Trump candidacy and movement. It will be published soon, and is an exploration of how 30 years of Bubble Finance policies at the Fed, feckless interventions abroad and mushrooming Big government and debt at home have brought America to its current ruinous condition.

It also delves into the good and bad of the Trump campaign and platform and outlines a more consistent way forward based on free markets, fiscal rectitude, sound money, constitutional liberty, non-intervention abroad, minimalist government at home and decentralized political rule.

In order to complete the manuscript on a timely basis, I will not be doing daily posts for the next week or two. Instead, I will post excerpts from the book that crystalize its key themes and which also relate to the on-going gong show in the presidential campaigns and in the financial and economic arenas. Another of these is included below.

I am also working with my partners at Agora Financial on a new version of Contra Corner. More information on that will be coming soon.

Trumped Final

Morning in America—the Historical Inflection Point

.......And that was the historical inflection point. Thereafter, Social Security and Medicare entitlement reform was off the table due to the trick of the front-loaded payroll-tax increase.

This caused cash surpluses in the trust funds and the accumulation of intra-governmental accounting IOUs for the next two decades. At the same time, these front-end surpluses functioned to bury the long range fiscal disaster these intergenerational “social insurance” entitlements embody in 75-year projections that are always way too optimistic.

Likewise, the White House took any further tax increases or defense cuts off the table in January 1985. The spending-cut-weary politicians of both parties, in turn, were more than happy to oblige by shelving any further meaningful domestic spending reforms, as well.

So in 1985, fiscal policy went on automatic pilot—where it has more or less languished ever since. Even well before the fiscal madness of George W. Bush broke out in 2001, the handwriting was on the wall.

By the time the 12 years of the Reagan-Bush administrations had elapsed, the national debt had reached $4.3 trillion, and was then 4X the size of national debt that Jimmy Carter had left behind.

Ironically, Ronald Reagan, the scourge of deficit spending, and his 1980 primary opponent, George HW Bush, who had noisily campaigned against “voodoo economics,” had teamed up to generate deficits that averaged 4.1% of GDP.

That initial 12-year plunge into permanent deficit finance was not owing to a weak economy or insufficiently robust real GDP growth, as Reagan revisionists have argued ever since. In fact, between 1982 and 1993, GDP growth averaged 3.6% annually and was at the top of the historic range.

No, it was a political choice that changed the policy landscape forever. The Reagan-Bush deficits amounted to 3X the average deficit that had been accrued during peacetime by FDR, Truman, Kennedy-Johnson and Jimmy Carter combined.

Accordingly, once the GOP had thrown in the fiscal towel, the Democrats would never again face Tip O’Neill’s great fear. Namely, that they would be someday flushed out of their congressional majority owing to a 1946 style GOP attack on the Democrats’ proclivity for deficit spending.

But there was something more. The economic ruin that was supposed to flow from large chronic fiscal deficits did not immediately happen—at least in the time frame that had been traditionally imagined.

Accordingly, the GOP gradually embraced a militant antitax doctrine that simply ignored the ballooning levels of national debt.

So in the blink of an historical eye, U.S. fiscal governance tumbled into the ditch. Both parties became advocates of free lunch economics, and the race toward national bankruptcy was on.

To be sure, Bourbon Democrats and the fading ranks of orthodox Republicans made one last run at restoring fiscal rectitude during the early Clinton days. And on paper, they made considerable progress.

Indeed, the federal budget registered surpluses during the last three years of the 1990s—albeit unsustainable ones owing to the massive one-time tax windfalls from Greenspan’s dot-com bubble.

But the structural fiscal problem was not solved; it was merely temporarily buried beneath three delusions.


The Three Great Fiscal Delusions

The first was that the giant Reagan defense build-up—which was actually a vast armada of conventional land, sea and air forces ideally suited to wars of invasion and occupation—would go quietly in the night when the cold war ended and the Evil Empire was no more. It didn’t.

Instead, the military-industrial complex and its neocon propagandists panicked the nation into a pointless “war on terrorism” after the fluke tragedy of 9/11. Soon the defense budget had doubled, rising from under 3.0% of GDP during the early post–Cold War period to nearly 6.0% of GDP after Bush’s war campaigns reached full intensity by 2007.

Likewise, the front-loaded payroll-tax hike eventually exhausted its capacity to deceive. Accordingly, by fiscal 2013 the OASI fund (retirement) ran a $95 billion cash deficit and the DI fund (disability) generated an additional $45 billion cash deficit. This means that on a combined basis, the cash deficit was nearly $140 billion annually and growing rapidly into the future.

In effect, the so-called Social Security surplus, which had financed the general fund deficit for more than two decades, had not simply disappeared. As we detailed at length in Chapter 8, they had now entered the liquidation phase of Washington’s phony trust fund accounting scheme.

What this means is that the $19.4 trillion of public debt outstanding today is the real debt—not the convenient illusion peddled by Washington and Keynesian economists that the “publicly held” debt is only $13.5 trillion and therefore a “manageable” 75% of GDP.

Nope, the nation’s true public debt ratio today is 106% of GDP. Thirty-five years on from the first trillion dollar crossing, the public debt burden on national income has tripled. And when you add the $3 trillion of state and local debt, the total public sector debt ratio is nearly 120% of GDP.

And that gets to the final question. How did Washington get away with this vast fiscal debauch? How did we get to the point where an unschooled outlaw candidate for president would utter the impertinence of default?

The short answer is that Trump is here because Washington’s fiscal kick-the-can-game depended upon a central bank monetary parlor trick that left Flyover America behind, and that, in any event, is now over and done.

To wit, “crowding out” and high consumer price inflation never occurred because the Greenspan Fed launched the entire world economy down a path of massive credit expansion and financialization—an insidious process engineered by the concerted action of all the major central banks. That convoy of money printers generated large but dangerous central bank “vaults” where Uncle Sam’s debt has been temporarily sequestered.

The Global Monetary Roach Motel

It was the equivalent of a monetary roach motel: the bonds went in, but they never came out. What happened in practical economic terms is that central bank fiat credit was substituted for real savings from privately earned incomes in the financing of public debt.

Indeed, owing to currency pegging by the mercantilist export economies of Asia and the oil exporters nearly $5 trillion of the U.S. public debt has been absorbed by foreign central banks and sovereign wealth funds. Another $3 trillion is owned by the Fed. And still another $5 trillion, as indicated above, had been temporarily funded by intragovernmental trust funds that are now about to plunge into an irreversible liquidation mode.

Two thing are therefore evident. The first is that massive monetization of the public debt cannot go on much longer, or else the monetary system will be destroyed. That’s what being stuck on the so-called zero-bound really means. And that’s why the lunatic money printing in Japan is a sign that the end of the monetization era is at hand.

In the case of Japan, the largest debtor government in the world has already destroyed its own bond market—the BOJ is the only bid left at negative 0.2% on the 10-year JGB.

Secondly, as we also documented in Chapter 8, the U.S. nominal GDP has been growing at barely 3% annually for the last decade, and, in a deflationary world, it has no chance of breaking away from that constraint.

Accordingly, the ridiculously optimistic rosy scenario currently projected by CBO does not have a snowball’s chance of materializing over the next decade.

In fact, the $10 trillion of cumulative baseline deficits over the next ten years projected by CBO is drastically underestimated. As we indicated above, Washington will generate at least $15 trillion of new public debt in the decade ahead under a realistic economic forecast that essentially assumes the next 10 years will perform as well as the past decade.

So the nation’s current mountain of public debt will inexorably rise to $35 trillion by 2026 or so. Likewise, the giant financial bubble and vast malinvestments generated by the world’s central banks over the last two decades now guarantee a long spell of global deflation.

That’s why I believe that the U.S. nominal GDP will be lucky to reach $24 trillion by that same year (3% annual growth). The math computes out to a public debt equal to nearly 150% of GDP.

The Global Sovereign-Debt Market—the Mother of All Financial Bubbles

For all practical purposes, these budgetary realities mean an endless fiscal crisis lurks in the nation’s future.

That’s the real end game of a lamentable path of unprecedented fiscal profligacy embarked upon 35 years ago.

Needless to say, it was not Donald Trump who trashed the “full faith and credit of the United States” along the way.

Nor is it Donald Trump who offers the prospect of a solution. As we demonstrated in Chapter 1, his stated plans would make the nation’s fiscal accounts even worse.

You don’t need a lot of wonky budgetary detail to know that if you increase defense spending, massively cut taxes and exempt Social Security, you end up with even more red ink. That’s what Ronald Reagan proved for all time.

No, the only thing which will arrest Washington’s headlong toward fiscal ruin is the upcoming crash of the global bond market. It is the mother of all financial bubbles thanks to the $20 trillion of bond buying by the world’s central banks over the past two decades.

This lunacy and financial fraud inserted the central banks’ big fat thumb on the supply and demand scales in the world fixed-income markets, thereby causing the price of bonds to soar and their yields to virtually shrink to the vanishing point.

Indeed, within the proximate $45 trillion worldwide sovereign debt market, upward of $13 trillion of government debt trades at sub-zero yields and the weighted average yield of the total outstanding is barely more than 1.0%.

When QE finally ends in Europe and Japan, and it will end soon in order to avert monetary catastrophe, there will be a massive rush for the exists when the punters who now own trillions of sovereign debt on 95% repo realize the jig is up.

That is, without the massive artificial bid of central banks, the price of government debt is going to fall hard. That will threaten, in turn, to wipe-out the accumulated capital gains of these bond market front-runners and crush the carry-trade spreads on which their speculative positioning is based.

Needless to say, when the fast money starts selling in order to lock-in what remains of their unspeakable windfall profits, there will be no bid for a falling knife.

Trillions will be lost. Government’s that can’t roll their massive but suddenly far more expensive debts will default. The Donald’s expertise in that department, at least, should be given its due.



David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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