A Financial Crisis That Could Bankrupt the United States

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club
puerto-rico-federal-debt

This week, Puerto Rico was placed under court protection in what amounts to the largest-ever municipal bankruptcy.

It wasn’t a close call.

The runner-up - Detroit - owed $9 billion when it entered bankruptcy in 2013. Puerto Rico and its agencies owe more than nine times as much.

The local reaction was instructive. “People sometimes just leave the key in the house or the car in the airport and just go,” said Nancy Madden, founding director of an educational nonprofit in Humacao, Puerto Rico.

Hmm. That makes this a good time to segue into my recent discussion about our own stupendous - and ticking - national debt bomb. And the serious-as-a-heart-attack investment implications.

(Yes, you’ve heard the merchants of doom warn about this for years. But I’m not a fearmonger - and my investment analysis may surprise you.)

As I mentioned in my last column, the federal debt stands at $19.9 trillion. It’s every bit as big as the country’s gross national product. Historically, this has been a red zone.

If you doubt it, ask a Greek or Argentinian.

Of course, the federal debt - atrocious as it is - isn’t the real problem. It’s the unfunded liabilities for Social Security, Medicare and Medicaid.

There simply aren’t enough workers to pay the generous retirement benefits for baby boomers like me. The debt bomb is actually a demographic time bomb.

These unfunded liabilities total $105.9 trillion - or more than 500% of GDP. Worse, they are growing at a rate of more than $8 trillion a year.

To put this in perspective, even if the U.S. government confiscated all of the taxable income of the nation’s corporations plus the entire adjusted gross income of every American in the nation making over $66,000 a year... it wouldn’t be nearly enough to cover even the $8 trillion annual increase.

(You might want to read that last sentence again.)

The vast majority of Americans have no idea how severe the problem is. Why?

In part because the government hasn’t produced the kind of financial statements required of businesses, detailing full and complete liabilities.

And because of the dereliction of the mainstream media. Reporters are forever in search of a hot new story - and the federal debt is old and boring. (At least, it has been so far. The ending promises more excitement than a Quentin Tarantino film.)

And partly because both major parties lack the political courage to tackle the problem.

There is only one way to avoid an outright calamity: reform our out-of-control entitlement programs.

Yet politicians know that no one wants to see their benefits delayed or cut. And so we don’t even have an adult conversation about it.

In fact, the presidential candidate who drew the largest and most enthusiastic crowds last year was Bernie Sanders, who promised to not only dramatically increase existing entitlements, but also create new ones, like free college tuition.

Neither Clinton nor Trump made entitlement reform an issue. (Why ruffle the electorate?) And so politicians keep kicking the can down the road, hoping the dam breaks on someone else’s watch.

The sad part is that the solution isn’t rocket science. Seven years ago, the bipartisan Simpson-Bowles commission made several recommendations that would have put us on the path to fiscal sanity: gradually raising the age of eligibility, capping spending, means testing and eliminating tax loopholes.

But today, the commission’s recommendations are just a faded list of bullet points... because the political will to implement them doesn’t exist.

It gets down to the true nature of politics. It’s not about implementing a platform or creating a certain kind of society. At the end of the day, politics is about gaining and holding power. Period.

Why walk into a town hall meeting and tell your already unhappy constituents that you favor delaying their retirement age, cutting their benefits or jacking up their taxes?

And so we careen down a dead-end street with a political class that refuses to tap on the brakes, lest it cost them their precious incumbencies.

Pundits and analysts have been warning about the debt for years, of course. Yet, as you’ve no doubt noticed, the economy and the financial markets have marched on... defying the naysayers.

It’s important to understand why.

The microscopic interest rates of the past few years have sedated us. They have boosted stock and bond returns. They have allowed Washington to pump up the debt without paying the price. As the debt doubled over the last eight years, the rate of interest halved.

At 4.8%, the prevailing rate as recently as 10 years ago, Uncle Sam would pay more in interest expense today - $654 billion - than he does for national defense.

Each day, more than 10,000 baby boomers retire. The Fed is set on normalizing interest rates and unwinding its Treasury portfolio. Deficit spending continues. And the only thing the two parties can agree on is the dire need to spend trillions of dollars upgrading the nation’s infrastructure.

(I’m not saying that the nation’s roads, bridges, tunnels and airports aren’t overdue for a refresh. But where are the offsetting spending cuts?)

It’s become increasingly clear that Washington isn’t about to rein in the spending until we have a full-blown economic crisis.

Not a junior-league one like the Great Recession, easily mitigated by deficit spending and central bank sleight of hand.

I’m talking about a full-on financial meltdown, where foreigners don’t want to hold our national debt, driving the dollar sharply lower, along with stock and bond prices.

At this point, I probably have your attention. But while you have every reason to be fearful, it’s too early to be terrified.

The storm clouds are gathering. But hold off on making wholesale changes to your portfolio.

In my next column, I’ll explain why.

Good investing,

Alex

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