The Real US Debt Issue: We're Broke

Have you noticed world markets are on edge as we await the August 2 "deadline" -- even though the deadline for meeting US debt payments is a somewhat artificial construct? The real issue is that the US government can no longer afford to spend money it doesn't have, and the entire American government is in denial about the issue.

If the US Congress collapses under the weight of its own bickering and we don't make debt payments after August 3 and the entire world financial system melts down, it's not because Republicans or Democrats or President Obama did this and that... it's because the US got itself into this situation in the first place.

Here's the way to think about it: On August 2, you have to make a huge mortgage payment. In the past, the way you made mortgage payments was by borrowing money from your rich Uncle Vinnie, because you actually have never been able to afford the mortgage. But this month, Uncle Vinnie is putting his foot down. He's not going to lend you any more money. You might miss the mortgage payment.

Now, in this scenario, is the real problem that Uncle Vinnie won't lend you money, or is it that you don't actually have the money?

In simple terms: We are talking about borrowing more money to pay for a budget that we don't have the money to fund! It's the classic scenario of using credit cards to make the mortgage payment. Some people would call it a Ponzi scheme -- and that's why banks don't let you pay bills with borrowed money.

Even the numbers being bandied about by the US Congress -- $3 trillion or $4 trillion in savings over 10 years -- don't fix the problem. Right now, the country is $14 trillion in hock, and annual deficits have been running more than $1 trillion. We're already in the hole another $1 trillion alone on 2011, according to the Office of the Treasury. The annual deficit is on track to hit at least $1.5 trillion again. That means $3 trillion buys us two years of deficit -- and the total tab probably still goes up.

The math is not terribly complicated. The monthly budget outlays of the US government are between $250 billion and $300 billion every month. The total receipts are between $150 and $250 billion. As I said, for many years now, we've been in the hole to the tune of $50 billion to $175 billion... every single month. Not one month in the green. You can get an in-depth look at the numbers here.

The monthly deficit is one thing. But what about the tab we've already run up? It's $14 trillion, which is frighteningly close to 100% of GDP -- a number that history has shown is deadly for debtor nations. Throw in unfunded Medicare and Social Security bills, as well as liabilities for such things as Fannie Mae, which are not included, and the bill is actually much higher -- greater than 100% of GDP.

Not one country in history has survived this kind of debt burden without some sort of restructuring.

Should we raise the debt limit? Well, short-term, sure, why not. Triggering a global financial crisis by defaulting on US Treasury debt probably won't help things. But as I said, it's an artificial construct. The problem is not the deadline. It's the debt burden. And even after August 2, the debt is still there. The bottom line is that a very short-term fix by Congress won't help things.

Of course, there's an easy way to fix it. Raise taxes and cut the budget by 30%. Everything would be instantly balanced! But Congress would never do that. "Tax revenue" and "budget cuts" are poisonous words on both sides of the aisle. Call them the aisles of denial.

If we cut the budget and raised taxes, there would be a nasty recession. But isn't that the reality of savings? If you are a household that has to cut back to make debt payments, you go into household recession. It's really unavoidable.

Then people ask: Why isn't this a disaster? Why isn't the stock market collapsing? Why aren't birds falling out of the sky? It's because we have the luxury of being the US Reserve currency, which means everybody in the world has to buy our bonds. Or we just print more money. But this process can get uglier, if the bonds start falling.

This is why on August 3, 2011, or October 20, 2011, or in January 2012, things could change drastically. The disaster hits whenever the US Treasury looses control of the bond market.

The current interest on treasury debt is running at about $30 billion per month. Imagine if the rates jack up and our interest payments double. Not out of the question that bond yields could go to eight percent. That means our budget deficit goes up by $30 billion per month, or $300 billion per year. That's ugly math. That's also more money than Congress is talking about cutting from the budget -- in the next ten years. But if rates go up 25%, interest payments will eat up the entire savings.

Greece didn't get in trouble because it had borrowed so much money -- it had been doing that for years. It got in trouble because, suddenly, its bonds started collapsing and investors demanded more interest. The Ponzi scheme ended. All great Ponzi schemes, of course, depend on finding new investors. When you fail to find new investors, the party is over. We are dangerously close to that point.