3 Budget Problems That Dwarf the Debt Ceiling

by Jeff Reeves | May 18, 2011 12:05 am

eliminate debt save money e1305655253906 3 Budget Problems That Dwarf the Debt CeilingThere’s a lot of fuss about the U.S. debt ceiling this week, including fears that the Treasury could “default” on its debt. Is the government going to go the route of so many hard-luck Americans during this downturn and just stop paying the bills?

Hardly.

As economist Ed Yardini[1] wrote this week, the U.S. Treasury can still auction new securities to raise funds. And according to Yardini’s math, net interest expenses by the Federal government were $213 billion through the last 12 months that ended in April, while Treasury revenue totaled ten times that. Specifically, the last 12 months saw $2.27 trillion in revenues for the Treasury – including nearly $290 billion in April alone due to tax season.

In short, the only way the government will default on its debt is if it chooses to and current scare tactics are pure politicking.

That said, just because the Treasury can easily cover debt interest doesn’t mean the rest of our spending isn’t a big problem. And just because we won’t suffer the world’s ire for defaulting on our debts doesn’t mean the global economy isn’t going to exact a severe toll on America for recent policy missteps.

So forget about the debt ceiling: Here are 3 very real problems all investors and taxpayers should be worried about.

1. The Government Can Steal from Social Security and Medicare

steal debt e1305655433566 3 Budget Problems That Dwarf the Debt CeilingThere is talk about how the Treasury is now raiding the coffers of government programs to bridge its spending gap until Congress approves a higher debt ceiling. In a letter full of political bluster on Monday, Treasury Secretary Timothy Geithner announced he would tap into two government employee pension funds to free up cash.

As discussed, this isn’t necessary – just a political trick. But thanks to this mayhem, one of the government’s ugliest sins is now front and center in the media. Namely, the ability to steal from programs with a surplus to sate its spending appetite.

And by programs, I mean Social Security and Medicare.

While it’s true Social Security and Medicare technically have a  “surplus” in their trust funds that will cover payments for decades to come – recent estimates are 2036 for Social Security and 2024 for Medicare – the raid on the pension programs shows that your retirement funds from Uncle Sam may not be as secure as you think.

If the Treasury has the ability to steal from pension programs, who cares how much of a “surplus” entitlements have socked away if they too are subject to Uncle Sam’s sticky fingers? When it comes time to break open the piggy bank and there’s nothing but IOUs inside, where will the money come from to pay for the food an electricity of America’s seniors?

Some argue Social Security has always been a Ponzi scheme. I disagree. As I wrote in a column last February[3], when functioning Social Security is a crucial “safety net” for millions of Americans – even if some of us think we could get on just fine without it.

Unfortunately, the potential good of this program will be a moot point if the surplus has been depleted. Once my generation finds out all the taxes we’ve paid over the years have been raided by corrupt bureaucrats, the label “Ponzi scheme” will be quite accurate if the balance sheet is just a fiction.

Only time will tell whether the amount of money borrowed from the surplus will be replaced in time to cover future benefits. Many contend the borrowing from entitlements is not theft solid, since it is backed by U.S. Treasury securities. But given the politicization of the debt ceiling and focus on borrowing, we should be very worried that the money in Social Security’s coffers isn’t cold, hard cash.

2. The Dollar’s Decline and Inflation’s Rise are Inevitable

inflation ahead sign 3 Budget Problems That Dwarf the Debt CeilingThe dollar has been volatile since the financial crisis, but the trend is strongly downward. In the 12 months, the British pound has gained about 20% on the greenback. The Australian dollar has also been strengthening, up about 30% in the last 24 months. Even the lowly euro, amid all the sovereign debt woes across the Atlantic, is up about 35% against the dollar in the last year.

Some like to tout the advantages of a weak dollar, such as increased competitiveness abroad as American exports see favorable currency exchange rates. And of course, higher profits for multinationals like McDonald’s (NYSE: MCD[4]) who do a lot of business overseas. But the flip side is that as a currency deteriorates, it becomes more expensive to import goods and inflation ensues.

Typically a central bank intervenes by raising interest rates when inflation gets out of control – but as we saw during the 1970s, a rising interest rates and runaway inflation can combine to create an ugly economic scenario. And as the numbers show, it’s going to take more than just a few basis points to get things under control. Read my previous column about 9 signs inflation is crushing America.[5]

Unfortunately, any interest rate hike could cripple the already fragile state of the federal budget. In 2010, the average interest rate on the various debt service instruments like t-bills, notes, and bonds was a little over 3%. If you add a few percentage points to the interest rate and a few hundred billion dollars each year to the already staggering $14.3 trillion in public debt, it’s not unrealistic to think interest payments could approach $1 trillion by the end of the decade – or nearly half last year’s total tax receipts.

In short, raising interest rates to counteract a falling dollar is a practical impossibility for our cash-strapped government. That means the greenback will continue its decline and inflation will run rampant

3. Government Spending Cuts Are a No-Win Situation

uncle sam 3 Budget Problems That Dwarf the Debt CeilingAs stated, any debt ceiling debate won’t result in a default. But if the debt ceiling isn’t raised, total federal spending will have to drop by over $1 trillion in the next 12 months as America is forced to “live within our means.” Some say this is long overdue and for the best – but no matter how necessary these cuts are for the long-term health of America, they will result in much short-term pain. Read about 5 economic reasons Obama is doomed to one term on InvestorPlace.com[6]

Consider that one of the single largest layoff announcements in 2010 was a plan from the U.S. postal service to cut 30,000 jobs by the end of 2011. Also in 2010, the City of New York announced a growing deficit would fire 11,000 workers including firefighters and teachers.

Should we continue to dig deeper into debt just to keep mail carriers employed? Hardly. But it’s naïve to think it’s as simple as just printing up 30,000 pink slips. Taking regular paychecks away from tens of thousands of Americans at a time when unemployment is high and spending weak will have an impact.

What’s more, though some hardcore libertarians would happily wave good riddance to public schools or fire protection, there are many Americans who rely on government services every day. We are so far over our heads that even services most Americans think of as essential need to be reduced or eliminated.

Consider this: Even if we slashed the entire military budget to zero America would “only” save about $690 billion – about half of our nearly $1.5 trillion budget shortfall. If you also eliminated the nearly $800 billion we spend on Medicare and Medicaid each year, however, that would get us to a balanced budget.

When you need to cut the federal budget by 30% to break even, there’s just no good way for things to end.

Jeff Reeves is editor of InvestorPlace.com. As of this writing, he held a long position in Bank of America stock. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.

Endnotes:
  1. Ed Yardini: http://www.yardeni.com/
  2. How to Trade the Debt Ceiling Crisis to Quick Profits: http://investorplace.com/41298/how-to-trade-the-debt-ceiling-crisis-tlt-tbt-gld-slv/
  3. As I wrote in a column last February: http://investorplace.com/30047/social-security-taxes-payroll-tax-investing-retirment/
  4. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  5. Read my previous column about 9 signs inflation is crushing America.: http://investorplace.com/39126/inflation-crushing-america-fed-bernanke/?cp=marketwatch&cc=synd
  6. Read about 5 economic reasons Obama is doomed to one term on InvestorPlace.com: http://investorplace.com/36925/obama-one-term-economic-issues-election/?cp=marketwatch&cc=synd

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