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Carnival of Debt Reduction – Can the Federal Government Cut Its Debt?

02/22/2010

The problem with our federal debt is that when shit hits the fan, debt prevents us from doing the right thing and starting the healing process to become healthy again. If we had savings rather than debt, then we could have spent that emergency fund without incurring debt. Because the government has so much debt, having extra stimulus packages results in having more debt! It’s like saying geez, we already have $50,000 in credit card debt, but we really need to tap out the extra $20,000 in lines that we have! And “hope” that our financial situation improves. I am deeply concerned about the level of Federal Debt and budget deficits we are running. Why on earth can’t we run a budget surplus!!!

This carnival of debt reduction is designed to highlight the plight we as a nation are in and hopefully make us aware that we cannot continue in our ways. I’ve decide to apply steps that we pf bloggers have always advocated to reduce debt and apply that to our nations debt situation.

1. Step 1 : Let’s figure out how much debt we have? – Well, I guess that is the first step we take, which is to figure out exactly how much debt we have. At present, the Federal Government has about $12 trillion in debt. And that excludes future obligations like social security and medicare. Furthermore, we are starting with a one trillion dollar budget deficit this year.

2. Step 2: Calculate our debt statistics – I guess we could use a Debt To Income Ratio Calculator to calculate this number. But all we need is to pull out simple statistics and we have the figure. And here it is : ($12.4 trillion / $2.1 trillion) = 590% of income. Our debt is almost 6 times income tax receipts!. Financial advisors (or rather the common wisdom) is that one takes out a mortgage whereby the mortgage payment every month not exceed 30% of your gross income. Projected interested by (according to the CBO) is about $207 billion, which is about 10% of income tax receipts (still relatively manageable).

3. Figure out where to cut expenses – The biggest projected expense in the Federal Budget are defence, medicare and social security. But cutting the biggest expense of all appears to be so politically difficult. These are the biggest areas where any significant cuts have the biggest impact on our budget and projected debt going forward. But politicians cannot get elected if they ran on a platform of cutting social security and medicare. Hence, all the debt reduction programs in the world cannot help good old uncle Sam. There simply isn’t the political will to tell the citizens of the necessary cutbacks we have to face.

What can we do to force the federal government to face the music? – Recently, President Obama announced he will be cutting the budget by a couple of hundred billion on discretionary spending. It was symbolism really as it really amounted to nothing. Yet, he said he will not touch social security and medicare. When is he or any politician going to confront the truth? Perhaps one way is to actually look at how much interest you are paying daily!.

Or perhaps we need a US dollar crisis, where the world loses faith in our currency and dumps them for other assets, to wake us up. By then, interest rates would have soared, the housing market would have collapsed again and yet, oil and other imported goods will soar. Perhaps, there will even be hyperinflation if we do not stop printing money.

Is defaulting on our debt an option? – Consumers like us can default on our debt. So can countries. Russia and other South American countries have been defaulting and structured their debt. It is hard to imagine Uncle Sam doing this as most countries reserves is held in dollars. For individuals, if you cannot pay your interest payments or evenyour taxes, there are negative consequences. And the same goes for countries. Credit ratings will be slashed and access to capital markets will be hampered. Interest rates will rise and cost of credit will increase. But defaulting on our debt will almost mean the end to the US dollar as the world’s reserve currency. It will almost spell the end of our military reach, which is only possible because foreign creditors are lending us money despite us having negative savings and a budget deficit.

Will we be able to endure sacrifices? – At the end of the day, it really boils down to the sacrifices we as citizens are willing to make. Are we willing to tolerate a substantial period of tighter credit conditions? If you are federal government employee, are you willing to forgo wage cuts and perhaps a cut in your “pension plan” (which is all underfunded by the way). If you are a senior citizen, would you be willing to sacrifice and living with cuts in your social security benefits and medicare benefits? We probably would have to go through sacrifices not just in the near term, but also also for a substantial period because the key to reducing our federal debt is to be consistent in paying them off and not incurring any more expenses.

A couple of other scary thoughts – Failure to rein in federal spending will simply have the consequence of having interest payment as a large portion of our budget. Unlike a mortgage where there is an amortization schedule, all of our federal debt is issued as a plain vanilla bond. Also, because of the positive yield curve, the treasury has a temptation to borrow more short term debt rather than locking in long term debt at a fixed low rate. When the treasury pays interest payments, they have to pay interest on every single bond that they issue no matter what the interest rate. This is unlike the new C.A.R.D Act where interest payments are allocated to higher interest first

Fruits of taking the bitter medicine – Despite the scary prospect of cutting spending, having more recessions and not so great growth for a few years, by taking care of our budget deficit, reducing our debt load, we will come off better at the end. We may suffer deflation in asset prices, perhaps even our wages. Our standard of living may decline. But when we have much more manageable debt load, with less long term unfunded liabilities, a low cost structure, we will be able to better compete in the world markets, have an economy is that is less reliant on credit and consumer spending. We could become a much more viable economy is as little as perhaps five to seven years. The Asian countries suffered for about three years but turned their economy around after that. That is why the bank bailouts, stimulus packages pisses me off because we are simply delaying the day of reckoning!

I want to end off by urging everyone to read this piece by Charlie Munger (partner of Warren Buffet about this wonderful land called Basicland.

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4 Comments
February 22, 2010 @ 11:11 pm

Great work, Mr. Credit Card. Here’s hoping someone in Washington helps turn this thing around.

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February 23, 2010 @ 11:54 am

Wow, well done! You can tell lots of thought went into this – thank you sir 😉

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February 24, 2010 @ 7:38 pm

Excellent work as usual, in putting this together. I enjoy these thoughtful commentaries on government policy and our economic / financial situation. Very creative!

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February 27, 2010 @ 8:19 pm

Excellent, excellent carnival! Thanks for hosting! 😀

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