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Falling for the Great Lie By: Vasko Kohlmayer
FrontPageMagazine.com | Monday, August 24, 2009

Speaking about foreign holders of American treasuries, the noted financial expert Peter Schiff said this in a speech at the Ludwig von Mises Institute:


“We're not going to pay the Chinese back their money. It's impossible. We can't. We can't possibly.”


Schiff's point was that America is not good for its debts. Sadly, he is right. Having incurred more than $65 trillion in obligations of various kinds, the federal government finds itself in an insurmountable fiscal hole. To give a sense of size, this amount is more than the annual economic output of the whole world and four times America's Gross Domestic Product. It would be impossible to manage this even if our leaders suddenly came to their senses and began to behave responsibly. There is little chance of that, however. The larger our debt, the more eager they are to spend more.


Despite our leaders' efforts to conceal the level of indebtedness, its reality cannot be evaded. The steady weakening of the dollar is one evidence of that. In recent months financial experts have even been discussing the unthinkable: The possibility that the American government may default. The well-known writer Niall Ferguson suggested this possibility in an interview with Vanity Fair in January of this year. Around the same time The Washington Post ran an article under the headline We're Borrowing Like Mad. Can the U.S. Pay It Back? This was at the time when the notion of a trillion dollar budget deficit seemed insane. Needless to say, the deficit will end up being close to $2 trillion at the end of this fiscal year.


In March, Market Watch reported that the spreads on credit-default swaps for U.S. government debt were growing at a rapid pace. What this means is that the markets are growing increasingly concerned about the possibility of the United States failing to meet its  obligations.


The question is how did America get into this position. What brought this country – once a citadel of financial stability – to such dire straits? The answer will become apparent when we look at the composition of America's debt burden.


The federal government's obligations consist of two main components. The smaller of the two is the one that is reported on more often. It is referred to as “public debt,” or “national debt,” or “sovereign debt.” This is the debt that the government has incurred as a consequence of its budget deficits over the years. It currently stands at $11.6 trillion, which is about 85 percent of GDP.


The public debt, however, only represents a relatively small portion of the government's total debt. The rest is primarily made up of obligation connected with three large entitlement programs – Medicare, Social Security and Medicaid. It is estimated that together their combined claims amount to roughly $55 trillion more than what the government will collect in designated taxes.


At this point Medicare and Social security do not yet represent a net budgetary expense, because revenues (FICA taxes) exceed what is paid being out in benefits. To put it differently, these programs are currently running surpluses; this situation, however, will not last indefinitely. The social security surplus will end around 2018. The negative gap will then widen rapidly with each successive year.


Contrary to what many people believe, the surpluses have not been kept in some special vaults in Washington. The money has been “invested” in government bonds and the government then promptly spent the cash. In other words, the so-called Social Security Trust Fund basically contains treasury IOUs. The $55 trillion question is: How will the government raise the cash once the surpluses come to an end?


There are two ways in which this can be done: by raising taxes or by borrowing. Neither seems like a good option under the circumstances. Taxes are already perceived to be high; bringing them much higher would be politically unpopular if not impossible. Furthermore, raising taxes would hamper growth, which would in turn decrease the tax base and thus defeat the purpose of the increase in the first place. As far as borrowing is concerned, it is almost certain that investors would refuse to finance additional debt given their concerns about its present levels. With no place to go, it is likely the federal government will do what governments usually do when caught in this situation: it will “meet” its obligations by printing money.


This, of course, is an easy way out, but it debases the currency and produces inflation. And since America's huge debt load is far beyond the government's ability to pay off with honest money, the level of inflation is likely going to be very high. It would actually appear that the government has already embarked on this path. There are even those who fear that the United States may eventually experience hyperinflation. Discussing the Federal Reserve's recent purchasing spree of government bonds, Joshua Zumbrun wrote this in Forbes last week:


“That purchase of government debt looked particularly ominous. Creating new money to buy government debt is the sort of strategy that's known to destroy economies – just ask Zimbabwe, which suffered so much hyperinflation that it destroyed its currency.”


Whatever its exact level, high inflation will likely arrive before the end of the entitlements surplus era. Concerned about the government's over-indebtedness and its ability to meet its obligations, bond investors will start pulling out well before social security surpluses turn into deficits. Unwilling and unable to control spending, the government will have no choice but to print. The soaring inflation that will follow will have a devastating effect on the already fragile financial system and will inevitably lead to economic breakdown. This will in turn set off centrifugal forces in a troubled and divided society.


America's impending travails are thus ultimately tied to fiscal mismanagement, particularly in the area of entitlements. It is as ironic as it is instructive that entitlements seek to confer the kinds of benefits the Founding Fathers thought the federal government should have no business of pursing. It was with this in mind that they drafted a constitution that sought to prevent the federal government from getting involved in those areas. They made it very clear that federal functions were to be few and limited, confined primarily to protecting the life, liberty and property of Americans. Ensuring people's well-being through the provision of retirement income, healthcare and other such goods was not to be the government's job.


It is to our detriment that we have betrayed both our founding principles and the Constitution. We have done this because we fallen for that greatest of lies, which is that government is capable of providing for citizens' material and social needs. Attractive as this idea may sound, it is impossible to accomplish in practice.


To many this will come as a surprise. Brainwashed by years of public education, many believe that ensuring the population's material welfare is precisely what good government is all about. But no government has ever been able to pull this off. We only need to look at what happened when it tried to do it in America. Take Social Security, for instance. In late 2006, the incoming House Speaker Nancy Pelosi proudly proclaimed:


“We will guarantee a dignified retirement, and we will begin by fighting any attempt to privatize Social Security.”


Those naive enough to rely on the government's “guarantee” of a “dignified” retirement are bound to be bitterly disappointed. When an aspiring reporter wants to file yet another tale of a cat-food eating retiree, he can always find someone by searching among those for whom Social Security is the only source of income. With many receiving less than $8,000 per year, it usually does not take long to find a protagonist for the sad story.


But if the only thing the government did was to fail to deliver on its promises, the situation would not be so dire. Unfortunately, it also did something else in the process – it has bankrupted this nation by saddling it with debts and obligations we cannot fulfill. This outcome is unsurprising. The old maxim is as valid now as it has always been. Government does not solve problems; it only makes them worse. Given the ambitious scope of entitlements, it was only to be expected that federal involvement would eventually create difficulties on an insurmountable scale.


The Founding Fathers knew of which they spoke. We have disregarded their advice and trampled on that prescient document they left behind as the law of this land. For that there will be a steep price to pay. 

Born and raised in former communist Czechoslovakia. the author is a naturalized American citizen. He is a regular columnist for Frontpagemag.com and his work has also appeared in The Baltimore Sun, The Washington Times, The American Thinker, The Jewish Press, RealClearPolitics, and other publications.

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