The United States is broke and in debt. The only people who refuse to understand that reality, and who refuse to care, are the big spenders in congress and the White House. Disaster approaches, and what informed citizens want to know is exactly when the hammer will fall on our currency and economy. Now Moody’s Investor Service has given us a clue. First, some background.
We all know the U.S. issues and sells bonds at over 200 public auctions each year. These bonds are sold on the open market and are essentially loans to us from other nations (like China) and private investors (like banks and individuals). These lenders buy the bonds and expect to be repaid after a fixed period, say, 30-years. Meantime, they collect interest. The money Washington gets from taxes, and money raised from bond sales, is used to pay for everything in the budget, from two wars to Social Security and Medicare—and to pay that interest. Since America enjoys a “AAA” credit rating now, the interest Washington pays buyers of these bond loans is low. As this is written, the interest on a 30-year bond is 4.49%.
Because of prodigious spending by a congress that obeys every whim of a profligate White House, the debt these bonds represent grows astronomically. If spending continues at the present rate, by the year 2020 all taxes and fees the government collects will not be enough to pay interest on the debt and still fund budget obligations and entitlements, like your Social Security check.
Obviously, 2020 is not a deadline cast in concrete, and investors in the bond market will act long before it arrives. It is also obvious that investors will raise the interest rate they demand from a deadbeat borrower—if they will lend to us at any rate of interest. The signal that sets the markets on fire is when the U.S. credit rating drops from AAA to AA+ or lower.
Remember the situation in Greece last week? What precipitated that crisis was the simple fact Greece could not pay the interest on its sovereign debt (those 30-year bonds). The credit rating for Greece fell through the floor, and no one would lend the Greeks more money just so they could pay the interest owed on money they had already borrowed.
The Greek crisis caused the New York stock market to plunge 1000 points, and similar drops happened in other markets around the world. Then along came the European Union (mainly Germany) and the IMF (mainly the U.S.) and lent them more money to spend! The world was saved from another meltdown.
But treating the symptoms does not make the illness go away, and Greece will be back—and Spain—and Portugal—and the rest of the EU spendthrift social welfare states. Think it cannot happen here? Sure it can, and it will certainly happen unless action is taken immediately. But let us return to the question of the American AAA credit rating.
How would the U.S. credit rating be lowered? What are the factors used in lowering the rating? The first answer is easy. Some 72 credit rating agencies around the world such as Dun & Bradstreet, Moody’s and Standard & Poor, publish their findings as alphabetical notations like AAA, AA+, AA, AA-, B++, and on down to D, E, F and S. Investors use those ratings and other factors to determine risk. But how do credit rating agencies arrive at their ratings for sovereign debt? Not understanding that process has caused investors to be uncertain of when and what would cause ratings to drop and interest on sovereign debt to subsequently rise. But now the Congressional Budget Office has published a chart based on revelations by Moody’s.
This chart shows that when Washington spends 18% of all of its revenue (politicians use “revenue”—they mean “taxes”) just to pay the interest on the national debt, the U.S. credit rating will drop. Why 18%? Because Moody’s managing director Pierre Cailleteau said 18% is the outer limit of AAA rating. So in 2018 the lights go out. But they will start to flicker long before then.
Congressional Budget Office estimates are always in line with what this congress and the White House want. We saw politicians skewing numbers when the CBO said spending a trillion dollars on the government healthcare program would save 150 billion. Similar to such “spend to save” nonsense are the CBO’s rosy estimates that future interest on government securities will remain low, spending will be restrained, and the economy will grow at rapid clip. But experts in the financial world differ with the CBO:
- “We see a limited risk of a U.S. sovereign debt downgrade in the next 2-3 years, beyond that we cannot be so certain.” Societe Generale
- “…wishful thinking” Brian Bethune, IHS Global Insight
- “…wildly optimistic” Len Burman, Milken Institute Review
Then there is the huge housing and real estate bubble in China. “The Chinese have been big buyers of Treasuries but are no longer running surpluses,” said Societe Generale economist Aneta Markowska. “They just don’t have the marginal dollars to recycle back into the Treasury market.” If China slows or stops buying, it is hard to visualize what the U.S. Treasury could do to promote bond sales that are so essential to pay the interest on the growing national debt.
Considering these less than optimum conditions, Moody’s now estimates the debt service will hit 22.4% of revenue in 2013, signaling the U.S. debt rating might fall in the next three years. But global investors will be much less forgiving of U.S. spending and debt policies than Moody’s. We saw the markets anticipate a Greek default by shunning their government securities long before Standard & Poor downgraded Greece’s debt rating to “junk” status. That is likely to happen to the United States unless this congress stops spending and takes an axe to the budget. That is not very likely.
Because our level of debt and current interest rates cannot be lowered overnight, the easy way to postpone financial Armageddon and retain a AAA rating is to “raise revenue.” This White House always takes the easy way. Not only will direct taxes be increased, the great temptation for congress is to institute a Value Added Tax—a tax on the value of everything manufactured and consumed. The failed European economies utilized a VAT, and then simply spent the proceeds. Greece now intends to raise their VAT to 21%, as if that will solve their systemic problem and pay for their socialist programs.
Would it not be wiser to avoid growth-killing taxes and simply end runaway spending and entitlements? Of course it would. And to judge by recent polls, by rallies, and by “early retirements” of members of congress, the American public understands what Washington is doing to their future.
Elections cannot come too soon. Let us hope they do not come too late.
Chet Nagle is author of IRAN COVENANT.