Charting America's Brief Trip In And Out Of Austerity... And Onward To Complete Disaster
One of the "positive" side-effects of the Treasury's plundering of retirement accounts is that total US debt in June actually declined for the first time since January 2010, dropping by $1.6 billion from the May 31 closing print of $14.344 trillion. No doubt this was predicated by the US Treasury officially breaching the debt ceiling on May 16. Yet due to this, or for some other reason (and it is not a surge in net income tax receipts as these appear to have reached an inflection point earlier in the year and are now trendlining lower on a Y/Y basis), something else happened: the slope on the cumulative deficit line since the start of the depression in December 2007 (see below), is now the shallowest it has ever been. In other words, the US over the past few months, faced with the threat and now reality of a debt ceiling breach was actively cutting spending, while benefitting from a transitory spike in income tax revenues, although unfortunately now that the unemployment rate is back on the trendline to double digits, this will be the only true transitory thing about the US economy. Whether this actual, factual fiscal prudence was conscious is unclear, however the result is clear: faced with the threat of being unable to finance every single dollar in perpetuity, the US government's involuntary self-imposed austerity actually... Worked! And yes, the direct side effect is that Q2 GDP is now likely to come at 1.6%: the worst quarterly increase since... Q2 of 2010 (recall that 2010 Q2 GDP was revised from 2.4% to 1.6$ on August 27 last year... hours before Bernanke announced QE2 ). And there once again is the glaring correlation between the slowing of the economy and the decline in debt issuance, and the actual deficit "improvement." Now take this slower deficit growth, and assume it actually is reversed, i.e., America has a budget surplus. While great for the country in the Long-Run, it would mean that GDP, which is now purely reliant on how much debt Geithner can issue, it would mean a collapse in the GDP, in the S&P, and in Wall Street executives' bank accounts. At least in the absence of QE3, 4 and so forth...
Another way of looking at this "austerity" data is the divergence between cumulative debt and cumulative deficit since December 2007. Since the Depression ver 2, the US generated $3.982 trillion in deficits, while adding $5.194 trillion in new debt (from $9.15 trillion to $14.343 trillion). However, what is notable is that June saw the lowest difference between cumulative deficit and debt, with "just" 30.4% more debt being issued than deficit had to be funded.
Unfortunately this "austerity" will be short-lived for two reasons. First, once the debt ceiling is raised, the nearly $260 billion in plundered retirement trust funds will have to be promptly reinvested. This means that over the next 3-4 months the Treasury will issue a whopper of short-term debt, as it scrambles to catch up to the historical Bill average as a percentage of total debt (which as we observed recently, has plunged). Second, it means that with deficit expenditures no longer having a medium-term bottleneck, deficit spending will literally explode in the next several months, which, due to the catch 22 nature of deficits and their debt-based funding, means that Treasury issuance will jump even more than just the Bill trendline "catch up" implies.
Bottom line, enjoy this slowdown in the speed of the US Titanic while you can. After August 2, we are fully convined the Treasury's bond issuance dial will be turned to the rather unfortunate "ludicrous speed."
The sad truth is that while an American's technical default will certainly not be as bad as all claim (yes, financial markets are rather adaptive ecosystems, and following a day or two of massive pain mostly for the Status QuoTM, things will stabilize) this last chance to fix the evils that came about with promoting moral hazard to the de facto only investment thesis 101, will be promptly gone. Alas, every single time something, anything, threatens the status quo's existence, the biggest threats start flying. What we can be sure is that while it took just under three years between Mutual Assured Destruction episode 1 when Paulson waved a three page blank check termsheet to Congress demanding supreme fascist rights, and the current MAD episode 2, MAD part 3, in keeping with the ever decreasing half life of government intervention and "bail outs", will come far, far sooner. Then MAD part 4 will arrive just after and so forth. At that point, threats about the end of the world will actually be true. However, they will be true no matter what choice is ultimately taken.
And speaking of end of the world scearions, here is Citi's somewhat sober and very detailed look at what will happen should the US default now (all with pretty charts). What is left unsaid is that this same analysis will be infinitely uglier the next time it has to be done, with the opportunity cost of doing the right thing being far greater than even now, as the global financial system shifts even further from equilibrium under the disastrous guidance of global central planning.
Gradually now the questions are coming in. “What will happen if the U.S. government defaults on its debt after August 2?” It’s still nearly unthinkable. The exact date may not be as precise as advertised. Predictably, more of these questions come from distant shores. But the longer Congress lingers, the more frequently the question will be asked.
Some part of this question is in the realm of “what will you do after you commit suicide?” While conflicting in substance, rumblings from Washington in the past week suggested action could be imminent. Of course something seems likely to get done. But to take the question seriously, if the U.S. could spend only its revenues, spending would need to be slashed by about 40%, or over $100 billion per month. That’s about 8% of current GDP non-annualized. If all checks from the Treasury were cut in size but not eliminated, legal obligations such as Social Security Payments would have to be cut by roughly $25 billion per month, or $300 billion at an annualized rate1. This is money that is spent in the U.S. economy, as are the payments for military personnel salaries, federal contractor payments and pension contributions that sum to larger amounts.
We doubt that even the most extremist of policymakers believes that private economic activity will immediately fill the void left by so large a drop in these deficit-financed “income” streams. Their many constituents would let them know the personal impact whatever the perceived benefits (see figure 1). If the U.S. Treasury was determined to make U.S. interest payments on the notion that if it does not, the U.S. might be required to spend only its revenues for far longer, than other outlays would need to be cut nearly 50% rather than 40%.
A near immediate income decline of 8%-9% of GDP, and the uncertainty around policy, would weaken expectations priced in asset markets, reducing economic activity by an even larger amount before long. Such would be the likely case even if Treasury debt payments were maintained and “prioritized.”
In the event of a Treasury debt default, we would note that U.S. Treasuries are a key risk-free asset on bank balance sheets across the world and the single-largest form of loan collateral. The U.S. Treasury is the ultimate guarantor of bank deposits. The financial implications of an actual Treasury default, even briefly, could represent the largest financial shock in history, potentially creating a domino of defaults. As such, creating quantitative economic projections on a default scenario seems like a foolish errand.
Scared yet? Good. That is precisely Citi's goal.
Unfortunately in the same note, Citi also shares some other charts, all of which indicate that no matter what happens this week, or at 11:59:59pm on August 2, the long-term fate of the world's premier entitlement state is one which ends in disaster, and if history is any indication: war... Only this time everyone has the same just as destructive toys.
The astounding growth rates for healthcare outlays both past and present – not matched by revenue streams – will unravel most any other structural changes in the budget given enough time (see figures 3-5 and “U.S. Budget: Why is a 9% Growth Rate for Healthcare Necessary?” April 25, 2011). As such, any long-term changes that matter will affect the health care budget.
Even the words “healthcare budget” seem at odds with the way Americans consumers and policymakers view healthcare - essentially “priceless.” It seems clear that a nation that spends double the developed country average on healthcare for sub-standard aggregate outcomes misallocates healthcare resources and almost certainly overspends in the process (see figures 6-7). As a practical matter for investors, one might want to question whether the long-term secular rise in the healthcare sector’s share of U.S. corporate profits will be allowed to continue unchallenged (see figure 8).
Having at least a “down payment” toward significant long-term structural budget underway could help with flexibility in running large budget deficits for the time being. In observable modern times, the U.S. has never improved its budget position during periods of rising unemployment or below-trend economic growth (see figure 9).
Reread the last sentence from Citi as it delightfully captures the Catch 22 nature of the problem. In its overarching attempt to take sole control of the US economy, funded with ever cheaper debt, the US government has now become a central planning behemoth the likes of which the USSR could only hope to emulate even in its heyday. And the lifeblood on which this behemoth lives is one: exponentially more debt. Which is why, more than anything, nobody in DC can possibly demonstrate the political will, which also equates to immediate career suicide, to do the right thing - in this case just say no to more debt - as it would mean one thing and one thing only: putting the fate of their country over and above their own career prospects, as this will expose the biggest lie: the welfare state that is the United Socialist States Of America is more naked than any emperor in history.
And as is well known, no career politician has ever cared enough about their country enough to actually see their own future as merely secondary to that of the United States.