More than that, though, I realized that I had an urgent story to tell. It’s not too much to call this the most important message of the age. And I don’t mean the most important financial message, because these issues straddle any narrow issue of industry or interest group. Our governments are going bankrupt. Our firms are chasing the wrong goals in the wrong way. Plenty of banks need to be razed to the ground and rebuilt from the foundations up.
Our policy makers are getting some of the biggest things totally wrong. The Federal Reserve in the United States has created QE Infinity: money-printing without end. Across the ocean, the European Central Bank is creating Bank Bailout Infinity: weak credit without end. These things cannot end well. The solution to debt is never more debt.
We need a change of mindset too. How bankers and their bosses are compensated. How corporate lobbying works. How politicians get elected. How they choose their advisers and the people who fill the key jobs of government and central banking. These things have been badly awry for thirty years. We need to go back three decades if we’re to find a better future.
It would be easy for you to assume that my position is an extreme one. That, much as the current political class might have gotten it wrong, the real truth probably lies somewhere in the middle. Yet the views I express in this book are nowhere close to the extreme. As a matter of fact, I’d say my views represent a fairly cautious, middle of the road opinion. Take, for example, those statistics I gave you about the stock market values of various major banks in relation to their accounting values: those numbers summarized not my view, but the view of the markets in relation to those huge firms. And it’s not just the markets that are worrying about these things. As we’ll see in due course, there are plenty of sober academic economists who share my views. Those economists say bluntly that the US is bankrupt. In the words of Laurence Kotlikoff, whose debt calculations we’ll review in a later chapter:
Uncle Sam’s Ponzi scheme will stop. But it will stop too late. And it will stop in a very nasty manner … This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.9
That moment of awakening is getting closer—and so is the kicking. But before we figure out how to handle that moment when it comes, let’s turn back to the origin of everything. How the Ponzi scheme started. What keeps it going. How the whole thing is still in place, still revolving, still expanding—and getting ever closer to the final showdown.
We start with government.
Part One
Washington
2
The price of liberty
The seminal moment in the history of public finance was a sea battle fought in 1690 by a French fleet under Admiral Tourville and an Anglo-Dutch fleet under Admiral Torrington. The French fleet boasted seventy-five ships of the line and a further twenty-three fireships. The Allied navies were scattered over a variety of duties and could muster only fifty-six ships, a huge disadvantage. Following direct orders from the Queen of England, Torrington’s Allied fleet sailed against the French—and was crushed. Almost a dozen Allied ships were destroyed. Torrington fled and was later court-martialed. The French were left in total control of the English Channel and, for a while, a French invasion seemed not merely possible but likely.
That unaccustomed naval defeat shook England to the core. The country needed funds for rearmament, but the nation lacked any sophisticated way to attract them. So, in 1694, the decision was taken to create the Bank of England, intended from the first as a means to raise funds for the English state. In effect, that moment marked the start of the modern era in public finance. Private subscribers to the Bank’s capital raised £1.2 million in twelve days. All that money was lent to the King, and half was immediately used to rebuild the Royal Navy. It was money well spent. The English (later British) government would come to enjoy almost two centuries of unchallenged naval dominance; the country would never come close to invasion again.
And that’s why countries have debts.
It’s so they can borrow money in times of national emergency. Not it’s-a-national-emergency-that-so-many-kids-are-flunking-out-of-high-school. Not it’s-a-national-emergency-that-our-elderly-are-facing-mounting-medical-bills. I’m talking about real emergencies. The War of Independence. The Civil War. World War One. Pearl Harbor and World War Two. Crises that threaten the fabric of the nation are unarguably powerful reasons to take on debt. In 1790 Alexander Hamilton, the first Secretary of the Treasury of the new United States, wrote that the country’s public debt, incurred as a result of war, was ‘the price of liberty.’1 He was perfectly correct. He also, however, made it clear that to incur debt was an emergency response to an emergency situation. In ordinary times, no government should seek to take on debt. On the contrary, during times of peace and prosperity it makes sense to pay down past debt as a protection against future shocks, creating room for maneuver.
Indeed, it’s not even clear that a peacetime government has any moral authority to incur debt. On what basis can one generation choose to saddle its successor with a financial burden? In times of safety and prosperity, government debt should either be close to zero or moving toward that level. There’s no other ethical, wise, or prudent alternative.
As you can see from figure 2.1, until recently—very recently—the United States obeyed this logic to the letter.2 The nation’s founding war left it with debts somewhat in excess of 30% of GDP. That debt (with a little blip for the War of 1812) was paid down to $0.00 in 1835. In 1836—there was no new debt. The country was at peace and unthreatened. The country had no reason to borrow, so it didn’t. A little later, the Civil War bumped up the debt, before it started to run down again. The same pattern was following during and after World War One.
Figure 2.1: Gross US federal debt since 1792
Source: Author’s calculations from various sources, esp. Christopher Chantrill’s website www.usgovernmentspending.com.
Indeed, prior to 1980, the only time that the United States increased its borrowing when it faced no existential threat was during the Great Depression. From a low of 16% in 1929, public debt increased to a high of almost 41% in 1934. If you’re a Keynesian, you can defend this increase on the basis that the country would have been in worse economic shape without it. If you’re not, you might feel that the economy would have fared just as well with balanced budgets and moderate federal spending. Either way, however, debt increased by just 25% of GDP and remained within highly sustainable levels. If Roosevelt got some of his decisions wrong, he didn’t get them badly wrong. In the country’s worst ever depression—the market crash, the unemployment, the dustbowl and farming slump, the collapse of trade—the government response never broke the bounds of a cautiously managed public debt.
Alas, that caution soon had to give way to other things. As the global situation darkened, the nation started to ramp up its spending in the years prior to Pearl Harbor. By 1946, debt had hit a high of more than 120% of GDP. The nation’s finances had gone through the meatgrinder; but the country had fought and won wars across two continents and was beyond question the moral, financial, and industrial leader of the free world. The grind had been worth it.
Over the decades that followed, debt retreated. In 1980, at the outset of President Reagan’s first term of office, debt stood at a shade over 32% of national income. For every dollar that the nation created in income that year, the government owed just 32 cents. It had been a long way back from those wartime debt levels, but the road had been steadily trodden nonetheless.
And then—something happened. Wall Street started to innovate. Leveraged buyouts funded by junk bonds became fashionable. The stock market soared. These were the years when the communist system collapsed; peace and prosperity reigned supreme. By all past standards, these conditions should have ensured a huge decrease in public debt. There was absolutely no r
eason why the nation needed to borrow. Yet it did. Like crazy. After three terms of Republican rule between 1980 and 1992, gross debt had risen to a startling 63% of GDP. After a pause under Clinton, debt started to rise again.
Since then, the US has experienced two insanely expensive wars. Nobel Prize winning economist Joseph Stiglitz estimated the cost of the Iraq war at $3 trillion.3 The Joint Economic Committee of Congress placed the cost at closer to $3.5 trillion, or approximately $31,250 for each household in America.4 If you care to add the cost of the Afghanistan war to the total, you can add another trillion or so, or around $10,000–15,000 per household. Perhaps the war in Afghanistan had some strategic necessity—no one wanted to witness another 9/11 launched from Afghan soil—but the war in Iraq was unquestionably a war of choice. A choice which, if you are a taxpaying US householder, will cost you over $30,000 once all the bills are in.
We’ve also witnessed the insanity of the $3 trillion tax cuts under George W. Bush. That’s something we’ll talk about more in the next chapter, but just bear in mind that those tax cuts were made when the budget was in deficit. That’s not a reduction in tax at all. It’s an increase, because future generations will need to pay back not just the amount borrowed, but the interest on the borrowings. Those ‘tax cuts’ were engineered by a president who claimed to be a fiscal conservative, yet was surely the least conservative president in history.
And he didn’t stop there. As part of his effort to hand on the worst in-tray in American history, President Bush also left the incoming administration a catastrophic banking collapse, a vicious recession, and a bailout program which Obama implemented broadly in line with his predecessor’s policies. That program was so extensive, so multifaceted, it’s hard to place a precise cost on it—or even to describe it accurately. The best ‘simple’ guide to the cost of the crisis is probably Christopher Chantrill’s website usfederalbailout.com, whose current accounting is summarized in table 2.1.5
Table 2.1: The cost of the bailout
Source: Christopher Chantrill www.usfederalbailout.com.
One of the problems with representing costs in a table like this is the way it removes all drama from the numbers. It’s easy to read the totals as being a little under 17,000 for guarantees, about 3,400 for net outlays. The table feels orderly and precise rather than frightening and chaotic. But remember: these figures are in billions of dollars. If you took a million dollars in hundred-dollar bills, it wouldn’t look like all that much. You’d have a stack approximately 4 feet high and light enough to be picked up by a single person without assistance. But that’s a mere million bucks. A trillion is a million million, so three trillion dollars—which is what that ‘net outlays’ figure really means—would form a tower well over 12,000,000 feet high. That’s a tower approximately 10,000 times as high as the Empire State Building; a tower whose middle and lower sections would risk damage from satellites in low earth orbit—and whose upper sections would lie well out of their range.6
Additionally, of course, the complexity and non-transparency of the various bailout programs make it hard to keep tabs on their cost. Take another look at that table. In the last row, you’ll notice that $7,621 billion has been guaranteed primarily via the FHFA and the FHLB guarantees. Do you even know what those things are? I don’t mean: Do you know the acronyms? (Respectively, the Federal Housing Finance Agency and the Federal Home Loan Bank.) I mean: someone has decided to issue a guarantee for $7.6 trillion, which is equivalent to more than 50% of US GDP. If you’re one of the 310,000,000 people living in the United States, you’re on the hook for your share of that amount: it works out at approximately $67,500 for each US householder. Unless you’re remarkably relaxed about your household finances, you probably aren’t in the habit of issuing guarantees for that amount without a certain amount of consideration. So do you actually understand what those FHFA and FHLB guarantees are for, when they might be called upon, and whether the economic justification for making them is remotely solid?
If you’re a little hazy in your answers, I don’t blame you. In July 2009 Neil Barofsky, a special inspector general for the Treasury’s Troubled Asset Relief Program (TARP), tried to make sense of the numbers and concluded that US taxpayers could be on the hook for as much as $23.7 trillion, or almost 170% of national income. Barofsky also stated that the Treasury has ‘repeatedly failed to adopt recommendations’ to increase transparency and accountability in the way the money is being spent or committed.7
These things ought to cause mass protests in the streets of Washington; but because the underlying issues are so technical, they tend to be buried in the finance pages of newspapers instead. Still, $23.7 trillion? Sure, it’s highly unlikely that all those commitments will be triggered at the same time. But the nature of a commitment is that you’re on the hook whether the world is as you expect it to be or not. It is simply beyond belief that the governing class could authorize pledges on this scale and that taxpayers could know essentially nothing about them.
Meanwhile, as I write, the politicians in Washington have just agreed to raise the federal borrowing ceiling to $16,700 billion. If you took that tower of hundred-dollar bills and laid it out flat, you could loop $16,700 billion one and a half times round the circumference of the earth. In theory, the increase in the federal borrowing limit comes in exchange for $2,400 billion in deficit reduction measures but, as we’ll see, that deficit reduction is somewhat theoretical. It’s a reduction counted in future-money, a strange currency which can mean pretty much anything you like. The one solid, unarguable reality is that the deficit for 2012 will be over $1 trillion, or about 7% of GDP. Our politicians will go into the 2012 presidential race talking about austerity measures and budgets cuts and vast savings and tough decisions … yet they’re still borrowing 7% of our national income to fund their spending. The reductions they’re talking about haven’t yet kicked in and maybe never will. Obama came into office promising change and an end to big spending and big government. We got change all right: an acceleration of the rate at which we’re accumulating debt. Somehow, I’m not sure that’s what voters thought they were voting for.
Absolutely everything is wrong with this picture. We’re going to analyze it piece by piece in the chapters that follow, but the main point is really simple. Government borrowing is an option to be used in time of war or other mortal danger. In the three decades we have lived through since 1980, that sober logic has expired. The logic of Planet Ponzi has come to reign supreme. Soviet communism has collapsed. America’s existing allies in Europe and Japan remain strong, free, and supportive. Economic growth has been dependable, innovation impressive. Older companies have found new strengths, new companies have built global businesses at an astonishing pace. All this ought to have meant that we paid off our debt. Watched it disappear completely.
That’s not some weird theoretical feat that never happens in practice. It does. It happens in oil-rich countries like Norway and Saudi Arabia, which have net asset to GDP ratios of 156% and 50% respectively. It also happens in ordinary, well-run, but oil-free countries like Chile (net assets of 11%), Sweden (15%), and Finland (57%).8 Those countries are piling up savings in the good times as a precaution against calamity down the road. And, of course, those savings generate interest income, so that teachers can be paid, soldiers trained, and medical bills taken care of through savings instead of through taxation. That’s the position we in the US ought to be in. It was the position we achieved in 1835–6. But when Planet Ponzi came to Washington all such rational aspirations flew out of the window—and our creditworthiness with them.
While you probably already know that the US government is highly indebted, I’m willing to bet that you have no idea how deeply bankrupt it truly is. What’s more, you probably aren’t aware that the government is effectively bankrupt even on its own (alarmingly optimistic) figures. The grim arithmetic of that bankruptcy is where we turn next.
3
Future-mone
y in happy-land
Following a period of heated and acidly partisan debate in Congress, in early August 2011 the House and the Senate voted to raise the US government’s debt limit, thereby staving off a situation in which the government would have become unable to meet its obligations. The US Senate passed the Budget Control Act by 74 votes to 26. Commentators on both sides of the aisle explained how tough the decisions had been, how difficult the compromises, how much the US economy would benefit in the long run. As part of the same package, the deficit had been, we were repeatedly told, cut by $2.4 trillion.
Now, I’m not fond of the deficit and I’m not fond of the mountains of debt that currently burden the US economy. So you might reasonably think I’d be elated to hear that the deficit had come down by $2.4 trillion. You probably think I’m already figuring out how high a tower I could build from $2.4 trillion in hundred-dollar bills, or how many times such a tower would wrap round the world.
But I’m not. The trouble with that huge deficit reduction is that it exists only in the mind of Washington. It has no bearing on the planet that you and I are living on.
Let’s start with the idea that our courageous politicians have just voted for cuts. According to the agreed plan (along with the raising of the debt ceiling, all part of the Budget Control Act), federal discretionary spending has just been ‘cut’ by $741 billion. The impact on the deficit, we are told, is even better than that because borrowing less money means we owe less interest, and so we need to borrow less money. Taking those interest savings into account, and some small additional adjustments to mandatory spending, that $741 billion cut becomes a total deficit cut of $917 billion. That’s pretty good news. News of the sort that ought to cheer me up.
Planet Ponzi Page 3