We have been living and investing in a low-inflation environment with falling interest rates for more than 20 years. Currently, all the evidence indicates we are headed for higher inflation and higher interest rates soon.
We have been living and investing in a low-inflation environment with falling interest rates for more than 20 years. Currently, all the evidence indicates we are headed for higher inflation and higher interest rates soon.
The inflation-adjusted data presented in the table below lends itself to a number of interesting comparisons. For example, notice President Barack Obama’s average annual deficit spending, it exceeds the annual deficit spending of the last 12 presidents combined. However, for our purposes we want to consider how these deficits add to our nation’s debt each year (See graph below).
Notice how our nation’s total public debt has grown from $100 billion (inflation adjusted) when President Ronald Reagan (1981 – 1989) took office; to almost $20 trillion by 2012 according to Mr. Obama’s budget.
Why so much excess spending each year? Maybe President Woodrow Wilson had a reason; he was fighting World-War I. Franklin Roosevelt was dealing with the great depression and World-War II. But what excuses do the rest of these administrations have?
Maybe we needed $700 billion in bailout funds to keep us out of a second great depression. Why does the President’s budget continue trillion dollar deficits for many more years? It took 205 years as a nation for total public debt to compound to $1.36 trillion (in 1981). Looking only at Mr. Obama’s budgeted annual deficit spending each year, it exceeds the total public debt it took 205 years to accumulate ($1.4 trillion). The total public debt, unfortunately, is just the tip of the iceberg when it comes to U.S. debt.
According to the trustees of the Social Security trust fund, the United States has unfunded future obligations with a present value totaling $18.8 trillion. The present value of unfunded future obligations of Medicare equal $24.2 trillion. In all, $43 trillion would have to be set aside in the trust funds today to fully fund the unfunded portion of the social security and Medicare benefits.
Unfortunately there is more. “State and local government pensions appear woefully underfunded. If state and local pension benefits are discounted using a 3.271% interest rate … total pension underfunding tops $3.5 trillion,” according to Andrew Biggs, resident scholar at the American Enterprise Institute in Washington, D.C., whose research focuses on Social Security, pensions and population aging.
Can we possibly continue to finance these obligations? First, let’s total up the present value of our U.S. debt and other estimated obligations at year-end 2009.
The U.S. Treasury reports our annual interest rate on all this debt is 3.36 percent. It will cost U.S. taxpayers [$14.2 trillion X .0336 =] $477 billion in interest per year, to maintain the total public debt. How much could we possibly afford to borrow if we used all of our federal government revenues to pay interest? We could afford to borrow a maximum $62.6 trillion ($2.105 trillion ÷ 3.36 percent) using every dime of government revenues ($2.105 trillion in 2009) forever, just to pay interest. That assumes no additional debt and that interest rates don’t increase.
How will we ultimately resolve this debt situation?
The United States will soon have no other choice but to default or pay off the obligations with worthless money (i.e. monetize the debt). Monetizing the debt through inflation has historically been the option of choice for other financially irresponsible governments.
The writing is on the wall; at this point inflation appears to be the only approach to resolve the U.S. debt problem. Now it is a question of confidence. That is, will the Federal Reserve and Treasury be able to orchestrate a seven to nine percent plus inflation rate over the long-term, or will confidence in the dollar be lost, which could lead to hyperinflation?
Begin to prepare yourself and your investments now. Sell your longer-term bonds and start accumulating real assets. Then think about how to explain to your children and grandchildren why you are leaving them a legacy of unfathomable debt.
-Vern Sumnicht, CEO of Sumnicht & Associates, founder and president of iSectors, LLC is an investment advisor with 27 years of experience helping wealthy individuals, foundations, trusts and other institutional clients manage their investment portfolios.
