The fiscal cliff debate has merely been deferred for a couple of months. Now the real fiscal battle begins with the debt ceiling debate. Didn't we just go through this recently?
The debt ceiling is north of $16 trillion. This represents the current, funded debt of the United States. It in no way represents all of the country's obligations which includes an unfunded $86.8 trillion for Social Security, Medicare, and federal employees' future retirement benefits. One of the reasons for funding gaps was the redirection of Social Security tax receipts towards current expenditures. For a time, Social Security tax receipts were greater than obligations. Rather than segregate those funds for future use, the Federal Government used them. In exchange for their use, the government created IOUs for the Social Security Administration. These IOUs are unlike traditional bonds in the sense they are not actually printed on paper and are not negotiable. They exist in electronic form whose records are stored in the Parkersburg, West Virginia offices of the Bureau of Public Debt. The amount of IOUs is in the trillions. The IOUs are not invested in anything and have no market value.
Why talk about IOUs? Recently, the Obama administration floated an idea to circumvent the debt ceiling that entails minting $1 trillion platinum coins. Let's understand the mechanics of this. After minting these coins, the Treasury passes them to the Federal Reserve who then credits the Treasury's account with equivalent multiples of one trillion dollars. The Fed typically credits the Treasury's account through their acquisition of government obligations like Treasury Bonds. Since the debt ceiling is a statutory limit, no more bonds can be issued by the Treasury once that limit is reached. Hence the debt ceiling debate. Through an obscure law from 1996, the Treasury has the ability to issue platinum coins in order to fund government.
Now let's go back to the Social Security IOU example. In that exchange, the government took funds destined for a retirement program and exchanged it with something (an IOU) of zero intrinsic value. In the case of circumventing the debt ceiling, the government wants to exchange something of minimal intrinsic value (the value of the platinum) for $1 trillion from a private entity, the Federal Reserve. Since 2008, the Fed's balance sheet has indeed ballooned with the accumulation of government and other bad debt. At least that debt can be exchanged for cash in the marketplace, perhaps not the face value of the debt but at least there is some value. In the case of the $1 trillion coin, how many buyers do you think there will be for a $1 trillion dollar platinum coin when the Fed wants to sell it?
The trillion dollar coin proposal has been floated by members of Congress as well as Nobel economist, Paul Krugman. We should all be concerned that neither Congress nor a Nobel laureate recognize intrinsic value. I would also be concerned if our central bank, the Federal Reserve, willingly adopted this scheme of accepting a small amount of platinum in exchange for $1 trillion. An ounce of platinum is currently worth $1,665. In order to mint a platinum coin worth $1 trillion, the coin would need to contain more than 600 million ounces of platinum. The largest producer of platinum in 2012, with roughly 40% of world production mined 1.18 million ounces. This means there were roughly 3 million ounces produced in the world. At this rate, it would take 200 years of current platinum production to equal the value of one trillion dollar coin. I make these points not to educate readers about platinum but rather to point out the absurd nature of the proposal.
Dear readers, this is where we have arrived. We are in the realm of the truly absurd. The upcoming debt ceiling debate, or should I say debt ceiling war, is at least a partial recognition that the day of reckoning is nigh. If we play by normal accounting standards, the accrued expenses of unfunded government programs (Social Security & Medicare) plus our annual deficit requires over $8 trillion in annual tax collections just to maintain current debt levels. If the government took all income of those earning more than $66,000 plus all corporate income, they would still be short over $1 trillion. This is a point I made in Escaping Oz: Protecting your wealth during the financial crisis. There simply is not enough taxing power available to a) pay back outstanding debt or b) maintain current debt levels.
Where do we go from here? Debt has one of two outcomes, repayment or default. There are some who favor default. There are others who still hold on to the fantasy of repayment. Another option, ultimately involving repayment, is a massive, and I mean massive, scale-down of the government and its obligations. To some this will smell like default. You thought you were going to get $1,000 a month from Social Security but you only will get $200. There are other potential outcomes that could favor a hyper-inflation though money creation would have to acquire a different complexion. None of the outcomes will be pleasant.
Trillion dollar coins anyone?
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis.