The United States is Facing Imminent Financial Failure

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It has become clear to me in the past few weeks that the United States is facing imminent financial failure.

I have known since at least the early 80s that if something were not done, the bill would come due within my lifetime. The difference now is that I'm seeing signs (or more accurately, putting together signs that have been there for some time) that this failure is imminent.

This isn't about our personal and individual finances. This is about the government failing to manage a sustainable budget and that failure getting progressively worse over a period of more than forty years to the point where the people it buys things from are considering not accepting the government's IOUs. But because the government is the guarantor of the dollar, bad things will explode out from that event, and the government is likely to make things much worse in order to maintain the status quo a little longer.

Watch this (if you haven't already). What happens when states fail, default on their pension and other obligations, and there's no money left in the federal treasury? Think they're going to keep printing and spending more indefinitely?

What happens when the people who have the things we need, be it money or other goods, stop accepting dollars for payment? It would have happened already except for the fact that the rest of the world has been so used to accepting dollars as payment that the government could basically print money to pretend it had the money to spend.

What happens when the rest of the world stops accepting dollars as payment?

Get this through your head: There is nothing any government function can do that actually creates wealth directly. The most it can do is create the conditions for producing wealth (something else our government has been doing a professional saboteurs' job with, but not the subject of this article). Every dollar the government spends has to come from someone's pocket in one of about four ways ranging from direct taxation to dilution of value. In fact, the $1 of government spending per $1 taken from someone's pocket is rather a "best possible theoretical case" and in large portions of our government, the ratio is over 2 to 1 even without considering the cost of interest on borrowed money.

Look to Weimar Germany or Zimbabwe to for a preview of when the world stops accepting dollars.

This is already starting to happen. Since the 1930s, oil has been sold in dollars. But probably not for much longer. People the world over have for decades accepted dollars for payment, rather than gold or their own local currency. That's starting to end.

Our government is running over a trillion dollar deficit every year for the foreseeable future (again, unless some major changes are made - but the people in Washington DC in both parties have made it plain they are unwilling to make those changes. Unfortunately, the longer they pretend they don't have to, the worse it's going to be.)

Since at least 1964, the attitude of the government (and most of the public at large) has been that "we're the richest country and the richest people in the world. We can afford to pay for anything."

Well, no we can't. The rational people have known we've been burning through our existing capital throwing a massive government (i.e. taxpayer) funded party for the last 40-plus years. The party has lasted this long because we were so wealthy to begin with, but no longer. The day of reckoning is imminent, when not only is the money all gone, everything we can borrow, beg, or steal is also gone.

The party is almost over. I can't tell you what day or even what month it's going to happen, but I would be immensely surprised if it were longer than the next national election.

That means the politicians in office now and the ones entering office in two weeks will be the ones who have to deal with it. There is no more time to find anybody better or anyone else.

This article isn't about blame. There's more than enough of that to go around. This is about what we're going to do. The more we think and talk about this in next weeks or months the more likely we are to have the best available answer when when the moment arrives.

Possible steps include (but are not limited to)

Currency devaluation. If the dollar is suddenly worth 1000 times less, we can easily pay existing debts. Here's that $5000 we promised you. Too bad for you it's only worth enough to buy a loaf of bread OR a gallon of milk. The problem with this is that it usually begins a vicious cycle of further devaluations in fact, whether the government recognizes it officially or not. This is about the worst thing we could possibly do as far as implications in its pain to average citizens, but unfortunately it's politically one of the easiest. The problem is that it not only impacts our ability to borrow money - driving those costs way up - but it also means that even our ability to actually pay cash for something we absolutely have to have simply vanishes. When the government uses other methods to cut obligations, $1 is still worth $1, and the costs of "normal" inflation are predictable. When the government starts devaluing currency, people won't want to talk dollars because they can be redefined as being worth less at any time. The people who have the stuff we want to buy aren't stupid. They understand this. "Last time I took $10 for this, and it suddenly became worth 10 cents. This time, I want not only the factor of 100 more dollars to compensate for what happened last time, but I also want another factor of 100 in case it happens again." This is how complete economic collapse happens. Once you start this cycle, you never know where it's going to end. Totalitarian Dictatorship is historically one of the most likely outcomes of currency devaluations of a magnitude big enough to make a difference for us.

Default on existing debt: Say "We're simply not going to try to pay you." Or we could partially default - "We theoretically owe you $1000 but all you're getting is $200" (and that ratio is likely to be more generous than we can afford). As far as I'm aware, none of the existing debt is subject to specific collateralization. In other words, they're all general creditors. They can't take Yellowstone or Yosemite away from us, haul off Lincoln Memorial to be sold at auction, or any of that. The problems are: we can do this only once, and it would negate the ability of the United States to borrow money for the foreseeable future. That ends the party, and the political way of life for the last 40-plus years. Therefore, politicians won't want to do it. Furthermore, the large creditors have lots of money to bribe, er, "make campaign contributions to" our politicians in currencies that will still be worth something. Politically this is the most difficult option to implement, but of the options I see, the one causing the second least amount of suffering on behalf of our citizens.

Cut government spending. Drastically. We're not going to have any choice about this. The only question is how much is going to be required. Hard as it is, this is the least painful of the available options (and politically easiest given the current environment), but we're so far in the hole that it's not going to be enough on its own, and there are things we have to continue to spend money on if we're not going to end up someone else's new territory.

Reduce government obligations going forward (i.e. pensions and public benefits). The current public pension plans are unsustainable on their own, never mind in the current environment. Even if we weren't facing imminent financial failure as a country, these would have eventually brought the treasury to its knees all on their own. The current situation is only accelerating it. Social Security, Medicare, public pensions, everything. If you're one of those currently receiving these monies, I've got a question for you: Which would you like better, modifying what's due to you or getting every penny but having it be completely worthless? Those are your choices. If there is no United States Treasury, how much are your benefits dollars going to be worth? Politically damned difficult, second only to defaulting on existing debts in terms of political difficulty, but reducing those obligations twenty, thirty or even fifty percent will harm these creditors much less than currency devaluation will hurt everyone including them.

Sell Stuff. States have been doing this. Arizona sold its capitol buildings and leased them back among many other examples. There's no reason the federal government can't. Actually, the Federal Government does this every day. Unfortunately, it's traditionally been a means for political cronies to enrich themselves at taxpayer expense, and that's unlikely to change. Furthermore, given the financial environment, the prices we get will make typical fire sale prices look good, and worst of all the government would likely be forced to lease a goodly proportion of this property back. Politically this is easy, but it will cost us massively more than we get. I'd like to see it held to a bare and unavoidable minimum, and only where it's not going to cause additional continuing future drain on the treasury in order to get a few bucks now.

Believe me, I'd like to hear some other options better than the above alternatives. And if it turns out I'm wrong and our government finds the will to do what is necessary avert the crisis, nobody will be happier than me (those actions would make any of the above options look politically easy). But don't assume that just because election day 2012 gets here before it happens doesn't mean it isn't coming. I'd be surprised if it goes that long, but that doesn't mean it might not take longer. Talk to me at the end of 2016 if you want an admission of being wrong. If it become obvious I was wrong sooner, I'll write an admission of it and be damned happy to do so.

If I'm right about this, the order I'd like to see happen is what I see as likely to cause the least damage and least permanent damage: Cut spending, Default on current debt, Reduce Obligations, Sell Stuff and currency devaluation only at the tail end of last possible options. We're going to have to use all of the first four to at least some extent, but I'd like to see the emphasis on the earlier entries of the list rather than the later ones. The pain will be more manageable, and more short-term. We'll still have to fix what's wrong, but the damage done will be less. The cycle a currency devaluation would trigger, however, makes everything else look like a pleasant walk in the park.

Caveat Emptor

(What's this got to do with a real estate site, you ask? Quite simply, it has gotten to the point where I felt it was irresponsible not to say something. I am quite confident that real estate is going to be a good investment for when it all shakes out, but in the meantime, it's not a liquid asset. You can't eat it if things get that bad for a while (unless it's a working farm). Once you have enough liquid assets in negotiable non-dollar denominated form, yes buying real estate intelligently is going to turn out to be one of the smartest moves you can make - especially if the currency ends up being devalued. However, if your money won't buy you food in the meantime, you may not be around to appreciate it.)


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Mike said:

So Dan - what are you doing to stay liquid? If one of your worries (and I understand it's not just you who is worried) is that the Dollar will hyper-inflate, how are you hedging? Euros? Singapore Dollars? Diamonds? Gold? pre-1964 silver coins?

Dan Melson Author Profile Page said:

The answer is not any one asset class. At this point we don't know what the government will do in response. I strongly suspect it will be the worst possible thing because that's politically easiest, but one of the reasons I wrote the article was to do my best to start people talking - hoping to create an environment where Congress decides the best way to save their own skins is to do something better.

I'm not going to recommend anything over anything else. What I am going to suggest is having some alternative method of payment (other than dollars - other currency, precious metal, etcetera) so that you can buy things like food that you MUST have. Also, have someplace you can go outside of big cities when things start getting ugly. Other than that, keep your assets diversified, but avoid anything valued explicitly in dollars - bonds, US currency, etcetera. You have to have enough negotiable to see you through the crisis itself but once that basic need is met, other assets are going to be better for your finances when it all shakes out.

The Ponzi scheme of national debt is about to collapse upon itself.

victor said:

Hi Dan, you should check out this book written by a scholar about the history of hyperinflations. Monetary Regimes and Inflation: History, Economic and Political Relationships by Peter Bernholz, prof emerit. of Econ from University of Basle, in Switzerland. Printed 2003.

Basically, he goes studies the history of inflation and makes an argument that the 3 conditions that exist in past occurrences of hyper inflation exist today in the US. You should check it out it will freak you out.


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This page contains a single entry by Dan Melson published on December 22, 2010 7:00 AM.

We Must Reform The Budgetary System In Order to Survive was the previous entry in this blog.

The Last Time I'm Going to Write About Blame for the Housing Market Mess is the next entry in this blog.

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