Welfare States ----RIP


Nov.17,2010The welfare state, a relatively recent historical concept, has failed miserably all around the world. The inability of politicians to say no or not play Santa Claus appears to be universal. It has every welfare state headed for bankruptcy. It is unlikely that politicians will act to head off this problem, but markets will eventually put these states out of their misery. Unfortunately, more damage will be done while we await markets to ring the bell.

Send in an Additional $1,525,000 With Your Tax Return: To further put the problem into perspective, the Federal Government owes about $112 TRILLION in actual debt and social promises. Assuming a total population of 315 million people, the portion of Federal Government debt that is owed by every man, woman and child in this country is about $381,000! Or, a family of four owes $1,525,000 of which they are unaware. This amount is in addition to whatever mortgages, credit card debt, car loans or other loans a family might have.

Would You Give This Man a Mortgage? … The Federal Government collects about $2.5 Trillion in total revenues a year. That is from all sources of taxes and fees. Think of that as an individual’s annual gross salary. The debt owed by the Government can be looked at as a great big mortgage. Thus, we have a family that has a mortgage 44.8 times greater than gross salary. That would be the equivalent of a man earning $50,000 gross salary having a mortgage of $2,240,000! An interest-only mortgage at 6% would require the family to pay annual interest of $134,000 per year. A conventional mortgage would be much higher. The example becomes even more ludicrous when one recognizes that taxes, food, clothing, savings, etc. all have to be subtracted from gross pay to determine what is left for debt service.

Debt Death Spiral: The Federal Government is in what is known as a Debt Death Spiral. They are unable to pay the actual and implied interest on their debt. Hence, the unpaid balance is added back to the amount owed, making the problem worse next year. This debt spiral is growing exponentially. There is no way to escape a certain mathematical end.

The US is insolvent. Mathematically, it is impossible to service the obligations without defaults. It is highly improbable that inflation can solve the problem, although that will probably be tried. Europe is in a worse condition. Japan,  is in a similar state.

In the US, the numbers are even worse than they appear. Gimmickry extends beyond accounting. For a sampling, see “Government is 79% of the Economy.” In addition, more than unfunded entitlements are unaccounted for. Per the Wall Street Journal:

The bigger issue is that all of Fannie and Freddie's liabilities, whether kept inside the companies or hidden in a dark corner of the Treasury, are now Uncle Sam’s responsibility. Moving their bad assets into a new Baddie Mae would only preserve the fiction that there is a difference between the government’s obligations and those of Fan and Fred. Not even Barney Frank could believe that any more.

Proper accounting for Fannie and Freddie would add over $5 Trillion of additional government debt. That would raise the debt obligation of the US government to $18 Trillion, well above the 90% of GDP that Reinhart and Rogoff consider critical.