How to Fund the National Debt

The U.S. national debt continues to soar — although over the coming months it won’t officially soar.

Last year, Congress suspended the debt ceiling until March 15, 2015. That date has officially come and gone, so what now?

The national debt now stands at just over $18.1 trillion. Because of the suspension, that is now the new debt ceiling, which isn’t supposed to be breached.

But Congress and the Obama administration are not all too anxious to deal with that issue right now. So the federal government will just have to stop running up the debt until it raises the ceiling… Well, sort of.

Treasury Secretary Jack Lew has a few tricks up his sleeve, which we can be certain he has learned from previous Treasury Secretaries. He is going to use “extraordinary measures” to keep funding the government at its current pace while also ensuring the official national debt doesn’t go up.

Lew will use accounting tricks that would have made Bernie Madoff proud. He will borrow money from other places within the federal government, such as pension plans for government employees. He has said that he should be able to do this until October, at which time Congress will need to raise the debt ceiling or suspend it again.

It is not clear why they refer to this accounting gimmickry as “extraordinary measures.” It seems it is becoming quite ordinary.

Balancing the Budget

Meanwhile, some congressional Republicans have come up with a plan to balance the federal budget in 2025. This is also a reoccurring theme — there is always some magical date in the future where the budget will get balanced.

It is easy for politicians to say something will be done 10 years from now. After all, they will either be gone from Congress or the situation will have completely changed and most everyone will have forgotten about the promises from a decade ago.

Of course, this plan to balance the budget in 10 years is a joke anyway. Even if Congress did not have to go through Obama on it (or any future president), there are so many far-fetched assumptions that it is irrelevant.

The proposal assumes a repeal of the Affordable Care Act (Obamacare). It would also change the current tax code, and it would completely restructure major federal government programs. And it would all have to happen in the next six months.

In other words, none of it is going to happen.

But let’s give the Republicans the benefit of the doubt: They are trying to come up with some kind of proposal, even if it is not politically realistic.

The next problem is the dynamic scoring used to project economic growth. There are some unrealistic assumptions about growth, and it basically assumes that we won’t have any kind of deep recession such as the one we experienced about seven years ago (and from which we still continue to struggle).

A 10-year proposal also makes the crazy assumption that all future Congresses are going to abide by the plan and enact it as shown today.

I have an idea: How about a proposal where actual cuts to government are made today by politicians in office today? How about actually reducing government spending?

Anyone can talk about balancing a budget in 10 years. An alcoholic can also talk about getting sober in 10 years.

How to Fund the Deficit

We can safely assume that — barring a major change — massive deficit spending is going to continue well into the future.

It is also important to realize that this is just a discussion of the official national debt and current federal spending. It does not take into account the staggering unfunded liabilities, which are promises that have been made but not funded.

Laurence Kotlikoff has estimated that the off-budget liabilities exceed $200 trillion. Most of this comes from the so-called entitlement programs of Medicare and Social Security. This number makes the on-budget debt look small by comparison.

The government has a lot of promises to keep. Many of them will eventually be broken, but for now, there is a lot of spending to be done by Washington politicians.

With increasing obligations and a federal budget that is nowhere close to being balanced, what does this mean? How will the continuing deficits be funded?

Up to this point, it hasn’t been too bad for the U.S. federal government. The U.S. dollar continues to reign supreme and foreign central banks help buy up the debt. But what happens if foreigners stop buying the debt, let alone sell any of it?

It isn’t too hard to pay the interest on the debt these days because interest rates are so low. What happens when interest rates start going up? Are they still going to be this low 10 years from now?

The Federal Reserve Will Step In

The Fed says it has a dual mandate: maximum employment and price stability.

I see its dual mandate a bit differently: support the big banks and fund Congress’ deficits.

The Fed wrapped up a two-day meeting this week that ended with a Janet Yellen press conference. They have dropped the word “patient” from the statement on monetary policy. This means they could raise the federal funds rate as early as June.

Yellen also talked about a point in the future where the Fed could stop rolling over maturing debt. In other words, the Fed would let its balance sheet shrink.

I find this incredibly hard to believe.

Perhaps Congress can keep up its deficit spending at current interest rates without Fed help for a little while. They can still get private investors and foreign central banks. But there is going to come a point where Congress is going to depend on the Fed to buy up at least a portion of its debt.

This is why we should expect more monetary inflation in the future. It is going to be used to fund the growing national debt — official or not.

The Consumer Price Index (CPI) is low right now. The Fed uses this measure, whether it is accurate or not. Consumer prices may be relatively low, but the Fed has been blowing up asset bubbles and misallocating resources on a grand scale.

If the Fed does not see price inflation as a serious threat as shown by the CPI, then it will not significantly reduce its balance sheet. It may raise the federal funds rate slightly, but only to hand over more money to the banks by paying a higher interest rate for excess reserves.

As long as the Fed does not fear high price inflation, we should assume it will step in when needed to buy the government’s debt. The only time we will see Congress forced to cut back on spending is when the Fed faces massive price inflation and is unwilling to help Congress by buying government debt.

So despite the seemingly tighter stance being adopted by the Fed, it probably won’t last long. This is why it is important to have a portion of your portfolio in hard assets that will do well in times of higher inflation.

Congress will not cut spending anytime soon. The national debt will continue to grow, despite the debt ceiling. And if private investors and foreign central banks slow down their buying of U.S. debt, then the Fed will surely step in. That is a safe bet for the future, regardless of any debt ceiling.

Until next time,

Geoffrey Pike for Wealth Daily