Kotlikoff: The IMF Says That the US Is Bankrupt, and They're Right

I have not read it yet, but Kotlikoff has a book out called "Jimmy Stewart Is Dead" which was reviewed in April by Craig Heimark at Naked Capitalism.

I have not followed Kotlikoff closely and will attempt to read some of his more serious material in the near future. I did listen to a long discussion on Bloomberg television this afternoon, and he made some real sense to me, although he did not penetrate the miasma of corporate sloganeering that represents the minds of the anchors. They seem to lean to the 'cut everything that is not a subsidy to or a cashflow owned by the oligarchy' school of economic reform. And he takes that sort of supply side hoaxing to task, and harshly.

I have to take a closer look at his analysis of Social Security, which is highlighted in this Bloomberg piece (quelle surprise). But his comments on the need for reform in the financial system was point on.

He disagrees with both the supply siders and the demand siders, favoring a systemic overhaul and reform, and so my interest in what he says is obvious.

Bloomberg
U.S. Is Bankrupt and We Don't Even Know
By Laurence Kotlikoff
Aug 10, 2010

Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.

What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.

Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.

Is the IMF bonkers?

No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

‘Unofficial’ Liabilities

Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.

For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.

The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

$4 Trillion Bill

How can the fiscal gap be so enormous?

Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.

This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: “Something that can’t go on, will stop.” True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.

And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

Worse Than Greece

Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.

Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.

My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”

(Laurence J. Kotlikoff is a professor of economics at Boston University and author of “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking.” The opinions expressed are his own.)

ZeroHedge: Richard Russell Slams Robert Prechter, Praises Gold, Tells Readers Get Out Of Stocks.

First, Richard Russell does not 'slam' Prechter because he is a gentleman and doesn't really 'slam' anyone. Fights between pundits can be fun in a voyeuristic way, but they are largely unproductive and generally used as a means of gaining attention, and providing distraction from what really matters, in the manner of panem et circenses. And sometimes people use provocative headlines to garner interest as well, in the manner of the New York Post and Daily News.

What Russell is saying is that Prechter is wrong in his interpretation of how deflation will play out, and what the endgame will look like. And he is saying almost the same thing that others, including Eric Janszen and myself, have been saying for quite some time, but in a slightly different ways.

Second, what Bob Prechter does not realize is that a contraction in credit does not imply a one for one decrease in 'money' just as an increase in credit these days does not result in a one for one increase in money. That is because credit is not money, it is the potential for money. Why more people don't get that is beyond me. They trumpet the diminishing returns of money production for each marginal dollar of credit, but they don't admit that this credit is vaporous, and as it dissipates it does not reduce money supply one for one either.

Third, and probably most importantly of all, even as the credit contracts, and the money supply contracts at some lesser rate as show in the money supply figures, the 'basis of value' of the money is also contracting. Since the US dollar is not based on gold, we have to look at what is providing the basis of its value. And what are those things, and what is happening to THEIR value.

And finally, there is a huge overhang of eurodollars out there, that are largely parked in Treasuries mostly of a moderate duration of three to ten years. By buying the Three and Ten year notes the Fed is 'monetizing them' and taking that supply off the market, softening the blow when foreign entities first stop buying them, and then eventually start selling them.

We can't detect the selling yet in the Fed Custodial accounts. And we do not have a reliable reporting of eurodollars because that is the ONLY component of M3 that was discontinued by the Fed a few years back. The rest were maintained. When the Fed said they would no longer report M3 what they were really saying is that they would no longer provide a reliable report on eurodollars. The conspiracy guys may have been right, but they were focusing on the wrong item.

Bernanke and the Fed are going to be playing these markets to manage bonds and the dollar, and it is going to be a balancing act, and most likely a race to the bottom. That is why it is hard to predict. So far Ben is being predictable, doing what he said he would do, even if it is not always clear to everyone. But he has some other things in his bag of tricks, and those might be a little more complex.

What the Fed is doing by lowering the Ten year note by buying it in the market, in addition to picking up the slack from the overseas banks, is trying to trigger another round of refinancing in corporates and mortgages. It is estimated that two trillion in refi's will be triggered if the Fed can get the Ten year down below 2.5 and even approach 2 percent.

And this prolonged quantitative easing has a secondary effect that supports this. These low rates tend to drive investors from low yielding instruments in search of return, which implies a mix of greater duration and risk. More on this at some future date.

I think Elliot Waves are popular because they are not particularly rigorous or scientific, are easily learned, and are flexible enough to justify almost any outcome you wish to see. Their value is that they remind people that things do not go straight up or straight down. Since most charting is just a forecast it might be no better or worse than the others.

But what does discredit Prechter is that he is using an economic monetary model from 'the last crisis' that was valid when the dollar was on an external standard. And it is a pure fiat currency now. That is a huge difference, and the failure to account for that in your thinking is an elementary mistake.

AND even worse, he has been repeatedly wrong about gold for the past eight years and has never admitted or understood why, and merely keeps moving his price levels. Although to his credit he has been very right about Treasuries, and people should not forget that either. Treasuries have been in an epic bull market for quite some time, and like bull markets in stocks have created quite a few market geniuses out there.

Bob has his points for and against like everyone else. He has made some very good calls, and some horrible misses. People tend to remember the hits and forget the misses.

Does Bob ever admit it when he is wrong? He has never done so on gold. And I find stubbornness in the face of failure to predict, the unwillingness to admit error and adjust, to be just the kind of amateurish investing error that causes people to take their trading accounts over Niagara Falls. And I think this is what concerns Richard Russell, that if and when the tide changes and the dollar resumes its long decline lower, that Bob will not recognize or admit it, and will take quite a few trusting souls over the cliff with him.

No matter what happens with easing or not, the primary issue is that a relatively small financial elite has taken control of the US economy, and is using it for their personal power and wealth, and corrupted the natural market processes.

And this corruption is being transmitted to the rest of the world's economy creating bubbles and collapses in distant places because of the importance of the US economy and the dollar. Since the Bankers have control of the issuance of the world's reserve currency, they can bend the world to their will, and their willfulness is not beneficial to anyone except themselves. The world is seeing the continuation of the 'cold war' under different means and with different objectives, and with a different set of adversaries and alliances.

But what about Japan? There are easily twenty examples of monetary crises and economic collapses since WW II, and Japan is the one seized upon as THE example of what MUST happen in the US, despite the tremendous differences in position of the two countries economically, culturally, and demographically. Talk about conformational bias. I have spoken about this at length in the past. Japan demonstrates that monetary outcomes in a pure fiat regime are a policy decision. And Japan was homogenous enough, and small enough, to play in its own policy sandbox long enough to realize the outcome that was achieved. Until recently, Japan was essentially a 'one party' democracy imposed on them after the War by the US, ruled by the LDP and the big corporations, the keiretsu.

All things considered, the Russian outcome seem more likely to me, except the US is short on natural resources, so it is hard to forecast what will finally trigger the recovery. The dominant industry is financial fraud, demand that seems to be on the decline in US' trading partners, unholy alliances amongst central banks notwithstanding.

The US financial sector is still greatly oversized, and exacting a debilitating tax on the real economy. The markets are manipulated and rife with fraud, so productive capital formation and allocation is short circuited by short term speculation at almost every turn. There will be no recovery unless the system can be brought back to a pre-bubble state. And the system will not cure itself by deprivation or a false austerity, dishing out more punishment to the victims. This will provoke a destructive reaction, not what anyone would call a cure.

That is the real issue. Everything else to me is a sideshow, gossip, distraction, and noise.

You can read the original article Richard Russell Slams Robert Prechter, Praises Gold, Tells Readers To Get Out Of Stocks.

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