Friday, November 13, 2009

Economic Capacitance in the U.S.A.

Earlier in this blog I used a term "economic capacitance" to describe the length of time an economic unit (i.e. individual, family, business, or government) can persist in the face of negative cash flow.

With no income, economic capacitance (EC) in months would be savings divided by monthly expenditures. If there were income, but expenditures are greater, EC in months would be savings divided by losses per month, where losses are income minus expenditures. If one has a good credit rating, one could add borrowing capacity to savings, which would lengthen the amount of time before excess expenditures render one bankrupt. In short, economic capacitance is the length of time one can maintain excess spending before the shit hits the fan.

The U.S. government is an economic entity. Income comes from taxes. Expenditures reflects the military, social, and infrastructure services it provides, and also subsidies and bailouts. To my knowledge, the Federal Government has no savings, nor any resources that could be construed as savings, but I won't rule out there could be something I don't know about. The federal government can pay for services directly with tax money, or through bonds it can float, which are then paid off with taxes.

The U.S. government has been deficit spending for years, with ever increasing debt reaching upwards of $12 trillion now, or close to $80,000 for every tax paying citizen. Some of the debt it accrues will be essentially forgiven by a targeted 2% inflation rate every year. But the government is still deficit spending well beyond that, exacerbated under the Bush administration, with no end in sight under Obama.

Through direct bailouts of banks and an easy money policy flowing in the direction of corporate America, this financial house of cards that is the credit bubble remains standing: but at a cost of hundreds of billions of dollars in bailout packages, and more in loans to poor credit risks, and more still on guarantees for toxic securities.

So, with that introduction, I'd like to reflect on: just how long can the government keep doing this?

As long as there is a market for Treasury Bonds, the U.S. government is in business. They can shovel as much money into Wall Street as they like. With all the chatter about where the dollar is headed, the market for treasury bonds shows no sign of letting up. So, in the end, the free market for Treasury Bonds decides the economic capacitance of the federal government. When people stop buying treasury bonds, and only then, would the government be forced to curtail its spending.

So when is that? Currently the U.S. debt is around 1.5 times its GDP. Most major European economies are around that. Japan's national debt is closer to 2 times its GDP, and they are far from financial armageddon. Now Iceland's debt is/was 6x its GDP and financial armageddon HAS hit there including a bloodless coup against the political party responsible. So the tipping point is a debt-to-income ratio somewhere between 2 to 6. The U.S. is too big to do what Iceland did; I'm going to guess that a debt to GDP ratio would be 3, after which borrowing costs would become prohibitively expensive. So that is around double where we are now, or another $12T the government has to play around with, in my opinion.

So then, is there any sense to curbing our spending to not reach that point, and go back to living within our means? Going into debt now reduces our capacity to accrue debt later, so future America will not have the same opportunities for deficit spending that we have today. Worse, if greater amounts of tax money in the future go to pay off the debt burdens accrued from the past, that narrows the government services future America will enjoy—either that or increases its tax burden, with all the impediments that puts on a market system.

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