This column continues with the review of the paper written by economist Dr. Jeffrey Rogers Hummel of San Jose State University where he states why he thinks it is far more likely that America will default on its debt.

Hummel sees the example of the 1998 collapse of Russia’s financial meltdown as a possible scenario for America.  In its case, Russia chose a partial debt repudiation (backing away from) over a complete collapse of its fiat currency.  A fiat currency is one not backed by gold or silver.  Under President Nixon, America was removed from the gold standard making our currency a fiat currency.  This says that our currency is backed only by the full faith and confidence of our government, which under decades of debt growth and lingering existing economic conditions, are beginning to erode among   our creditors. Hummel has created a graph which depicts America’s expenses and incomes with respect to percentages of GDP from 1940 – 2008.  From his analysis, two facts become apparent that merit consideration:

1. Federal tax revenue (income) since the Korean War has been smoother than expenses, and has tracked 20 percent of GDP very closely for well over 50 years.  This suggests that 20 percent is some kind of structural-political limit for federal taxes in America.  Further, this indicates that variations in the deficit stem from changes in spending rather than taxes.

2. Federal tax revenue at the height of WWII never quite reached 24 percent of GDP.

Next, our author factors in some demographic changes anticipated for our aging population that will drastically affect the unfunded costs of Social Security, Medicare, and Medicaid.  The point is well made that these social programs will heavily impact our  government’s fiscal budgets.

The income from federal tax revenues is probably capped between 20 and 25 percent of GDP and the politicians have almost no incentive to rein in social security, medicare, and medicaid.  Thus, the prospects are sobering.

Prominent economists, Hummel says, have started considering a possible treasury default, while the business-news media and investment rating agencies have begun openly discussing a potential risk premium on the interest rate that the U.S. government pays.

The financial structure of the federal government currently has two nominal firewalls.  The first, between treasury debt and unfunded liabilities is provided by the trust funds of Social Security, Medicare, and other smaller federal insurance programs.  But according to intermediate projections of the trustees in 2008 as Hummel was writing this paper, Medicare Part A trust fund will be out of money in 2017, and the Social Security trust funds will be empty by 2037.  Other parts of Medicare are already funded from general revenues.  The first firewall will be gone should these trust funds not receive the necessary cash injections and the general fund has to bear the load.

The second firewall is between U.S. currency and government debt.  Hummel  considers the option of the Federal Reserve’s unleashing the Zimbabwe option and  repudiate the national debt through hyperinflation, which would destroy the dollar completely.  Given the choice, he believes the government would save the dollar, and  default on the debt.  In such an event, claims by the treasury securities are secondary to Federal Reserve notes (currency).

Very difficult decisions ahead in this stagnant economy.   Take heed of 2 Chronicles 7:14.

 

By Aaron Russell Sr.