Paper Skyscrapers: The long road to fiscal responsibility
By Tony Allison, April 28, 2008
The numbers thrown around during the ongoing credit crisis are so large; they effectively lose their meaning to most of us. I would like to put the millions, billions and trillions in some perspective by referring back to an article I wrote years ago (The Debt Bomb) about our growing debt problems. Unfortunately our debt has only worsened since 2004, and many of the issues are even more relevant today. The example provides some clarity to how large one trillion is, and how long a road we must still travel to become a fiscally responsible nation again.
Warren Buffett For a Day
Most of us hear billions and trillions tossed around and our eye’s glaze over, unable to grasp the enormity of the numbers. However, suppose you were Warren Buffett for a day, and drove to your favorite bank to retrieve one million dollars, in crisp thousand dollar bills. The tightly wound stack would be about 4 1/2 inches high. You could stuff it in a small bag and off you go.
If you decided to withdraw a billion dollars (in thousand dollar bills), it would stack over 365 feet high, roughly the height of a small skyscraper. You would need a large, and well-guarded, truck to haul it home. A trillion dollars is another story, even beyond the reach of Warren Buffett’s savings account. A trillion dollars would stack 69 miles into the blackness of suborbital space, beyond the sight of the human eye, and perhaps the human imagination. A trillion is a ridiculously large number, even in today’s over-inflated, derivative-addled markets.
200 Years to One Trillion
Our federal financial obligation is so big that it is hard to fathom. From the beginning of our nation in the late 18th century until the mid 1970’s, roughly 200 years, our accumulated National Debt was less than one trillion dollars. This takes into account the Revolutionary War, the Civil War, two World Wars, the Great Depression, the Korean War and Vietnam. Today our federal debt is now $9.3 trillion, over half of which has been borrowed in the last dozen years. Today that debt, in thousand dollar bills, would reach well over 655 miles into space. Mount Everest only reaches 5.5 miles into our atmosphere. Mount National Debt is over 119 times higher!
While it took 200 years of American history to reach one trillion dollars in national debt, it took only six years to build our debt from five trillion to six trillion dollars. Incredibly, in less than two years the National Debt soared another trillion dollars, reaching seven trillion in January 2004. By September 2007, the National Debt surpassed nine trillion dollars. Do you detect a frightening trend here? The curve is accelerating as new debt is rapidly created and annual interest payments compound, already exceeding $400 billion. At the current rate, each and every day adds $1.5 billion more, or 1 1/2 new paper skyscrapers to the thousands already inhabiting our National Debt skyline. Printing more dollars appears to be the only way in the short to medium term to keep the ship of state afloat. Looming longer term this century, beyond the current National Debt, are unfunded federal mandates for Social Security and Medicare that exceed $70 trillion. These skyscrapers may one day reach the moon.
Stimulus Life Rafts
As the government debt skyscrapers multiply, so do those of its citizens. Americans owe more than $950 billion in credit card debt, and $1.6 trillion in auto loans and other non-revolving debt. As our nation has evolved into a consumer economy, Americans have evolved into a state of chronic credit addiction. Clever financial engineering and declining interest rates have kept the party going for 25 years, but the lights are dimming and a hangover looms ahead. Rising personal debt service and the bursting of the housing ATM are putting tremendous pressure on the middle class. The weakening dollar, a result of our decades of consuming more than we produce, makes the basic food and energy needs of Americans ever more expensive. The government “stimulus” package will be welcome, but it is a band-aid approach in an election year. Expect more stimulus packages from Washington dropped from the sky as life rafts to its debt-burdened populace.
Debt Compounds on Debt
The debt is not going to magically go away. Debt compounds on debt and just grows faster. And a severe recession will mean less tax revenues, and yes, even more debt. This problem was decades in the making and will not be solved easily, quickly or without pain. Perhaps that’s part of the problem itself. During the credit expansion bubble of the last 25 years the culture seems to have evolved to the point where everyone feels deserving of cars, houses, clothes and travel, right now, without the onerous task of earning or saving the money first.
Politicians, ever diligent to the wind direction, have become terrified of even suggesting belt tightening or self-discipline in any form. They have rapidly expanded government spending without regard to future consequences. “It’s morning in America” they proclaim. We are such a great nation that we no longer have to manufacture anything, or even save for a rainy day. “We are now a consumer economy, so do the patriotic thing and go shopping!” (on borrowed money of course).
Trade Deficit Blues
In addition to the National Debt of $9.3 trillion, there is the chronic trade deficit, totaling $700 billion in 2007, the result of importing much more than we export. That number came down a bit last year as our declining dollar helped boost exports. Unfortunately, as long as we import 70% of our energy needs, the trade deficit will not go away. Our manufacturing base is no longer large enough to export us to “creditor nation” status.
The long term trade deficit is perhaps the most alarming debt skyscraper of all. As the world’s largest debtor nation, we are steadily transferring our nation’s “net worth” abroad. And with our national net worth increasingly owned by foreign sources, our ability to act as an independent, sovereign nation is undermined as well.
Source: Bureau of Census
Source: Bureau of Census
Squandersville and Thriftsville
Warren Buffett wrote about this issue in Fortune Magazine back in late 2003. He used the fictional example of two islands, Squandersville and Thriftsville, to illustrate how persistent trade deficits ultimately take a great toll. Even though the US dollar has eroded significantly since Buffett’s article was published, the trade deficit is still roughly 5% of GDP. In the following excerpt, Buffett clearly explains the dilemma in which we now find ourselves.
“Simply put, after World War II and up until the early 1970’s we operated in the industrious Thriftsville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment, our holdings of foreign assets less foreign holdings of US investments, increased from $37 billion in 1950 to $68 billion in 1970.
Additionally, because the US was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.
In the late 1970’s the trade situation reversed, producing deficits that initially ran about 1% of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.
Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4% of GDP (5.1% of GDP in 2007). Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the US than we own of other countries. Some of this $2.5 trillion is invested in claim checks, US bonds, both governmental and private, and some in such assets as property and equity securities.
In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4% more than we produce, that’s the trade deficit, we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.
To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what’s already been transferred abroad is meaningful, in the area of 5% of our national wealth.
More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade deficit level, which means that the deficit will be adding about one percentage point annually to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding. Goodbye pleasure, hello pain.”
In the article, Buffett suggests a tariff system of “import certificates” to force a dollar for dollar trade balance between imports and exports. It appears the plan was never acknowledged by the current administration.
It is interesting to note that the US behaved much like Thriftsville until the early 1970’s according to Buffett. In 1971 the US went off the gold standard and the dollar became a fiat currency subject to unlimited Fed printing power. Perhaps this was just a coincidence, perhaps not.
There is always hope for a new beginning, as bleak as the situation has become. When economic events become too painful and the quality of life drops too far, the wheel will slowly reverse. Attitudes toward debt and consumption will change. Attitudes toward saving and producing will change as well. It will be a long, painful march back up the mountain, but at least it will be in the right direction. The wheel may already be slowly changing direction.
This attitude change will hopefully coincide with the long overdue realization that our national infrastructure needs to be rebuilt. If our nation is to regain its economic vitality and remain a magnet for global capital, then our infrastructure situation must be addressed, and soon. A 2005 study by the American Society of Civil Engineers put the price tag at $1.6 trillion. With dollar inflation and further infrastructure deterioration, the price tag today likely would exceed $2 trillion. Of course that’s in today’s dollars. By the time the country actually deals with the issue, the price tag will be much, much higher. The rebuilding of our infrastructure is a challenge so large, complicated and expensive that one fears our current crop of politicians is likely to punt and defer any action until the inevitable crisis forces their hand.
A national consensus to attack this issue with a “Manhattan Project” determination is needed to get the country moving forward. It will be enormously expensive, but it will also create millions of productive jobs and should ultimately lead to all the benefits of productive growth.
Address Energy Dependence
In addition to rebuilding our decaying infrastructure, we need to address our dangerous energy dependence. China is rapidly building refineries and nuclear power plants, and drilling for oil and natural gas. The US needs to do the same, as well as aggressively pursue solar and wind power. There is no one silver bullet, so we better get started.
Interestingly, foreign bonds helped build our original infrastructure in the 19th century. We may come full circle and tap foreign creditors again to help us rebuild America in the 21st century. It won’t be easy or without great sacrifice, but this may be our last great chance to begin knocking down the thousands of paper skyscrapers and replacing them with real ones, built from saving, hard work and self-discipline (Thriftsville once again). Let’s hope that attitude, so evident in the 19th century and most of the 20th century, will come full circle as well.
U.S. stocks ended mostly lower on Monday, with caution ahead of a two-day meeting by the Federal Reserve offsetting news of a buyout of William Wrigley Co. by privately held Mars and Warren Buffett's Berkshire Hathaway.
The Dow Jones Industrial Average fell 20.11 to close at 12,871.75. The S&P 500 Index was down 1.47 to close at 1,396.37. The Nasdaq closed higher, ending at 2,424.40, up 1.47.
Crude-oil futures closed slightly higher at $118.75 a barrel Monday after hitting a new record near $120 a barrel, as a strike at a Scottish refinery forced a pipeline closure, while rebel attacks in Nigeria and tension in the Persian Gulf also fanned concerns about supply disruptions.
© 2008 Tony Allsion