Reality Check of Economics

“Solving our problems starts with facing reality.”

​In the past ten years, nation states worldwide have deficit spent to meet the public’s demands for government services. It has become a way of life. But do we know of any formulas that would indicate that there are limits to the amount of debt that a government can accumulate before it impacts an economy negatively? Certainly recent turmoil in Greece would provide evidence that there are limits to how far a sovereign nation can go into debt before it hits its Debt Wall.

The definition of a debt wall is the point at which a country cannot further borrow money without paying an interest rate that they cannot afford. It doesn’t mean that they don’t borrow more money; but the borrowing is not conducted pursuant to normal market mechanisms. At this point, there is some intervening government action that allows the country to continue borrowing money through a special process or arrangement. Natural free market mechanisms are distorted.

In the case of Greece, the EU Central Bank, led by Germany, tendered a work-out agreement structured specifically for Greece. This allowed them to continue to spend money, provide government services, and avoid collapse. The cost of this refinancing is partly borne by the members of the EU through subsidization of Greece’s deficit spending. Conditions were set that Greece must meet, pursuant to the terms of the bailout agreement. The citizens believe that the conditions are austere. In fact, the terms required Greece to rethink and restructure government finances. The cost of the package was therefore shared among many countries. Angela Merkel, Chancellor of Germany, had to decide whether or not a bailout for Greece cost Germany less than allowing Greece to fail financially and withdraw from the EU. It was deemed that Greece’s withdrawal, requiring an untangling of all currency and debt in place, would be more egregious. The situation is not resolved. Greece is still deficit spending. If they do not restructure, the crisis will present itself again.

The above chart was published in April of 2011. It was an analysis of all government debt in the world shown as a percent of world Gross Domestic Product (GDP). At the time, world GDP was approximately $62 trillion and world government debt was approximately $71 trillion. This analysis is calculated on cash-on-cash expenditures, not based upon contingent liabilities. It is a proven economic axiom that when a country’s accumulated debt exceeds 100% of GDP, each additional dollar of deficit spending has a negative impact on economic growth. Currently, the United States’ accumulated debt is in excess of $17.5 trillion. Our estimated 2015 GDP is approximately $16.2 trillion. Therefore, the United States is approximately 108% in debt to GDP. There are 183 countries in the World Trade Organization. All of which deficit spend,with occasional exceptions to include Switzerland. Dr. Milton Friedman believed that when annual world government deficits amounted to 10% of world GDP, pressure on currencies would cause the rise of interest rates. Quantitative Easing (QE) was implemented in the United States to keep interest rates low. The amount of QE1 and QE2 were each tranches of $600 billion. They were announced as one-time transactions. This allowed banks to remain liquid in the hopes that the economy would grow through access to cheap money. This strategy has not worked, primarily because of the axiom of too much accumulated debt. The above research predicted that if something wasn’t done about world government deficits, including in the United States, in 15 months QE 3 in the U.S. would be required, and this time it would be ongoing month-by-month. This happened exactly as predicted. In a sense, the United States hit its Debt Wall. Further borrowing for deficit spending was made possible without an appropriate rise in interest rates because of the intervention of the U.S. Treasury and the Federal Reserve.

The average interest rate for the cost of capital for governments of the world through primary currencies since 1870 has been 4.2%. That is the target rate of monetary policy. When a government “prints” money or devalues its currency, it is done so for the purpose of correcting a short-term problem in its economic structure. The strategy is to allow the equalizing forces of the free market to then recalibrate currencies and interest rates to find their equilibrium. When markets are distorted for an extended period of time, other unintended consequences are the result. To keep interest rates low, for over five years now, has damaged the bond market. Annuities rely on a stable bond market to produce long-term revenue for pension funds, life insurance contracts, and other financial instruments. Interest rates have been low for so long that many funds have had no alternative but to seek relief in the equity markets (the stock markets).

The United States government and its Federal Reserve find themselves in a catch 22.  It is impossible to have economic growth without cost of capital. If you’re borrowing or seeking investors, the lender or investor requires a reasonable interest rate as rent on their money. The United States, however, cannot allow interest rates to rise to the historical average because it would add $735 billion in interest costs to carry the national debt past blended rates. Therefore, if the economy grows, interest rates must rise. Keeping interest rates low to afford the interest costs of accumulated debt inhibits economic growth – hence the catch-22.

Recently, the Chinese Yuan was devalued by the Chinese Central Bank. This was caused by a communist government “printing” money to spend that had not been received from taxes on profits. This further exacerbates the equilibrium of the world’s currencies. If the U.S. Federal Reserve raises interest rates later this year, it will make the dollar stronger against the currencies of emerging markets and put pressure on those countries’ debt structure.

Municipalities, which are at times required to invest the corpus of pension funds in Triple A rated bonds, are having difficulty finding bonds that yield sufficient dividends to meet their long term needs for pension funding. Occasionally projections are made for budget purposes on future dividends which are not sustainable.

The stability of financial markets for all concerns requires free market mechanisms to set values on all currencies and financial instruments. Continuing to distort natural free market forces will only make the matter worse in the long run when reality presents itself.

What then is the reality check of economics?

The United States government must get control of its deficit spending. This will require a commitment from the American people. The latest Congressional Budget Office numbers indicate the United States is on track in 2015 to take in a record $3.1 trillion. However, we are spending $3.8 – $4 trillion. The deficit is still in excess of $500 billion, cash-on-cash. To balance the budget requires a cut of approximately 25%. That is a real cut, not a cut in growth. Cuts are not just unlikely, they are very difficult to implement. What is required is a restructuring of government services. A new relationship and understanding between the federal government and the states must be established. Priorities must be set. Setting priorities begins with determining what is important to us as a people. Doing more as citizens to take care of ourselves must be reexamined. Volunteerism must become a social priority, not just a social luxury.

Solving our problems starts with facing reality. What is the real situation we face and what are we going to do about it?

Resolve must be found. Leadership is critical.

It was the intent of the Founding Fathers to create a new concept of government on the face of the earth by establishing the United States of America. In all of their personal journals, in all of their declarations, and in all of their public debates, they made it clear that the sacrifices they endured and the costs that they risked were not for themselves, but for the generations to come. To proclaim their intentions, they set the motto on the Great Seal of the United States with these words: Novus ordo seclorum, a new order for the generations. This motto currently appears under the Eye of Providence on the primary unit of currency of the United States, the one-dollar bill. What was meant by this motto was that a new opportunity for our children and grandchildren was to be established and forever protected. They were not to be enslaved by debt or future dictators. They were to be in charge of their own destiny.

History is replete with failed governments that disrespected the creed and laws of freedom. If we as a people are to maintain this great experiment of government committed to freedom and prosperity, not just for ourselves, but for our children, it is time to find our resolve to meet the challenges. It is time to face the terms of economic reality.

My name is Marc Nuttle and this is what I believe

What do you believe?

For more information on the Debt Wall and Catch-22, go to: