Lear Capital: Where's The Can? - Part One

by David EngstromDecember 05, 2014
Where's The Can?

Excuse me!  Where’s the can?  No not the one down the hall and to the right.  I’m talking about the can the media was talking about for two years after the last debt crisis.  You know . . . the Debt Can!

Day in and day out the media warned us that adding to our debt through massive stimulus was not solving anything.  All it was doing was kicking the can down the road.  A road that would some day come to an end and bring with it another debt crisis even bigger than the one that nearly wiped out the free world.  We all heard it.  The media canned the phrase.  It wasn’t something dreamed up by someone like me, nor was the warning. 

The last crisis was triggered by $10 trillion of debt.  Now our debt just blew past $18 trillion and while it is said stimulus has ended, the damage has already been done.  So, where’s the can now? No one talks about it anymore.  As though there was never anything to worry about.  Do you know where the can is?  I know where it is and I know where the road ends.  Follow along and I’ll show you.

As we begin our journey, let’s stop at the Government Unfunded Liability window to check our balance.  Unfunded Liabilities are just what they sound like.  Liabilities with no funds to back them.  Have you ever tried to borrow money without any equity to secure the loan?  Let’s be clear.  Unfunded liabilities are debts with zero equity to back them.  Some would argue that cash within these unfunded accounts has been invested into Treasury Securities and are backed – at least in part.  I guess I would concede that point.  Unfunded Debt is indeed backed by debt.  Interest is even paid into the unfunded accounts in order to meet the debt obligations.  But, who pays the interest?  Herein lies Clue #1 as to where the can is today.

The Unfunded Liabilities of our government include Social Security, Medicare and Medicaid.  Money borrowed from taxpayers and expertly invested into Treasury Securities to secure our future - after we get our gold watch. 

Now we can check our balance.  Keep in mind different sources give us slightly different balances but the one I refer to shows our current balance to be $115.8 trillion dollars.  (This amount is likely most subject to dramatic change as upcoming budget cuts related to health care affect debt estimates.)  It breaks down like this.  Let’s start with Social Security.  Some believe this is the largest of the three unfunded liabilities.  Sorry, it actually comes in at number 3 with a balance of $15.2 trillion.  Let’s move on to Medicaid or as referred to, Prescription Drug Liability.  That comes in at $20.2 trillion.  Now on to Medicare.  Clearly, it is the largest of the unfunded debts coming in at $80.4 trillion and rising. 

Disclaimer:  These numbers change rapidly.  Today’s numbers are only a snapshot taken at the time of this writing.  

Here’s the real shocker.  Today's indicators show this debt is growing by $8 million dollars a minute.  That’s a half billion dollars an hour, $12 billion dollars a day.  If my math is correct that’s more than $4.3 trillion a year.  Bringing it to a more personal level that’s a $988,000 liability per taxpayer.  The total of taxpayers is 117.1 million with husbands and wives generally counted as 1 taxpayer.  I think we can all agree, this debt will never ever never be paid back.  Clue #2.

The two largest Federal Budget Items are interest payments on Medicare/Medicaid liabilities and Social Security.  If I take a snapshot of the projected total of interest to be paid against Unfunded Liabilities, that number today is $1.685 trillion.  Let’s backdrop this number with the total of tax revenue collected by the Federal Government of $3.1 trillion annually, based on our snapshot of today’s debt picture.  More than half of the money we collect goes toward payment of these debts.  Clue #3

Time to move on to the next debt window and check another balance – Federal Pension obligations.  Like the Unfunded Liabilities, this is obviously a debt.  It is owed to anyone who has retired from Federal Government service.  Why they don’t call it “Unfunded” is peculiar to me as all of our debt is unfunded.  The total of debt (whatever that is) is lumped into our National Debt which just surpassed the $18 trillion mark.

With the dubious honor of being one of the top six Federal Budget items, Federal Pension obligations currently account for $247 billion of our annual budget.  When added to the $1.685 trillion of interest paid against unfunded debt, we now account for $1.932 trillion of our annual budget.  Perhaps you begin to see where we are headed.  Let’s move on.

The top six federal budget items include the three just discussed plus spending on Defense and spending for Income Security.  Without going into great detail, Income Security is essentially Federal Welfare to include such things as food stamps, federal unemployment benefits and other family support programs.  These two budget items would not be considered interest payments.  These expenses can be cut at any time with generally no future unfunded obligation on the books.

This now brings us to the next debt window and item #6 amongst the largest budget items - Interest on Debt.  It is this amount which is often referred to in discussion about the state of our budget.  That amount is $267 billion and it represents just 1.48% of our total debt. (remember this number may change as debt is continually refinanced)  It is claimed to be small and manageable, yet, even at the low borrowing rate of just 1.48% this amount represents 55% of our current budget deficit.  Clue #4

Now considering the $267 billion interest payment on our National Debt, the total of interest payments now being made against all debt – both unfunded and current – is:


Unfunded Liabilities……………..     $1.685 Trillion

Federal Pensions………………….      $  247 Billion

Interest on National Debt……      $  267 Billion

Total Interest On All Debt...       $2.199  Trillion


Now it’s time to reset our perspective on our debt.  It’s not just the $18 trillion spoken of by the mainstream, it’s really a combination of National Debt and Unfunded Liabilities.  Let’s do the math:


National Debt ………………………     $18 Trillion

Unfunded Liabilities ……………..   $115.8 Trillion

Total Debt Obligation ………….   $133.8 Trillion


An interesting correlation is now developing.  We have already established that our $18 trillion of National Debt appears to be financed at a 1.48% rate.  A simple calculation tells us our unfunded debt is being financed at a 1.67% rate.  All of this debt is being financed through the issuance of Treasury Securities.  The correlation between the rate of interest being paid on these debts and current Treasury yields is amazing.  I took another snapshot of today’s treasury markets and for illustration sake looked at the 2 Year Treasury, the 5 Year, the 10 Year and their respective yields.   - .65%  -  1.69%  - 2.31%

For the sake of argument, let’s say our national debt is being financed via equal distribution between these notes.  Of course there are shorter and longer term notes with higher and lower yields than those chosen for this illustration.  If equally distributed, the average yield (interest paid) on these notes would be 1.55%.  Final Clue #5

It should now be clear how much our true debt is and how it is financed.  Equally clear should be just how vulnerable our entire financial system really is and how close we are to a crisis of Pompei-like proportion.  With the Fed now retired from its bond buying job, Treasury prices must now adapt to less demand.  Less demand means lower prices and higher yields. 

Today the 2 Year Treasury Note yield hit a 52 week high.  Nearly double what it was in October.  God help us if the majority of our total debt was financed 2 years ago with 2 year notes.  Chances are, at least some of it was and now rates are double what they were then.  The Five Year and 10 Year also spiked higher today.  While the Fed mutters threats to raise key interest rates, rates are rising on their own due to normal laws of supply and demand.  Less Fed demand equals more supply, lower prices and higher yields.  Some believe, however, the Fed never really stopped stimulating.  We will keep an eye out for such evidence.

Have you found the can yet?  The can is $2.2 trillion down a $3.1 trillion road.  The end may seem far enough off but it is being kicked at a faster and faster rate.  The current rate of interest being paid to service the total of Unfunded Debt and National Debt is indicated at 1.64%.  This is the key – Interest Rates!  What happens when today’s rates rise just 20% or 40 or 75?  What happens if they double?  We can now predict when the can will reach the end of the road.  Follow along if you dare.  The path is charted.  The starting point is $133.8 trillion of debt financed at a 1.64% interest rate.  As the interest rate rises, the debt service obligation rises in direct correlation.


Debt                      Interest Rate               Increase                 Total Interest Payment

$133.8                    1.64%                                                           $2.199 Trillion

                                1.97%                          20%                         $2.639 Trillion

                                2.13%                          30%                         $2.859 Trillion

                                2.29%                          40%                         $3.078 Trillion

Road End                2.31%                           41%                           $3.100 Trillion  


Even I was stunned.  If interest rates rise just 41% (67 basis points) from where they are now, we reach a point where every dime we collect in taxes goes toward paying just the interest on our real debt.  This number also correlates to the dollar amount of interest paid per our our snapshot ($2.199 trillion) against $3.1 trillion of revenue.  Critics will say, “but our economy is growing and tax revenues are rising.”  My answer to that is, “And so does our debt.”  As you recall today's indicators show our debt is rising at an incredible rate of $12 billion per day.  It rises faster than I can write.  In just 30 days, the 133.8 trillion turns into $134.16 Trillion.  In 180 days $135.96 Trillion.  Oh and I forgot one thing.  Dang!  According to some sources, there is a new Unfunded Liability – HEALTH CARE!  $9 Trillion worth!  Screws up my whole chart.  Too late now.  We will have to go with the numbers shown.

So, while the chart to the end of the road ignores the potential for higher tax revenue, it also ignores the acceleration factor of rising debt.  Still think the Fed is going to raise interest rates?  What would just a .25% increase do to bond prices?  What would it do to the economy?  If lower rates stimulate the economy it must be so that higher rates slow it down.  Oooops!  There goes that higher tax revenue theory.  While some yearn for, even call for the return of more normal rates of 4, 5 or even 6%, the Fed quakes in its boots at the thought.  Now we know why.

That leaves all of us with two choices.  Hope is choice one.  We can hope taxes go up.  Don’t worry, it gets worse.  We can hope rates go even lower.  But, how does the Fed go lower than ZERO?  We can hope market forces, force rates down.  Possbile but not likely!  Even at today’s low rate of inflation, any investment into bonds produces a negative real return.  And our last hope, we can hope the Fed intervenes again and creates more demand.  Then watch inflation fly.

Hoping is not an option.  Time to take control.  There’s only one can you can’t kick down the road.  That’s a can filled with gold and silver.  If inflation soars, gold and silver can soar along with it.  If higher rates destroy the economy and the markets, gold and silver can become priceless.  All of a sudden those forecasts of $100 silver and $5,000 gold don’t look so far-fetched. 

No one knows the day or the hour the can gets kicked to the end of the road.  It is difficult to know the maturity dates of the combination of bonds used to finance the current debt.  All we know for sure is to watch the signs and get prepared now!  That’s what the banks are doing.  I will tell you how in Part Two.

As always, some of what I write are my opinions.  I let the facts speak for themselves.

If you dare, follow me @DaveTheGoldDr


Disclaimer:  Data for this writing have been drawn from information provided at usdebtclock.org.  It changes rapidly and is subject to revision.                            


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