October 2004 TeraDime Newsletter

Topic: Vote Early and Often!

Now that the presidential debates are over and the �well-informed� have declared the latest winner � Kerry or Bush depending on whether you watched the debates on CNN or FOX � we can discuss their economic platforms in an effort to pinpoint who will be better for our economy going forward.� The answer, you�ll come to see, is simple: they are both equally bad!� The only economic questions we, the taxpayers, should focus on at this point are related to our ever-growing debt:

1 When are we going to pay for it � next year, two years from now, or ten years from now?

2 How are we going to pay for it � will we be facing the further devaluation of the dollar, heavy inflation, the crash of the real estate and/or stock markets, or all of the above?

To start with, please do not believe that the deficit problem was caused by the Bush tax cut alone, nor that rolling back tax cuts on people who make over 200K a year will fix the problem.� This tax adjustment is like putting a band-aid on when surgery is needed. �Most of the people making over $200K are already paying the Alternative Minimum Tax (AMT).� The AMT is a separate, somewhat convoluted, calculation of one�s total tax liability.� If the AMT is found to be higher than the tax liability calculated on Adjusted Gross Income, the AMT becomes the individual�s overriding liability.� Say that I calculate a liability of $10,000 owed in taxes, but the AMT calculation came up with $15,000, than my liability is now the latter and I owe Uncle Sam an addition $5K.�

Kerry�s adjustment won�t matter to the majority of taxpayers in this group and both candidates know it. �The real problem is spending. �Congress is writing spending bills left and right, and the president continues to sign them as though it were going out of style.� Our �conservative� president is forced to sign every bill to keep the war in Iraq going, and his opponent is labeled, �the most liberal on Capital Hill.�� To support a third of Kerry�s proposed initiatives, what makes you believe he can possibly stop spending?� Oh, that�s right�he said it on TV, therefore it must be true. J

The only way to pay down the debt and reduce the budget deficit is to stop spending, stop passing bills that give subsidies to farmers and corporations, and stop satisfying every lobbyist and special interest group in Washington.� Reform Social Security and face the reality � we are broke.

Let�s analyze why deficits are bad for the economy. �The deficit is just like spending on a credit card. �As long as you make the minimum interest payment at the end of the month, the lenders remain happy.� This continues to hold true even while it becomes more difficult to make that minimum payment.� The lenders continue to lend until you cannot pay the interest.� In the case of our Federal government, the lenders are other governments and investors who hold U.S. bonds.� Every year that the budget is not balanced and the government continues to have a budget deficit, the amount of the deficit gets added to our overall debt.� The balance of debt becomes larger and larger, as does the interest payment.� Due to year upon year of budget deficits, we are getting to the point now where the federal government is borrowing money just to pay the interest!� Yes, borrow from Peter to pay Paul.� Not a very smart way of running the financial affairs of a State.� So, what is our budget deficit this year, what is our debt balance, and why the promises from both candidates, to cut the budget deficit in half over the next 4 or 5 years, is just not good enough?

v The projected budget deficit for Fiscal Year 2004 is: $412.55 billion�

v The total debt accumulated over the years: $7.385 trillion

Let that sink in a moment � trillion equals a great deal of money!

Now for a little 4^th grade math:� The candidates promise to reduce the budget deficit (not the debt) in half over 4 years.

Fiscal Year 2004 deficit = $412 billion (from above)

In 4 years, the budget deficit = $206 billion

Assuming an equal reduction of the deficit every year over 4 years, divide $206 billion by 4. This results in a $51.5 billion reduction per year. Let�s assume that our future president does better than promised and reduces the deficit by $52 billion every year � Seriously, what�s $500 million among friends?

So,

2005 budget deficit will be = $412 billion � $52 billion = $360 billion

����������� 2006 budget deficit will be = $360 billion � $52 billion = $308 billion

����������� 2007 budget deficit will be = $308 billion � $52 billion = $256 billion

����������� 2008 budget deficit will be = $256 billion � $52 billion = $204 billion

The U.S. debt over the next four years will therefore increase by $360BB + $306BB + $256BB + $204BB = $1.126 trillion.� This is the increase in debt that both candidates have promised us.� Yes, you are reading this correctly � we�ve been promised not a decrease in debt but rather an increase!� In 2008 our total debt will be:

$7.385 trillion (current balance) + $1.126 trillion (promised increase)
= $8.511 trillion!!!

Let�s take another look at it: 8,511,000,000,000.00

But the absolute values (even large ones) do not truly tell the whole story.� After all, you may think that a $1,000 balance on a credit card is insurmountable if you bring home $10,000 a year in income (debt makes up 10% of income).� However, it is not nearly as large a balance if your income is $100,000 a year. In this case, $1,000 debt is only 1% of your income and should be quite manageable.

The U.S. current debt is $7.385 trillion (i.e., U.S. credit card balance).� Our Gross Domestic Product (GDP) or national gross income is around $10 trillion.� Therefore, our debt is representing about 70% of our gross income. �The net income that our government collects in taxes is only around $2 trillion dollars a year.� Out of this, $1 trillion is being collected for Social Security and Medicare (the FICA and Medicare lines on your paycheck stub).� This leaves $1 trillion for general spending such as Homeland Security, the war in Iraq, payment to �poor� countries for HIV prevention, No Child Left Behind, and paying interest on $7 trillion of debt.� For the sake of argument, we can say that a typical U.S. family, in addition to credit card debt, has a mortgage that is often greater than 2 times their income.� However, this comparison isn�t valid because the debt from a mortgage is secured by the real estate � something that has a relative value!� Real estate is something physical that you can touch and can live in for the next 40 years.� Several decades ago this country and all other countries with convertible currency secured the currency through gold.� The only thing securing U.S. debt now is the �full faith and credit� of the U.S. government.� Simply stated, people trust that we will pay them back.� On a side note, a similar trust clause exists in the tax code as well.�

So, let�s recap: $7.385 trillion is our credit card debt; $10 trillion our gross income; and only $2 trillion our net income, half of which goes directly to Social Security/Medicare.� The $7.385 trillion debt is therefore 738.5% of our net income.� Imagine a credit card balance that is 700 times larger than what you take home! �I wonder what kind of credit score we, the United States of America, might be given�

But this is not where our problems end; think about the annual interest owed on that balance?� The good news is that the government can refinance at any time without paying closing costs � it�s good to be the king. J� But even if we assume that the government is financing this entire debt in 5-year bonds (similar to a 5-year ARM mortgage) at 3.5%, the interest on the $7.385 trillion balance this year comes to a whopping $258 billion!� What may interest you more than any other political commentary is that more than half of this year�s budget deficit is due to the interest on our debt!� We spent a combined $120 billion from the warfare in Iraq and Afghanistan.� Politicians please wake up and stop spending! �We are broke!� �

How would you like to end this increasing level of borrowing and end the creation of new debt to pay off the original debt?� Ah, now for the �Catch-22�: ��

1) Raise taxes and cut spending.�� The result will be an economic recession. The stock market will go down and unemployment will go up.� No politician who is looking for longevity will possibly walk this path.� The bond market stays strong in this scenario, however, because foreign governments/investors believe that this country will take drastic measures to pay off the debt.

2) Keep interest rates artificially low below the point of inflation. �This is focused on real inflation, not the one that Greenspan is talking about; but rather the one that you feel every day.� The low interest rates are offset by a slowly devaluing dollar. �Sooner or later, people will realize that even though long and short-term interest rates are low (because China and Japan are recycling their surplus dollars into our government bonds by buying U.S. treasuries each and every month) the real buying power of the dollar is falling.� How can you personally see this effect?�

The price of Gold went from $280 to $420 over 3 years.� That is a 50% increase in the price of gold in dollars.� The Euro went from 85� for 1 Euro to $1.20 for 1 Euro.� What you notice is that the cost of goods from Europe went up by 41%.� You wouldn�t feel that pinch when you buy a BMW, but that�s because it is actually made in the U.S.; you would, however, feel it when you buy something that is actually made in Europe.� The price of oil in dollars went up from $30 a barrel to $54 a barrel � an 80% increase. This can obviously be felt because we do not make the oil here, so we have to pay for it with money that is losing value by the day. �

This is called �monetizing� the deficit, effectively raising prices by devaluing the currency.� In this situation U.S. stocks will go down, hopefully slowly, until people wake up one day and realize that they have been fooled.� The stock market suddenly drops and helps send the economy into a recession.� Politicians will then organize a commission, spend three years researching the problem and analyzing the results, pass 20 different bills and then blame the Federal Reserve.� Hopefully, for Greenspan�s sake, there�ll be someone new at the helm to take the fall.� The problem, ladies and gentlemen, is not Greenspan, but the Congress and President who continue to pass spending bills.� Remember, Greenspan does not create debt, Congress does; Greenspan and the Fed just have to deal with it.

3) Print more money and pay off debt.� Only the U.S. government can do this.� Interest rates on long-term debt will sky-rocket because foreigners will stop trusting us.� They will initially dump the U.S. long-term bonds, and follow that with not buying any new bonds.� This resolution will prevent us from borrowing for the next decade and will truly be on par with the Russian and Argentinean way to beat bankruptcy.� (It�ll be something to tell your grandchildren about)� Some Harvard economist will right a book and get the Nobel Prize in Economics.� Seniors in this country are going to get wiped out because they are major holders of government bonds.� They will wake up one morning and the value of their portfolio will be cut in half. �They�ll still receive the 4% interest on their holdings, but the inflation rate will have jumped to 12%.��

So, what can the politicians really do? �Keep taxes low, stop spending immediately, and cut subsidies to corporations and special interest groups.� Further, it is time to tell China that we will not trade with them unless they stop �pegging� their currency to the dollar.� Unfortunately, for those affected, we�ll have to stop promising healthcare for every American and prescription drugs for every senior � we simply cannot afford it.� This will hurt, but it will prevent the collapse of this great country and its teetering economy.

Generation X, it�s time to wake up!� The baby boomers screwed us big time!� On top of this debt we will have to pay for their social security, which is a separate, but equally big political topic. �Our goal is to leave this country in a decent shape for Generation Y.� If we do not pay baby boomers debts now, the next generation should rightly punish us by not paying into the Social Security system.�

Now, if you are still undecided, go make up your mind and don�t forget to vote on November 2^nd.� Let�s all hope that I am wrong.