State Debt Crisis Approaching

I have warned that a debt crisis of a magnitude we have never experienced before is approaching. States and municipalities are going bankrupt along with the Federal government. Economists foolishly applaud sub-3% growth in GDP when it took a $1 trillion budget deficit to produce. There is some serious misunderstanding of the fundamentals of our economy right now, and this is going to create some crazy volatility.

States are in horrible shape; suffice it to say that they are going to encounter a major crisis soon. What people don’t realize is that states received billions of dollars in aid as part of the American Recovery and Reinvestment Act of 2009. The influx of government money encouraged states to ignore structural debt issues. In fact, expenditures in states grew in 2009 and 2010 while general fund spending was down both years. In other words, states revenues have still not recovered to pre-recession levels, which means states have been relying very heavily on Uncle Sam. States have also increasingly turned to the bond market (up over 20% from 2009) to fund their budget gaps. These are nothing more than delay tactics.

In all likelihood there will be cuts in pensions. Citizens may pay lip service to how they want austerity, but when they are faced with proposed reductions in their entitlements, you will see how quickly they change their tune. My best guess is that civil unrest will result with the inevitable entitlement cuts. Think of it this way. Baby Boomers are relying on Social Security, which very conservatively is $10 trillion in deficit. At the same time their government pensions are in danger, Boomers must pay ever-increasing property taxes on their homes, which of course, most Boomers viewed as a savings account. To add insult to injury, the Fed brought interest rates down so low that Boomers can’t get a reasonable return on their savings. All I can say is that Boomers as a whole are going to get hit extremely hard by this crisis. Our government is going about this the wrong way- they should not continue to issue interest-bearing debt in a debt crisis. This is just plain nuts.

In the real world, it’s obvious that anyone whose debt is greater than their income shouldn’t be borrowing anymore.  Anyone in this situation who borrowed money at interest to “stimulate” their finances would be laughed at. The borrower is not getting wealthy, the credit card company is. Why our leaders can’t make the connection with our government finances is quite surprising. Foreigners hold our debt, meaning interest payments are stimulating their economies. Lowering interest rates doesn’t guarantee banks will lend or that people will borrow. During the Great Depression, interest rates fell right with the economy into the abyss. Helicopter Ben is purportedly an expert of the Great Depression, yet he conveniently ignores this fact. Where is the stimulus lower interest rates would bring? Where are the jobs? Is it time we rethought useless theories that are not applicable in the real world?

There is no way out of this crisis because states cannot print their way out of this, only the Federal government can. Every potential outcome of this crisis I have considered is bad. For example, if China listened to the U.S. and allowed its currency to rise relative to the dollar, it would effectively decrease the value of their U.S. bond holdings. In other words, a rising RMB risks a sell-off in U.S. Treasuries, as well as other American assets held by the Chinese. Be careful what you wish for.

I don’t know what else to say except that this is pretty obvious crisis to predict. The government has dug itself into a deep hole, and all the predictions of economists and professionals concerning the effects of stimulus have proven to be dead wrong. The lack of common sense in our country will lead to our downfall. Real estate is still in serious trouble, and this will adversely affect banks and municipalities. The sell-off in the bond market is going to make deflationists look like amateur forecasters very soon, while, of course, increasing the burden of our debt. People are starting to realize what I’ve always said:  the Fed ultimately has no control over the bond market. The foundations of the debt crisis are already very strong. It is only a matter of time before the debt crisis starts wreaking havoc.

Source: State Debt Crisis Approaching