The U.S. Debt Catastrophe Is Closer Than You Think

Richard Robinson's picture

Wednesday, November 8, 2017 - 2:30pm

by Richard Robinson

In 2013, a speaker at an economic summit made a rather remarkable statement. The speaker, a high-ranking government economist, said that if the United States didn't get its spending under control, the government risked a debt-to-gross domestic product (GDP) ratio in excess of 100% by 2024.

The statement immediately drew chuckles from the attendees, most of whom were non-government economists. Of course, most economists knew the government would bypass the 100% level years sooner than predicted. In fact, at $20.4 trillion, the national debt is now 105% of GDP -- just four years after the infamous statement.

Worse, the ratio will accelerate from here. You see, much of the budget sequestration caps enacted in 2011 have been abandoned. As such, the only true limit to the national debt is now a fiscally conservative Congress, which is an oxymoron if ever there was one. 

The Republican-controlled Congress is no more likely to limit spending than Democrats. In fact, the only difference between the parties is the names of the beneficiaries of taxpayer dollars. Democrats like to reward the poverty industry while the Republicans reward the military-industrial complex. But make no mistake: Neither party seems to acknowledge the cliff to which we are fast approaching. 

In fact, now that the 100% debt-to-GDP ratio is in the rear-view mirror, the only real question is how fast we'll get to 200% of GDP and beyond. Unfortunately, we'll get there a lot faster than you think. 

If the 10-year Treasury rate stays exactly where it is now, the national debt grows to more than $35 trillion by 2035. But if the 10-year Treasury normalizes to its historic average of 6.3%, the national debt grows to more than $90 trillion. Of course, that scenario results in a catastrophic debt-to-GDP ratio of 330% -- and a first-class ticket to banana republic status.

But given the idiocy of Washington politicians, it isn't outside of the realm of possibility to reach the 300% level without the need for the 10-year rate to normalize. 

The Threat Is Very Real
There's a movement afoot around the world to wean off the petrodollar. If successful, this movement could prove disastrous to the United States and its ability to fund its massive debts. And without foreign investment funding our fat, stupid, and lazy Uncle Sam, the American economy goes into a death spiral. 

Here's how this plays out...

Global oil imports total roughly 45 million barrels per day, costing roughly $2.7 billion per day (at $60/barrel). The United States and China combine to take about 40% of that, about 18 million barrels daily. But this is just a fraction of the value of the oil futures market.

You see, roughly 1.5 million oil futures contracts are traded on the exchanges every day. And because each contract controls 1,000 barrels of oil, the futures market trades the equivalent of about 1.5 billion barrels daily -- 33 times the amount of oil actually imported globally. All of this trades in U.S. dollars.

But China is looking to change how oil is traded by introducing a Chinese yuan-denominated oil contract. This is a significant move against the dollar's global dominance and reserve currency status.

The yuan-backed contracts enable its trading partners the choice of paying in gold or converting yuan into gold without needing to buy Chinese assets. Of course, this precludes the need to turn the assets into U.S. dollars as well.

And support is strong for the change, especially from countries like Russia, Iran, and Venezuela which can avoid U.S. sanctions by trading oil in yuan instead of dollars.

Here's what this does for China...

Should China be successful in buying its 8 million barrels of oil per day via yuan-based futures contracts, the country would trade the equivalent of 264 million barrels of oil daily. That comes to roughly $3.8 trillion in annual trade. This will devastate the U.S. dollar at a time when the United States needs monetary strength.

With the falling dollar comes higher interest rates for the government bonds desperate to find buyers. And given the sheer volume of bonds needed to be sold by the Treasury to prop up Social Security's $15.5 trillion shortfall -- as well as the roughly $20 trillion (current value) of on-budget debt -- the U.S. government will face a catastrophic financing problem. And it starts in less than a decade. 

Of course, the burden for the sins of the Washington elite falls squarely on those born after 1970. They're the real victims of the incompetence in Washington. And with about a decade before things get really ugly, they don't have any real hope of avoiding the fiscal cliff.

The irony in all of this is that a Chinese government committed to a watered-down version of communism outsmarted the pseudo-intellectual elites in Washington. They've accomplished what no other nation on earth could do militarily. And there's almost nothing we can do to stop it. 

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does not personally hold positions in any securities mentioned in this article.
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